Strange premium

BS Compass

The impact of Digital's merger with HP's software services arm is critical

A rally like the current one can do funny things to stock prices. Take, for instance, the Digital GlobalSoft stock, which had plunged to Rs 360 from the Rs 500 levels on the disappointment of the merger ratio with HP's software services arm in India, HPISO. The stock now trades at Rs 550, 10 per cent higher than the levels prior to the announcement of the merger.

HPISO had been valued higher while calculating the merger ratio, despite the fact that its revenues were half that of Digital's. True, HPISO is slowly changing itself into a profit centre from a cost centre.

According to analysts, new projects are being done at bill rates comparable to Digital's and new staff is being hired at lower salaries that are comparable to the pay scales at Digital.

But one still doesn't know for sure what impact the merger would have on the company's FY05 EPS. Moreover, billing rates could be revised downwards by HP, since it would account for over 87 per cent of the merged entity's revenues.

Since these concerns still remain, it's strange that the Digital stock now quotes at a premium to its levels prior to the merger announcement.

Ideally, one now needs to look at the combined entity's results and Digital's standalone results don't hold much significance. Nevertheless, since the merger has still not been effected, the company gives only the stand-alone results.

For the September quarter, Digital's revenues grew 6.91 per cent sequentially and almost 95 per cent of the incremental revenues came from HP.

Besides, a big chunk of business moved offshore - the share of offshore revenues jumped to 48.8 per cent last quarter compared to 44.3 per cent in the June quarter. Surprisingly though, operating margin fell 140 basis points.

According to the company, utilisation dropped from 82 per cent in June to 80 per cent. Besides, the share of revenues from the Middle East and other Asian countries (where billing rates are lower) increased last quarter, which also hit margins.

On the positive side, the company added 1,200 employees in the September quarter to add to the 750 employees it had added in the June quarter.

So far this fiscal, the company has increased its workforce by a whopping 78 per cent, which points to a bullish trend in volumes. But it's the outlook on pricing and the financial performance of HPISO that would hold the key for the stock going forward.

Indo Gulf

The impact of a good monsoon is there for everyone to see in Indo Gulf's performance for the September 2003 quarter.

Despite a plant shutdown in July, topline grew 37 per cent. The crucial considerations for a fertilizer company are the operating profit and the interest outgo due to the high levels of working capital.

While interest outgo has remained stable (minimal by industry standards), operating margins have shrunk almost 500 basis points compared to the same period last year to 20 per cent.

This is due to the decline in inventories by 73 crore compared to Rs 13 crore in the corresponding quarter. This implies that inventories possibly built up during the previous quarter were sold in the market.

However, despite a shut down during the quarter, raw material expenses including inventories jumped from 41 per cent of sales to 58 per cent of sales, whereas the shut down is reflected in the 43 per cent decline in power and fuel costs for the quarter.

Notwithstanding the monsoons during the first half, the full impact should be seen in the second half of the current fiscal. The company is currently accounting for sales of urea on a provisional basis, any finalisation of the retention price under the new Group Concession Scheme will result in an adjustment with retrospective effect.

Apart from the buy-back by the company, the huge cash inflow of prior period subsidies from the government of Rs 180 crore in FY03 has also been the basis for investor interest in the stock.

Going forward, while offtakes are expected to improve in the second half of the fiscal, a driver for the stock will be any newsflow on account of divestment of the fertiliser companies such as NFL and RCF.

With contributions from Mobis Philipose and Sameer Ranade