Wipro: Two to tango

The deal may be expensive but there are some clear long-term synergies.

Wipro's acquisition of the US-based IT outsourcing company Infocrossing Inc is expensive at a price to EBITDA (earnings before interest tax and depreciation) multiple of 14.3 times CY06 and 12.5 CY07.

At an enterprise value of $600 million, the price to profit after tax multiple is over 70 times CY06 and about 54 times CY07.

Therefore, the deal though positive from the point of business synergies, does not immediate boost the financials. However, the all-cash deal is earnings accretive.

Infocrossing, which hopes to post revenues of between $250 million and $255 million in CY07, a growth of 9-11.4 per cent over CY06, currently has an operating margin of 18.5 per cent lower than that of Wipro's at 26.1 per cent in the June 2007 quarter. The Wipro management claims margins can improve, once the synergies are exploited.

What Wipro hopes to do is to strengthen its IT infrastructure management business, where it is already well-entrenched. The combined value of the IT infrastructure business will be $500 million and it should be possible to increase this to $1 billion in a couple of years. This it will do by utilising Infocrossing's five data centres in the US.

Wipro hopes to bid for bigger outsourcing deals and compete with players like IBM and Accenture which differentiate themselves with the presence of data centres across geographies.

Infocrossing also brings to the table, a BPO presence in the healthcare vertical which would help Wipro grow its healthcare business that currently contributes less than 5 per cent of revenues.

At the current price of Rs 459, the stock trades at just under 20 times estimated FY08 earnings and 17 time FY09 earnings and is reasonably valued given the potential for offshoring.

GSK Pharma: Sales pinch

The revenues of the key pharmaceuticals division of GlaxoSmithKline Pharmaceuticals grew 5.2 per cent y-o-y in the June 2007 quarter, which were below expectations.

Analysts point out that this lacklustre sales growth could be partly attributed to a shift in Glaxo's strategy - from purchasing traded goods to manufacturing on a loan and licence basis, which was necessitated by changes in excise regulations.

As a result, operating profit grew 4.8 per cent y-o-y to Rs 143 crore in the June 2007 quarter compared with 0.55 per cent fall in its total operational income (including other income for clinical research done for its parent) to Rs 416.26 crore. Other income amounted to Rs 20.65 crore in the June 2007 quarter, a y-o-y growth of 83.4 per cent.

However, Glaxo's results of the June 2007 quarter are not strictly comparable with a year earlier, given the sale of its animal health business on July 31, 2006 for Rs 207 crore to Virbac. Other MNCs such as Pfizer's operating profit margin declined 60 basis points y-o-y to 24.1 per cent in the quarter ended May 31, 2007.

Glaxo had launched Arixtra (Fondaparinux), a medication used at the time of hip fracture, in the last quarter and the company is expected to launch three new medications in CY08. However, new launches typically lead to increased marketing expenditure and put pressure on margins, point out analysts.

In addition, Glaxo has also sold its fine chemicals business, which forms part of the other business segment, for Rs 240 crore to Thermo Electron India.

The fine chemical business was estimated to provide 8 per cent of net sales in CY06, or approximately Rs 124 crore, say analysts. This disinvestment will enable the company to focus on its key pharmaceutical business. At Rs 1211, the stock trades at 25 times estimated CY07 earnings, and is attractive considering the new launches from the parent's portfolio.

Hindalco: Weak realisations

Hindalco's performance in the June 2007 quarter was affected by weak alumina prices on a y-o-y basis, coupled with a rising rupee which curtailed realisations of both alumina and aluminium in local currency.

A small cushion for margins was provided by its copper division, thanks to stronger treatment and refining charges (TC/RC) on a y-o-y basis in the last quarter.

As a result, operating profit fell 5.3 per cent y-o-y to Rs 884 crore in the last quarter, while net sales expanded 9.45 per cent to Rs 4678 crore. Its operating profit margin fell 290 basis points y-o-y to 18.9 per cent in the last quarter.

Meanwhile, Hindalco's alumina production rose 1.1 per cent y-o-y to 302,430 tonne in Q1 FY08. However, alumina prices were estimated at $352 a tonne in the last quarter, a decline of 36 per cent y-o-y. Its primary aluminium production was also up 8.3 per cent y-o-y to 116,169 tonne in the last quarter, helped by a successful ramp-up of phase-I at Hirakund.

No doubt, average aluminium prices were $2,762 a tonne in the last quarter, a rise of 4.1 per cent y-o-y, but the rupee has appreciated nearly 7 per cent sequentially. As a result, segment profit of the aluminium division fell nearly 10 per cent y-o-y in the last quarter.

In its copper division, Hindalco's copper cathodes output rose 22.5 per cent y-o-y in the last quarter, while continuous cast copper rods production rose 25 per cent. Of crucial importance, is that its TC/RC margins were estimated at 31.2 cents per pound in the last quarter, as compared to 28.8 cents per pound a year earlier. As a result, segment profit of copper division rose 14.8 per cent in the last quarter.

However, the company's TC/RC margins are likely to be under pressure over the next few quarters on account of tight global supply of copper concentrates.

Hindalco has also completed all the requirements related to the acquisition of Canada-based Novelis, and the Street will be focused on how quickly the profitability of the overseas company can be improved. At Rs 157, the stock trades at about 10 times estimated FY08 earnings.

With contributions from Amriteshwar Mathur and Shobhana Subramanian