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Subex charts recovery path after disastrous acquisition

Subex charts recovery path after disastrous acquisition
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First Published: Tue, Jan 26 2010. 10 15 PM IST

Expensive deal: Subex founder Subhash Menon says the firm had fallen off the cliff after the buy.
Expensive deal: Subex founder Subhash Menon says the firm had fallen off the cliff after the buy.
Updated: Tue, Jan 26 2010. 10 15 PM IST
Mumbai: Subhash Menon, chairman and managing director of Subex Ltd, is trying to turn around the company he founded after a disastrous acquisition in 2007-08 almost tipped the firm into bankruptcy.
The strategy appears to be working. On 19 January, the Bangalore-based telecom software maker declared a profit of Rs41 crore for the December quarter compared with a Rs16 crore loss a year earlier.
Expensive deal: Subex founder Subhash Menon says the firm had fallen off the cliff after the buy.
Menon, who spoke to Mint in two sessions (before and after the results were announced), admitted his company had “fallen off the cliff” after it acquired in March 2007 Syndesis Ltd, a Canadian telecom software firm, for $164 million (around Rs760 crore). The purchase, the company’s seventh, was funded through $180 million of foreign currency convertible bonds (FCCBs) maturing in March 2012.
The acquisition turned bad at the height of the financial crisis in 2008, when Syndesis clients failed to place orders as expected, making it look overpriced and pulling down the Subex stock, which was beaten down to as low as Rs18 in mid-March 2009 from an all-time high of Rs803 in mid-January 2007.
Menon’s memories of the time are predictably sour. “Many (investors) behaved badly,” he said. “Shareholders who gave bouquets earlier gave brickbats instead.” For a company once regarded as one of the most promising software plays, the decline was precipitous. Menon’s rehabilitation theme is still to catch up with some of its erstwhile champions.
An equity analyst at an institutional brokerage said coverage of Subex had stopped because it “did not see much value in the company” and the management was not “really transparent”.
A sore point with investors and analysts, gathered from transcripts of analyst conference calls available on the company website, was that Subex did not hire independent valuers to assess Syndesis. The Canadian firm, with an annual revenue of $42 million, had been acquired at four times revenue. “Back then, it did sound a little expensive, but the way things unravelled, it does sound very expensive now,” said Dipen Shah, vice-president, research, at brokerage firm Kotak Securities Ltd.
Admitting that valuations had been arrived at internally, Menon defended himself, saying independent consultants such as Deloitte Touche Tohmatsu had been hired to conduct due diligence on the firm’s financials.
Revenue at Syndesis, projected at $50 million for the 2008 fiscal, turned out to be half that. The FCCBs that were due for conversion into equity by March 2012 at Rs656 a Subex share, or redeemed at a total $245 million, accentuated the distress.
“There is an element of risk and an element of luck,” Menon said. “Between the due diligence and the acquisition, there were some six or seven months, and many things can happen in two quarters.”
Menon, who started Subex from scratch with Rs20,000 in 1992, decided to approach FCCB holders with a fresh proposal to scale down debt exposure.
“It was give and take,” he said. He offered a conversion price of Rs80 a share and a proposal to reduce the face value of the FCCBs by 30%. Around 80% of the FCCB holders agreed, giving Subex some breathing space.
Menon said the period was much worse than the rough patch Subex went through during the 2001-03 dot-com bust. One thing he’s learnt the hard way—never borrow to buy. “The learning is that a software company should essentially use equity for acquisitions,” Menon said.
All six buys made before Syndesis had been funded through equity and internal accruals. All had been small firms except the sixth one, Azure Solutions Ltd, which whetted Menon’s appetite for big-ticket acquisitions.
The purchase of Azure for $140 million in July 2006 had been touted then as the largest overseas acquisition by an Indian infotech company. For a brief period after that, the company even came to be known as Subex Azure. Azure had annual revenues of $31 million at the time of the acquisition.
One of the criticisms levelled by analysts, which also finds mention in the prospectus issued in November for raising FCCBs, was that Subex is a family-run company and the company is “highly dependent” on Menon and his brother, chief operating officer Sudeesh Yezhuvath.
Further, Subex is also among the companies that have not complied with certain Reserve Bank of India (RBI) norms on raising FCCBs and is liable to be penalized for contravening the Foreign Exchange and Management Act (Fema), 1999.
The central bank, in a letter dated 22 July, said the company had contravened guidelines and asked it to apply for compounding under Fema. This involves settling the offence “through imposition of a monetary penalty without going in for litigation after the contravener acknowledges having committed the contravention”, according to the RBI website. The company’s response to this—asking the central bank for compounding—is currently pending with RBI.
Following the management’s bid to clean up its balance sheet, it reported a Rs74 crore profit for the nine months ended December, which includes foreign exchange gains as a result of restating FCCBs in view of the appreciating rupee. That compares with a year-earlier loss of Rs153 crore.
Sales, however, fell to Rs120 crore from Rs160 crore, while operating profit (before taxes, interest, depreciation, amortization and exceptional items) fell to Rs28 crore from Rs34 crore.
To get to where it is now, Subex underwent some “drastic cost-cutting measures” that involved shifting work from overseas to India and making the necessary job relocations. According to Menon, Subex cut expenses by around 25% in 2007-08 and an additional 10% in 2008-09.
Menon, who spent much of last year troubleshooting, meeting bankers and investors and not “shying away”, said the strategy helped convince investors such as Birla Sun Life Trustee Co. Pvt. Ltd and the government of Singapore to stay put.
Some analysts acknowledge the effort.
“The biggest challenge at this point would be to scale up the sales machinery. They did some serious cost cutting in the recent months and I hope that they haven’t cut back on their sales force,” Kotak Securities’ Shah said. “From the commentary that we are hearing from the larger IT (information technology) players, the telecom vertical is slowly reviving, so hopefully Subex should benefit from that.”
Menon, who had a 12% stake in the company prior to the FCCB restructuring, will see his ownership stake coming down significantly if all bond holders convert their debt into shares.
The founder said he plans to buy more shares to increase his stake without specifying how he’s going to do that. At the same time, almost 60% of his 12% stake is pledged with lenders to the company—not, he said, for his personal benefit.
The reduction in the conversion price to Rs80 will mean that the equity capital will get diluted. Already, some bond holders have taken advantage of the recent spike in the share price by converting the bonds into equity and selling it in the open market.
Barclays Capital Mauritius Ltd sold 385,000 shares on 12 January at Rs90.98 apiece and 250,000 shares at Rs78.18 each on 13 January. Credit Suisse (Singapore) Ltd sold 338,000 shares of Subex on 12 January at Rs80.38 apiece.
Some investors still believe in Subex. Morgan Stanley picked up a 6% stake in the company on 18 January by converting bonds into shares.
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First Published: Tue, Jan 26 2010. 10 15 PM IST
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