A high price for small growth

A high price for small growth
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First Published: Wed, Aug 08 2007. 01 38 AM IST
Updated: Wed, Aug 08 2007. 01 38 AM IST
The buyout of Infocrossing Inc. greatly increases Wipro Ltd’s presence in IT infrastructure management services and in the health-care outsourcing segment. The question the market is asking is whether Wipro has paid too much. The Infocrossing management has guided for calendar 2007 earnings to be between 43 cents and 52 cents per share, which means the $18.70 (Rs755.48) per share that Wipro is paying for the acquisition values the shares at a multiple of between 43.4 and 36. That is expensive.
True, the deal values the shares at a premium of 13% to the average traded price in the last six months, but then persistent rumours of Infocrossing being acquired, either by an Indian outsourcer or by Accenture, have been in the air for over a year and have helped boost the company’s stock from around $6.60 in November 2005 to the near $18 levels it reached before the announcement of the buyout by Wipro.
Is high growth the reason for Infocrossing’s high price-earnings multiple? If we accept the management’s guidance on earnings per share, earnings growth could range between 16% and 40% for calendar 2007. While the former estimate certainly doesn’t justify the high multiple, the higher estimate does. But a look at Nasdaq stock research data shows that the consensus earnings estimate for Infocrossing’s calendar 2007 earnings is 43 cents per share, or the low end of the management’s guidance. Moreover, the management’s revenue guidance, even at the top end of the range, implies revenue growth of just 9%. And for the March quarter, growth in revenues was a low 5.8% compared with the year-ago period. The projected earnings growth is therefore largely on account of containment in cost of sales and low growth in depreciation, amortization and interest payments. At 2.6 times sales, the acquisition is the most expensive by Wipro so far, although it’s also the biggest.
Nevertheless, the acquisition will certainly help improve Infocrossing’s earnings by increased offshoring and capacity utilization at its data centres, which is around 50% at present. Also, Infocrossing brings in 119 clients and, although there’s some overlap, Wipro will be able to sell its other services to the new customers. Wipro has said that revenues from infrastructure management services will move up to $1 billion within 24-36 months. That’s not really a huge increase, considering that the combined revenues of Wipro from this vertical and Infocrossing’s revenue, were more than $450 million in 2007.
Analysts have been clamouring that the IT majors, which sit on huge cash hoards earning very low rates of return, should step up their acquisitions. Wipro, which had cash and equivalents of Rs5,166 crore as on 31 March, has obliged with two big-ticket acquisitions in the last two months. But the price it has paid has led to a tepid market response.
Tata Steel Ltd’s issue of convertible alternative reference securities is part of the process of wrapping up the financing for the Corus deal. There has been a sea change in analysts’ views on the Corus acquisition, thanks primarily to the fact that steel prices have remained strong. The Tata Steel stock has gone up as a result. However, Tata Steel’s June quarter results have not helped, since the rise in profits owed much to huge extraordinary gains on account of net foreign exchange gains. Shorn of extraordinary items, the company’s profits before tax were up 8.4% year-on-year, while revenues rose by 7.6%, buoyed by an 18% y-o-y rise in realizations.
But, while steel prices are important for Tata Steel, they are far more so for Corus, which has high fixed costs. Tata Steel’s signing of an MoU with Riversdale Mining Co. of Australia to acquire 35% of the latter’s Mozambique coking coal project will tie up captive coal for Corus, thereby reducing costs, although the project is at the development stage and the first coal consignment is still years away.
Far more important is the outlook for steel prices. Vishal Chandak, analyst with Emkay Share and Stock Brokers Ltd, says that consolidation in the industry and lower Chinese exports—the result of a tax on exports—will lead to firm steel prices. Posco, South Korea’s biggest steel maker, has reported a 55% growth in profits in the June quarter. Asian steel stocks have risen to record levels on higher prices of hot-rolled coils. And although steel prices in Europe have eased and inventories increased, prices are expected to firm up later in the year as ArcelorMittal may reduce production. Tata Steel’s convertible issue, at a yield to maturity of 5.15%, conversion at a 35% premium and two times subscription in these turbulent markets, is another indication of the strength of the company.
Write to us at marktomarket@livemint.com.
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First Published: Wed, Aug 08 2007. 01 38 AM IST