Sunday, March 30, 2014

Tata Elxsi - high tech history but lots of uncertainty

TATA Elxsi was formed in 1989 and has Subramaniam Ramadorai in common with TCS. It was setup as the Indian arm to manufacture multi-processor based computers. Wikipedia claims that the TATA group was a venture investor in Elxsi in the US as well.

The company does 2 things - software development & services and systems integration. Over 90% of the revenue comes from the software development & services division. I fail to understand how this company does not have a conflict of interest with TCS. Even though the company claims it is the embedded product design arm of the TATA group (77% or so of the revenue of the company is in this basket) - TCS does the claim to do something similar in the TCS Embedded Systems group.

There are some reports about Madhukar Dev saying that they should be at a 40% growth rate by FY2015-16 and that TATA Elxsi is a focus area for the TATA group.

1. How big is the moat?

Grade C moat
  • Brand: Maybe it is a brand in the embedded systems area but I get the feeling that most of the brand is in the TATA name for this company. Current customers include TATA Motors, Taj group of hotels, and the Indian motion picture industry - films(for animation and special effects).
  • Sales and distribution - I don't understand how this company is going to compete with its parent/sibling TCS.
  • Employees - Tata elxsi does seem to have a good team but nothing that the other software companies cannot replicate or don't already have.

2. Risks

  • Erratic sales pipeline could lead to lots of fixed costs such as the team
  • No real growth plans shared with investors
  • Transparency risk - how do the TCS embedded systems group and TATA Elxsi compete?
  • Customer credit - large debtors risk at 25% of sales
  • Obsolesce risk - the company needs to keep pace with technology as it is in a space where products and services can rapidly become obsolete. Elxsi itself went through that cycle back in the day when its multi-processor based systems didn't really pickup.

3. Financials

  • Cash flow from operations is actually leading net income - which is a rare and excellent sign
  • 19% is domestic business and the rest is export. Falling rupee with definitely benefit this company.
  • Employee cost is 57% in FY2013 compared to TCS at 37%. Pricing seems to a massive issue for TATA Elxsi. Also the employee cost might be rising due to wage hikes in the technology space in India.
  • Dividend % of sales in FY 2013 was 81% or so which is high because the company was trying to maintain the dividend level despite the falling profits. Also it does not seem that this company has any aggressive growth plans.
  • Return on equity in FY 2013 was 11.5% and TTM ended Dec 2013 is around 30%
  • Margins have gone down to 3.6% in FY2013 from 13.9% in FY2009
  • The company has some debt to the tune of 0.81 times Debt to EBITDA but why pay large dividends when the company has to increase its borrowings?
  • Debtors % of revenue stands at 23% which shows almost a 3 months payment cycle and is not a healthy sign.
  • R&D expenses are being counted as intangible assets - The intangible assets on the balance sheet are around 26 Crores. They claim to be amortized over 3 years but nevertheless rising. I find this practice and the fact that this is more than the net profit in FY2013 a bit worrying.

4. Soft Factors

  • The TATA group only owns 45% of this company whereas they own 70%+ of TCS.
  • I have been unable to find the director's shareholding in the company.
  • BSE website shows no insider transactions after 2009
  • Growth - a few good deals could really send the earnings zooming up as most of the costs are fixed and the company seems to be well staffed to take on challenges. Wikipedia claims TATA Elxsi's headcount to be 3500. But as a systematic high probability outcome thing growth may not be so much on the cards here.

5. Pricing

  • Current market cap stands at 1670 Crores with a TTM earnings of 58.5 Cores giving us a TTM P/E of 28.5. That price would be justified if the company grew its earnings at 30% per year for 7 years and 10% a year consistently after that. This is an unprecedented performance from this company and unlikely in my opinion.
  • At this point this is not a value investment.



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