Wednesday, December 31, 2014

RS Software - Review from 23 Apr 2014

The RS software review from April 23, 2014. The stock has run up quite a bit since then. May be still decent to buy but the margin of safety is ZERO which makes me fearful so I am ambivalent.


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RS Software

A payments processing IT services company.

1. How good is the moat?

B+ Grade
  • Brand: Brand might not be much but in India this is one of the few companies doing the IT infrastructure for payment processing systems. Typically tenure is important in the payment processing space as the protocols and ability to take risk is lower. Which is why I believe that competition will be touch. Large companies like TCS, Infosys, etc have practices in this area as well but probably are not as focused.
  • Product replication: Replication for a new entrant is harder because of the risk involved in a new player and the requirement for six sigma beating reliability.
  • Sales and distribution - not big advantage here over the big guys.
  • Vendors - not great moat here.
  • Employees - there is a lot of focus on employees. In fact the average compensation per employee is far higher than TCS or Infosys at 20L/year. There is a RS Software employees welfare trust (RSSEWT) that owns stock in the company. The idea behind the trust is noble although the company is rapidly giving loans to the trust and I don't understand why.
  • Performance during recessions - this seems to be fairly recession proof as payment transactions have to be done for the economy to run and rapid improvements are required in the space. There might be some dips but not huge ones.

2. Risks

  • The largest source of risk stems from the loans given the to the RSSEWT
  • Un billed revenue is a large part of the profits - this is always dangerous for a software company but this is included in the trade receivables and those are only 12% of sales which is far better than what TCS is doing.
  • Expenditure in foreign currency in FY2013 is stated as 175 Crores which I don't understand because 175 Crores of FX expendature means that 66% of the cash expenses have been made in foreign currency. That is unlikely as around 70% of the employees are in India. It could mean that the wage difference in the overseas an Indian employees on an average is over 10x which is typically not the case. Typically this number is around 3x which is the PPP adjustment (Purchasing power parity adjustment).
  • Warrants and ESOP dilution - massive % of the company has many times in the past been issued to the CMD of the company after which the price has sometimes risen rapidly (Like in 2009-10)
  • Board composition is weak and heavily in the favor of the promoters. Independence would be good.

3. Financials

  • Cash flow from operations lags net income because of the large loans given to the RSSEWT which is not a good sign. The latest FY2014 financials for the quarter ended Mar 2014 the short term advances have risen by 27 Crores! Which I am currently presuming are again advances to the RSSEWT - which seems to be a way to control the company. As long as it is not a way to swindle the small shareholders it should be fine for a minority investor
  • Net FX earner
  • Stock options dilution - massive dilution happening. Warrants have been issued to the promoter to the tune of sometimes over 10% of the company. Currently the dilution expected due to options and warrants is 6.9%.
  • Dividend % of earnings is rising and is currently at 16% in FY2014
  • Debt is almost zero.
  • Debtors % of sales is excellent at 12% - far better than IT peers

4. Soft factors

  • Promoter shareholding has been rising which is an excellent sign. Even though its due to under priced warrants  (which people might argue were fairly priced at the time they were issued). Currently promoter holding stands at 38.5% in Mar 2014- up from 29% or so in Dec 2011
  • Growth - I think this should continue as the company has done well in establishing itself in the payments space.
  • High conviction positions - Dolly Khanna. She got in Q3 of FY2013:
DateShares%
Mar-14       420,7873.29%
Dec-13       352,7872.77%
Sep-13       293,2572.31%
Jun-13       320,2572.64%
Mar-13       282,3702.33%
Dec-12       191,7231.67%
Sep-12                  -0.00%
  • Corporate governance: CMD comp is not very high at 79Lakhs per year. There is only 1 really independent director on the board - R. Ramraj. He may or may not have been a friend of the management. So overall corporate governance is a big concern.

5. Pricing

  • On the face of it the stock looks cheap at 5.66 times earnings and 1.65 times price to book.
  • There is a lot of cash on the balance sheet in FDs which scares me because its not being utilized and when that happens companies tend to take rash decisions.
  • Overall to me it sounds like a value investment.