Polaris Software Lab - IPO

First Published at Dhan.com on July 27, 1999

After years of deep slumber, the primary markets have shown signs of a minor re-awakening in 1999. And this is entirely due to the almost impregnable euphoria over software stocks. With valuations reaching astronomical levels, it is no surprise that many IT companies find it attractive to sell their shares to the public.

Though this is a danger signal in itself, for the moment there is little evidence of demand being satiated, and investors are riding the wave. For many retail and institutional investors who missed out on the phenomenal gains in the sector, IPOs are a way to get in. The extent of demand can be gauged by the overwhelming response that some of the earlier IPOs managed to get.

Those who applied for shares in Sonata or KPIT saw their holdings more than quadruple in a matter of months. Even the scrips of lesser known companies have shown good appreciation on listing. Sadly enough, this has attracted a number of dubious operators, trying to capitalise on the fancy for information technology stocks. Recent moves by over thirty companies (mainly finance firms) to append software or tech to their names - and the subsequent rise in share prices is evidence of the reality that when investors are willing to be fooled, there are plenty of people only too happy to oblige them.

However, amidst all this chaos, there is one company that appears to stand out amidst the riff-raff. And that is Polaris Software Lab, a Chennai based software company whose IPO opens on the 4th of August. Unlike many of the fly-by-night operators, Polaris does have a track record, and a pretty decent one at that.

The company which was incorporated in 1993, has benefited largely from its relationship with Citibank. In the early years, the bulk of its business came from Citibank. This allowed them to build up skills and infrastructure. Over time, Polaris has reduced its dependence on business from its largest client, but Citibank still accounted for 35% of their turnover in FY99, down from 51% in the previous year.

The IPO seeks to raise nearly Rs. 92 crores, of which Rs. 77.5 crores is a fresh offering, while the rest is a secondary offering by Citicorp Finance. About 75% of the money raised will be used to set up three new offshore development centres at Navaloor, Noida and at a third (yet to be decided) location in South India. They also plan to set up development centres in New Jersey and London, as well as marketing offices in the US and Europe.

In FY99, the company had a respectable sales figure of Rs. 60 crores, with net profits at Rs. 14.65 crores. Slightly disturbing is the fact that profitability at the operating level has jumped massively in FY99 (28%) as compared to FY98 (21%) - which makes one suspicious that this could be a pre-issue bloom. From an accounting point of view, they tend to write off development expenses in the year incurred (rather than amortizing them) which is reassuring.

They have 725 employees as of now, and around 85% of their revenues come from exports. Around half their sales is from off-shore services while on-site work accounts for 45%. The nice thing is that they have almost no exposure to Y2K. Their prospectus uses all the standard, jazzy jargon like CORBA, e-commerce, Internet, COM/DCOM and all the rest of it and they claim that 20% of their engineers have specialised skills in e-commerce. They have developed a product called Super Store for the automation of various retail businesses (shops/stores), though they have not achieved any sales as yet.

The plans of the company appear quite ambitious, and since they have no track record as a listed company, it is difficult to say how good or timely the execution will be. In addition, the pricing of the issue appears a mite aggressive at Rs. 210. At this price, the market capitalisation of the company (Rs. 358 crores) is six times last year's sales, and the historic P/E (on diluted equity) is 24.4. On projected figures for the next year, the market cap to sales ratio falls to a more respectable 3.2, while the P/E will be 15.

These figures are definitely optimistic, though they are in line with what the software sector has been able to achieve in the recent past. Also, though the valuations are a bit steep - they are well within the levels that other software companies quote at.

In fact, given the strong valuations that similar companies command, there appears to be ample scope for appreciation on listing. And ultimately, this is what drives the IPO market. Essentially, unless the broad valuations of the software sector collapse suddenly, the near term risk appears acceptable.

So in conclusion, the issue appears to be a good bet (at least they are a genuine software company!) for the short run. In the long term, the call is essentially on where you think the average valuations for the software sector will settle - and on that count I appear to be the only pessimist in a sea of optimists.