Niraj Cement Structurals IPO Analysis

Investors can avoid the Initial Public Offering of road building contractor, Niraj Cement Structurals. The asking price of Rs 175-190 appears stiff, given the small scale and limited scope of the company’s business, fluctuation in profit growth and high risks specific to the company.

At the offer band, the price-earnings multiple works out to 19-21 times its FY-2008 earnings on the pre-IPO equity base.

The asking price also discounts its estimated FY-2009 per share earnings (post equity expansion) by at least 18 times. Peers of similar size trade at a considerable discount.
On the company and offer

Niraj is a road construction company with most of the projects in the form of sub-contracts from principal contractors. While the company also manufactures cement structurals, this business forms a negligible portion of the total revenue.

The company plans to raise about Rs 60 crore through this IPO and seeks to list the stock at the Bombay Stock Exchange. This would expand the current equity capital by 45 per cent.

The offer proceeds are to be utilised towards purchase of capital equipment and for meeting working-capital requirements.
High volume on the cards

Niraj currently boasts of a massive order-book of Rs 660 crore, amounting to seven times its 2007-08 revenue of Rs 92 crore. This is likely to provide impetus to the revenue growth witnessed by the company.

However, the limited time-frame available for completion of the projects poses a challenge to its execution capabilities. Most of the orders need to be completed within a 12-20 month period. Agreed that the company’s plan (through the IPO proceeds) to increase capacities of its Ready Mix Concrete (RMC) batching plant would hasten the input availability, at least in the projects sites where they are installed. Transporting the RMC units between project sites may pose logistics problems.

In addition, the RMC batching plant planned would have a capacity of 1,44,000 cu. m. of RMC per year as against 20,000 cu.m consumed by it in FY-2008. This essentially implies that despite high orders in hand, the company may have excess capacities after captive consumption.

The sale or lease of the same may not be easy given that the market size for RMC remains limited in India, apart from transportation costs involved. The capital expenditure to be incurred hence holds risk of high costs.
Burdened by interest and taxes

The company’s profit margins have remained in line with other road builders such as C&C Constructions and Roman Tarmat. However, net profits have witnessed a decline since 2005-2006.

Despite surge in revenues, mounting interest costs and taxes have dented the bottomline.

The mounting borrowing cost is reflected in the shrinking interest coverage ratio. While profits (before interest and taxes) covered the borrowing costs by fives times in 2006, the same ratio shrunk to 2.8 in the latest fiscal.

The company has further disclosed its default in payment of interest and repayment of loans to some of its lenders. Taxes have also seen an increase; this apart, the company has stated that it has been claiming deduction under Section 80-IA of the Income Tax Act, a benefit that is no longer available for contractors such as Niraj.

The offer document states that the company has not made any provisions for the additional tax burden either for the current year or for retrospective years from 2000. The provisioning and higher tax burden in future would hurt net profits.

Further, Niraj’s sub-contract status has heightened its risks of non-payment from the principal contractor. Sundry debtors of Rs 103 crore, is higher than full year revenues for 2007-08, indicating legacy receivables and delay in collection.

This could lead to increased crunch in cash flows for the company. The offer is open from May 26-30.

Bafna Pharmaceuticals IPO Analysis

Scalability concerns, low profitability and presence in the highly competitive formulations business without a specific niche, peg up the risks associated with the Initial Public Offering of Bafna Pharmaceuticals.

The 27-year-old company is proposing to offer 40.05 per cent stake to the public and use the net issue proceeds (of Rs 23.55 crore) to mainly undertake brand-building in domestic and international markets, partly repay loans and procure R&D equipment.

The fixed offer price at Rs 40 per share, also does not leave much on the table for investors, as it discounts the 2007-08 (annualised) earnings per share of the company at 37 times, on the post-issue equity base.

The pricing appears stiff compared to similar sized players in the formulations business, as well as other entrenched players engaged in Contract Research and Manufacturing Services (CRAMS) — an area Bafna is targeting through its new facility at Grantlayon, near Chennai.

Though CRAMS is an exciting opportunity for Indian companies, Bafna’s size does not instil the necessary confidence in its ability to quickly occupy a position of strength and profitability in this area.

Bafna has long experience catering to less-regulated countries such as Sri Lanka but only limited experience in carrying out CRAMS in regulated markets.

Though these factors argue against an investment in the IPO, the stock may be worth reviewing, post-listing, with a longer financial record.
Business profile

Bafna Pharmaceuticals’ profits have grown by 12 per cent on the back of 23 per cent growth in net sales on a compounded basis across five years.

The company now draws all of its revenues from its manufacturing facility at Madhavaram, near Chennai; a scale-up in revenues and margins could be expected once the Grantlayon unit gets MHRA accreditation, allowing it to enter the regulated markets of the UK and other European countries.

The company has signed a five-year agreement to supply Simvastatin — a drug to lower cholesterol levels — to a UK company.

However, it will be a little unreasonable to expect Bafna’s Grantlayon unit to make considerable contribution to both topline and bottomline over the next 12-15 months because the business may take time to scale up its client base.

This could put pressure on existing financials as planned brand-building exercises, consisting of significant deployment of human resources in marketing, would see a bulge in expenditure from hereon, thereby shrinking already low operating margins (7 per cent).

Bafna displays high client concentration (top five contribute 80 per cent) and product dependence (top five contribute 65 per cent of sales) — typical of smaller entities.

Bafna plans to further scale up domestic business (exports contributed 30 per cent in last nine months ended December 2007) and launch its own brands as well as cater to new therapeutic areas (life-style diseases).

Challenges to these will arise from the substantial presence of large established players and Bafna’s small scale of operations.

Bharat Forge

Shareholders can continue to stay invested in the Bharat Forge stock. Fresh exposures need not be considered at this point in time as the company is faced with the twin challenges of a slowdown in the US commercial vehicles industry and a pause in the domestic auto industry’s growth.

But the company’s conscious efforts to de-risk its exports business and the foray into the non-automotive sector hold promise over the long term, suggesting that investors need not part with their holdings in the stock. At the current market price of Rs 276, the stock trades at around 15 times estimated consolidated earnings for 2010.
De-risking of export business

To weather the US slowdown, the company has adopted a two-fold strategy. One, it has reduced the export of heavy truck chassis components and has instead concentrated on the supply of passenger car components.

From about 50 per cent of the total exports in 2006-07, the export of truck components has come down to around 38 per cent this year while passenger car component exports have increased by about 10 percentage points during the same period.

Two, the company has focussed on increasing its Europe business. For the year-ended March 2008, exports to Europe constituted almost half the total exports as against 31 per cent the previous year.
Non-automotive foray

In a bid to diversify client base and shield their businesses from cyclicality in the automotive industry, several auto component makers are diversifying by supplying to sectors outside of automobiles. This entails high-value products that also bring in better margins.

Bharat Forge has moved into forging and machining of high-value parts required for the oil and gas, Railways, aerospace and Defence sectors.

The company has recently ventured into the capital goods sector as well. This February, it entered into a joint venture with NTPC (National Thermal Power Corporation) to manufacture forgings, castings, fittings and high-pressure pipings required for power and other industries.

It plans to invest Rs 200 crore initially in this joint venture which will also look at manufacturing power plant equipmentin the near future. Non-auto components business currently contributes around 20 per cent to the revenues but the company plans to double that by 2012.

To serve this end, the company is setting up plants at Baramati and Pune which are expected to commence production in the second half of the current financial year.

To fund this expansion into the non-auto segment, Bharat Forge is also considering a rights issue of non-convertible debentures with detachable warrants for Rs 400 crore. They are also looking at acquiring small and medium companies in the non-auto space.
Financials

On a standalone basis, net sales grew by 12.3 per cent year on year to Rs 580 crore during the fourth quarter, backed by a 23 per cent growth in exports.

Net profits, however, fell 18 per cent to Rs 52.5 crore after excluding extra-ordinary income (profit) of Rs 30.3 crore arising from the consolidation of its overseas operations (excluding Bharat Forge America) into one company, CDP Bharat Forge.

The bottomline has been hit by a Rs 15.8 crore foreign exchange loss on restatement of its foreign currency debt.
Subsidiaries underperform

The company’s fully-owned subsidiaries registered a 4 per cent decline in sales in the fourth quarter. Net profits too fell by about 30 per cent compared to the same period last year.

This can be attributed partly to the subdued performance from Bharat Forge America, which has been hit by the slowdown in US truck sales. Operating margins for the subsidiaries too are at a thin 7.2 per cent, which the company aims to improve to 12 per cent in the next two-three years.

To achieve this, it has embarked on a process of product rationalisation to pull out low-margin products and change product lines, if necessary.

This exercise will help improve margins, but low synergies with the parent company and operations in mature markets such as the US and Europe may pose challenges to a significant improvement in their performance in the immediate future.

Revenue growth for the subsidiaries have so far been lacklustre and earnings have not gained traction since they were acquired, beginning 2004.

But a marked shift to the Europe geography and, hence, the access to a wider clientele indicate that subsidiary earnings may improve in the medium term.

This, along with the revenue flows expected from the non-automotive business, make the stock worth holding on to in the castings and forgings space.

Geodesic Information Systems

Investments with a 12-18 month horizon can be considered in the stock of Geodesic Information Systems, considering its niche business, moderate valuation and good growth prospects. At Rs 181, the stock trades at 11 times its FY-08 earnings and nine times its estimated current year earnings.

With a net profit margin of 49 per cent, much higher compared to other listed, products-focussed technology companies, the valuation appears attractive, especially considering the good growth prospects.

The company has managed a compounded annual revenue growth of 67 per cent and profit growth of 68 per cent over the past three years

Geodesic operates in a niche area in technology. The company derives most of its revenues from developing instant messaging platforms/services and licensing them mainly to enterprises under the ‘Mundu’ brand. Instant messaging is a rapidly expanding mode of real-time communication across the world. A Radicati Group report of August 2007 puts the market size of IM to be $530 million by 2011.

Geodesic’s product (Mundu ICE stack) caters to clients ranging from portals and publishers to telecom operators, mobile handset manufacturers, system integrators and even end-consumers. Geodesic also licenses its instant messaging platform to mobile handset manufacturers and telecom operators, thus providing it with sustainable revenue streams, with scope for expanding margins.

The product’s capability of allowing seamless chat services across Google Talk, Yahoo! and MSN has been a major selling point to drive sales.
Hybrid revenue model

For its enterprise and portals and publishing clients, Geodesic charges a licence fee, a customisation fee, annuity based service charges and charges for upgrades and updates.

For retail customers, it charges a fee based on subscription.

This model clearly provides a sustainable revenue stream.

The significant proportion of licence revenue means that it is also able to de-link revenue growth from headcount growth, by optimising costs.

Client profile provides sustainable business: A recently won deal from Nordisk Mobiltelefon, a European telecom and ISP operator, for providing messaging and Internet radio on the mobile phone, is a typical example of its engagements. Geodesic has won a similar deal from Idea Cellular in India. This allows leeway for clear revenue-sharing arrangements, as downloads or logins to access internet radio on the mobile would be clearly measurable.

The company has also launched its messaging services in Nokia and Sony Ericsson smartphone handsets and has an agreement with players like BenQ. Mio Digi-walker, a key player in the mobile GPS navigation space is another client. The roster also includes portals such as Naukri and bigadda.com, players which constantly upgrade their Web sites and offer more cutting edge-services, providing a sustainable business proposition for Geodesic.

As handset manufacturers increase their smartphone presence in rapidly growing markets such as India and the rest of Asia, Geodesic stands to gain from their expansion.

The company has launched an instant messaging platform for the hugely successful iPhone and may be well-placed to capture a share as and when Apple allows third-party software platforms on its phones. iPhone’s impending Indian foray later this year also represents an opportunity.

Other key developments: This apart, the company has also developed voice over internet protocol (VoIP) products to work with Windows mobile and Symbian-based phones and desktops, for PC-to-PC calls. VoIP is also an ever expanding market providing for cheap communications.

The launch of Amida Simputer, a wireless data processing and communication device, is under trial runs with about three million customers for the government’s proposed multi-purpose national ID card project.

The company has also forayed into publishing by acquiring the Chandamama brand. The subscriptions have increased 60 per cent in the past quarter after the acquisition.

With its Telugu version already launched and Hindi and Tamil versions on the anvil, this may help capture regional audience as well. An increased subscription may lead to more keenness on the part of advertisers, leading to increased ad revenues.

The risks to this business are scalability challenges in executing any multi-million dollar deals, technological obsolescence and competition from platforms such as IBM’s Lotus Sametime.

ENIL

Investors with a long-term perspective can buy the stock of Entertainment Network India (ENIL), which operates the radio channel, Radio Mirchi 98.3 FM. Within the media sector, radio is poised to record the fastest growth in advertising spends, although on a low base. It is also likely to be less vulnerable to any slowdown in advertising spends given its lower advertising rates compared to television and print. As a market leader with a 47-48 per cent share of the radio industry and an increasing presence in the other emerging and promising media platforms – outdoor advertising and event management – ENIL is a unique play within the listed media space.

However, all three platforms – radio, out-of-home media and event management – are yet to mature as advertising platforms. Radio as yet accounts for only 3 per cent of the advertising pie. Hence, a three-five year holding period is necessary to reap the full benefits of this investment. The valuation of the stock, too, from a near-term perspective is expensive. Government approval of TRAI’s recommendations for the radio sector on hiking the FDI limit, allowing operators to operate multiple channels within a city and permitting the broadcast of news, are likely triggers for the stock.

ENIL has successfully rolled out 22 radio stations over the past year, taking its total number of stations to 32. New stations weighed on profitability in 2007-08, with margins on a standalone basis dropping by about 200 basis points to about 24 per cent. Operating margins of its 10 legacy stations are, however, at close to 40 per cent levels. Margins have also improved sequentially, which suggests rising profitability in newer radio stations as well. There is, therefore, significant headroom for margins to expand once the new radio stations start maturing.

ENIL has a presence in all key markets and enjoys a leadership position in most. This makes it a preferred choice for both national and local advertisers. Both the outdoor media and the events management business are growing at a strong pace, on the strength of the promoters’ experience in this business. The outdoor media subsidiary, TIM, is well funded for further expansion in the outdoor business and is aggressively buying properties in key metros. Delays in handing over of properties can affect operations, however, as was the case in the fourth quarter. However, ENIL may be one of the leading players in this emerging media segment.