CMC : The IT Partner for your Portfolio !!!

FOR HIGH RISK APPETITE INDIVIDUALS ONLY

Scrip Code: 517326 / CMC

CMP:  Rs. 1165.80; Buy at Rs. 1155 - Rs. 1165 levels.

Medium to Long term Target – Rs. 1200; STRICT STOP LOSS – Rs. 1073.00; Market Cap: Rs. 3,532.37 Cr; 52 Week High/Low: Rs. 1,187.30 / Rs. 721.30

Total Shares: 3,03,00,000 shares; Promoters : 1,54,89,922 shares –51.12 %; Total Public holding : 1,48,10,078 shares – 48.87 %; Book Value: Rs. 229.84; Face Value: Rs. 10.00; EPS: Rs. 53.06.82; Div: 125 % ; P/E: 21.71 times; Ind P/E: 7.20; EV/EBITDA: 19.18.

Total Debt: Rs. ZERO Cr; Enterprise Value: Rs. 7,065.05 Cr.

CMC LTD: The Company was founded in 1975 and is based in New Delhi, India. CMC Limited is a subsidiary of Tata Consultancy Services Limited which holds 51% as a promoter. CMC Limited was formerly known as Computer Maintenance Corporation Private Limited and changed its name to CMC Limited in August 1984. CMC Limited engages in the design, development, and implementation of software technologies and applications, as well as the provision of professional IT services in India and internationally. The company’s Customer Services segment is involved in the provision of IT infrastructure architecture, design, and consulting services; turnkey system integration of large network and data centre infrastructures; procurement, installation, commissioning, warranty, and maintenance of imported/indigenous computer and networking systems, and software; and provision of on-site and remote support services. Its Systems Integration segment undertakes the activities of solution deployment that includes embedded systems, software development, software maintenance and support, turnkey project implementation, and systems consultancy. The company’s IT enabled Services segment provides business process outsourcing and knowledge process outsourcing services for front end and back office, which include on-demand software services, office records digitization and document management, recruitment and examination results management, and legacy data migration management. Its Education and Training segment offers education and training programs in the areas of information technology, soft skills training, integrated career development, skills development, and vocational programs to corporate organizations, government institutions, and individuals. The company’s Special Economic Zone (SEZ) segment rents its SEZ campus facilities located in Hyderabad to TCS. It serves customers in banking and financial services, ecommerce, e-governance, defense and space, power and utilities, government, and hi-tech and telecommunication industries. The Company is compared with NIIT Technologies, Sonata Software ltd, Kpit Cummins Infosystems Ltd  

Investment Rationale:

CMC is a leading systems engineering and integration company in India under the strong parentage of TCS. CMC’s unique solutions approach in the System integration space along with the focus in the Hi-tech space has enabled CMC to post a robust growth in an uncertain environment and also ensured revenue stickiness for future. The company has been working for last several years with TRW a large automotive electronic player primarily due to its unique domain capabilities and hi-tech approach. It is believed that like other successful mid cap focused players CMC’s expertise has been the Hi-tech space where competition has been limited which enables significant revenue and client stickiness. The above solutions and technology approach along with TCS parentage will provide CMC with all advantages of a large player (inspite of being a small player) right from capabilities to offer services across geographies to a large balance sheet required to participate in huge projects like the Indian passport project. Looking at the result side CMC has posted an average 36 % growth (YoY) over the past nine quarters in the System Integration segment driven by robust traction in the US market, which contributes more than 70 % to the vertical’s revenue. The segment’s PBIT margin has also been above 20 % and management expects it to rise further with increase in offshore execution. Also, with the rising government focus, particularly on e-governance & on faster economic developments, the Indian markets are rightly placed in the fastest growing category in the APAC region. CMC’s execution track in the domestic space currently contributes 35 % - 40 % of total revenues. CMC gives services to Indian Railways’ online reservation, ICR for Office of Registrar and this clearly exhibits its powers in executing complicated projects. The company also expects offshore execution to increase by at least 10 % in the System Integration (SI) business which will enable its margins to improve by at least 300bps or 3 %. It is believed that there is a scope for at least 400bps or 4 % margin improvement in this vertical, which will boost overall margin by at least 200bps or 2 % over the next couple of years. CMC has been able to emerge strongly in the SI business in both revenue and margin primarily due to its arrangement with TCS. CMC and TCS have an arrangement whereby contracts are won by the latter in the international market and executed by the former, for which CMC pays a marketing fee. There are also instances where the companies have executed projects jointly with a revenue sharing model, more so in case of extremely large size and complex projects like the Indian government’s passport project, requiring varied skill sets and a strong capability at the project winning stage.

Outlook and Valuation:

According to Nasscom Indian IT has predominantly been known for strong exports (23% CAGR over FY04-12) in the past vis-a-vis domestic spend (18% CAGR over FY04-12). India is significantly underpenetrated (going by even per capita IT spend) versus most developed nations and both governments at the Centre and state levels have time and again emphasized on the importance of IT adoption and its role in streamlining key work processes like land records, e-rolls etc. The government’s National e- Governance Programmes (NeGP) and Unique Identification Development (UID) programme are just a first few key steps towards digitisation. It is believed that UID will lay a significant stepping stone for the future IT infrastructure. Nasscom predicts India to be the fastest growing IT services market worldwide. Management has clarified that the company has exited from loss making equipment deals in Q1FY13 and will maintain 10 % margin going forward. CMC has consistently paid dividends over the years with payout ratio being in the 17-25% range. Going ahead too, the company plans to continue the policy of paying dividends. An estimated dividend payout ratio of 30% for FY13 and FY14 is expected. CMC is expected to post robust revenue and earnings CAGR over FY12-14E, respectively, driven by strong growth in SI business and exit from loss making deals in the CS segment.  CMC could be bought with a long-term due to strong uptick expected from government spends, timing of which is difficult. In my view CMC could report FY13E EPS of Rs. 79.70/sh and for FY 14E of Rs. 104.40/sh. The stock could be bought for the target price of Rs. 1255 and recommend Accumulate on the stock.

KEY FINANCIALS	FY11	FY12	FY13E	FY14E
SALES (Rs. Crs)	1,096.20	1,469.30	1,873.60	2,313.40
NET PROFIT (Rs. Crs)	179.40	151.80	241.30	316.40
EPS (Rs.)	59.20	50.10	79.70	104.40
PE (x)	16.30	19.30	12.20	9.30
P/BV (x)	4.50	3.80	3.20	2.60
EV/EBITDA (x)	11.90	12.10	8.80	6.80
ROE (%)	27.40	21.30	28.40	30.70
ROCE (%)	31.20	27.40	34.10	36.50

I would buy CMC LTD with a price target of Rs. 1200 for the short term and Rs. 1255 for the 6 month target. As I always say, I am a long term believer in markets & I do respect the markets and will keep a strict stop loss of 8 % or Rs. 1073.00 on every purchase. 

READ HERE TO KNOW MORE ON LONG TERM INVESTING - CLICK HERE

ARE SHARE BUYBACKS BENEFICIAL TO SHAREHOLDERS !!!

Some few months back Coal India Ltd. (CIL), the near-monopoly coal producer announced that it will seek shareholder approval at its upcoming Annual General Meeting to amend its Articles of Association in order to facilitate buyback as it was sitting on cash pile of around Rs. 58,202 Cr as on March 2012. As soon as this news was out, stock prices of CIL rose by more than 2%.  The reason for this price rise was primarily the expectation that the company will announce a share buyback.

Historically, share buybacks or even company announcements of a share buyback have had a similar effect on the respective stock prices. The market is usually quick to react positively to such news. But are share buybacks always beneficial to investors? Before we answer this, let’s understand what is a share buyback.

What is a Share Buyback ?

The repurchase of outstanding shares by a company in order to reduce the number of shares on the market either to increase the value of shares still available or reducing the supply. There are four basic options available to a company when it makes a profit: sit on the cash, re-invest it into profitable opportunities, pay a dividend or buyback shares.

Buyback is generally seen as a method of rewarding shareholders by returning excess cash to them, when a company doesn't see good growth avenues to deploy its resources. This can be done in two ways:

• It can tender an offer to existing stockholders to buy up to a certain number of shares at a fixed price within a fixed period of time, or,
• It could offer to buy the shares in the open market over a period.

What are the main intentions behind a Share Buyback? 

There are different motives that prompt the management to go in for a buyback of shares:

1. To reward shareholders: When a cash-rich company doesn't see good growth avenues to deploy its resources, it can choose to return cash to its shareholders via buyback of shares. Such an action can be viewed positively by the analyst community and reflect positively on the management.

2. To send out a confidence signal to the market: When a company announces a share buyback, investors see it as a positive sign in terms of the management’s belief in the company’s future growth & earnings. This could act as a confidence booster and leads to investor's buying into the company’s shares leading to a price rise.

Take for example, the Reliance Industries buyback scheme which was announced in February this year. After a series of quarterly results which were below expectations, the share price was languishing at INR 700. The share buyback announcement which was just 2 days before announcement of its quarterly results, led to a 5 % jump on the day of announcement. It was largely seen as an attempt to shore up the market sentiment in order to prevent a further fall in share prices after the announcement of another set of poor quarterly results.

3. To improve Financial Ratios: A buyback gives a temporary boost to some of the key financial ratios of the company that are based on the number of shares and cash as an asset. Suppose a company buys back 10 lakh shares at INR 15 per share for a total cash outlay of INR 1.5 crores. Below are the components of the Return on Assets (ROA) and Earnings per Share (EPS) calculations and how they change as a result of the buyback.

In the this grid, following a buyback, the company’s cash holding reduces from INR 2 crores to INR 0.5 crore, and the total assets of the company (cash being an asset) reduces from INR 5 crores to INR 3.5 crores. This leads to an increase in its ROA (Earnings/Assets) from 4 % to 5.71 %, even though earnings have not changed. A similar effect can be seen in the EPS number (Earnings/Shares Outstanding), which increases from INR 0.20 to INR 0.22.

4. To prevent dilution of control: A buyback helps to absorb the excess shares, which were caused due to dilution, may be due to the exercise of employee stock option programs or due to conversion of FCCBs or warrents. Thus, a buyback reduces the total number of shares outstanding in the market and helps to increase shareholders value.

5. To prevent unfriendly takeovers: By undertaking a buyback, the company makes it more difficult for a raider to take control by acquiring majority stake from the open market.

Now when we have clearly known about the prime intentions behind the Share buybacks, but are these buybacks always an good idea or can it decrease shareholder value. ?

When  are the Share Buybacks not good for Shareholders ?

1. Buyback of overvalued shares: a company buying overvalued shares from the market would lead to destroying shareholder value, and would be better off paying that cash out as dividends, so that shareholders can invest it more effectively.

2. To boost earnings per share: contrary to popular wisdom, increasing EPS doesn't increase fundamental value of the shares. Though the EPS derived from the P&L statements of the company may seem to rise, there is no net increase in the cash EPS. Since companies have to spend cash to purchase the shares, valuations are adjusted for reductions in both, cash and shares.. The result is a cancelling out of any impact in the cash EPS, as now lower cash earnings are divided between fewer shares to produce no net change in the earnings per share.

3. Using borrowed money to fund the buyback: Using debt to fund a buyback could have an adverse effect on the credit rating of the company, since in effect the company reduces its equity, increases its debt, with no net increase in cash to serve as a cushion for the increased leverage.

So, are Share Buybacks really beneficial for Shareholders ? 

Stock buybacks can be great for shareholders if the company cannot utilise the excess cash productively. As mentioned before, it could lead to a cash inflow for shareholders as also lead to appreciation in share price. However, the price at which the company buys back the shares should be right.

On the other hand, you should be careful and assess the reasons for the buyback. You must exercise a reasonable amount of caution in the following cases:

• Where a stock grant to employees by way of employee stock options or a stock issuance for merger & acquisition is offsetting the shares taken out of circulation, thereby resulting in no net increase in share value.
• Where the management aims to cover up weak ratios or improve the market price of the shares by playing with investor sentiments.

The new norms for Share Buybacks :

Market regulator SEBI on February 7^th 2012 modified norms for share buyback through the tender offer route under which companies will have to reserve 15 per cent of the offer for small shareholders.

"15 per cent of the number of securities which the company proposes to buy back (through tender offer)... shall be reserved for small shareholders," the Securities and Exchange Board of India (Buyback of Securities) (Amendment) Regulations 2012 said. Small shareholder refers to a shareholder who holds shares not exceeding Rs. 2 lakh of a listed company. The buyback process through the tender offer route can be completed within 41 days of the board approval.

As per the guidelines, a company would have to publish advertisement in newspapers within 2 days after securing board approval for the buyback and after 5 days it has to file the offer document with the Sebi. The offer for buyback shall remain open for 10 working days & within 7 days the company would have to pay the buyback amount to the shareholders.

Before this amendment there were two ways by which a company can come out with a buyback - open market and tender offer. While in open market offer companies can buy back shares from shareholders without knowing the buyer, under tender offer the company has to write to every shareholder saying it is willing to buy back shares in proportion to the issue.

Under Section 77A(2) of the Companies Act, 1956, Buyback of Equity shares by a company shall be up to 25 % of the total paid- up Capital and the amount intended to use for buyback shall not exceed 25 % of total paid-up Capital and Free Reserve and requires the approval of members by way of Special Resolution. 

• Promoters shall not participate in the buyback.
• As per the Act, the ratio of the Debt owed by the company should not be more than Twice the Share Capital & Free Reserves after Buyback.
• The Company will not be allowed to issue fresh equity shares within a period of 6 months after the completion of the Buyback except by way of Bonus issue or in the discharge of subsisting obligation such as conversions of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity.
• The company should confirm that there are no defaults subsisting in the repayment of deposits, redemption of debentures or preference shares or repayment of term loans to any financial institution or Banks.

Example of calculation of the Buy Back - 

The Total number of Equity shares as on 31st March were 218,16,86,781 shares

Maximum Amount permissible for Buy-back i.e. 25 % of the Total paid up and free reserve of Rs. 2,551.26 Cr = Rs. 637.81 Cr.

Maximum Shares permissible for Buy-back i.e. equity bought back cannot exceed 25 % of 218,16,86,781 shares = 54,54,21,695 shares.

So, Company can buy back 54,54,21,695 shares & money to be used should not be more than Rs. 637.81 Cr.