Management: Great Expectations - A Reality Check [Pg. 2]

Contn.
Great Expectations-A Reality Check

Treading Softly On The Software Turf

We analysed the valuations of IT companies, during their previous peaks (March, 2000) and compared them with their more recent troughs (April, 2001) to explicitly reflect the future growth expectations.

The analysis throws some interesting observations. The valuations were clearly over optimistic in March 2000, and since then have taken a correction. However, the extent of corrections varies significantly across IT companies. We have classified the companies into three categories-Red, Green, and Yellow. The valuations of "Red" companies have swung from extreme optimism to abject pessimism where they now have negative FGV/MV. The "Green" companies' valuations still imply high growth expectations despite the correction and the "Yellow" companies lie somewhere in between.

The Red category companies (Global Tele, Pentamedia) FGV/MV averaged around 86 per cent in March '00 and by April '01 has drastically fallen to a negative 67 per cent! A negative FGV implies that instead of growing, the investors expect the operating economic profitability of the company to decline. Let us take the example of Global Tele-systems (See Global Tele's FGV Analysis) In the month of March 2000, when the markets were buoyant, the market value of the company was about Rs 10,200 crore. The COV is about Rs 1,000 crore, and this meant that the future growth value was about Rs 9,200 crore. The FGV/MV metric was about 90 per cent. This implied that the company had to create an extra EVA of about Rs 250 crore each year, forever. Was this realistic?

The recent low market value of the company (based on the average share price for the month of April 2001) is about Rs 850 crore, therefore, it has a negative FGV of around 150 crore. This implies that the market expects that the company to destroy its EVA by about Rs 4 crore year on year, forever. Has the pendulum swung too far to the other extreme for this company?

The average FGV/MV for the 'green' companies has come down from a high of 96 per cent to about 88 per cent. Note that these companies had the highest FGV/MV during the peak and continue to have even today. The market continues to give a green signal to companies like Wipro, Infosys, Hughes Software, Satyam, HCL Technologies. Is this because of their better ability to manage their ''knowledge capital" and (or) their better track record?

The "yellow" companies (Polaris, NIIT, Aptech) FGV/MV earlier averaged around 93 per cent and now has fallen to 45 per cent.

There is a clear divide in these categories based on the current FGV/MV. The 'reds' have their FGV/MV ranging from 5 per cent to negative 245 per cent. The 'yellows' fall in the range of 70 per cent to 30 per cent and the 'greens' have their FGV/MV ranging from 74 per cent to 97 per cent.

The markets have given their signal and we reflect that using the FGV/MV metric. Whether the signal (FGV/MV and the Market Valuation) is reasonable or not requires a judgment call that we leave to you the reader. We should point out that when we ran this analysis for US tech stocks with Fortune magazine in early 2000, during the hey days of the tech boom, it pointed out that many valuations at that time were ridiculously and unsustainably high. This they proved to be. Geoffrey Colvin of Fortune in praise of this technique said: ''Such analysis perhaps shouldn't be an investor's only tool-but it's a tool no investor should be without.'' So give our analysis a close look.

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