R. S. Software -- moving up the value-chain

Recommendation: Buy

Suresh Krishnamurthy

The stock of R. S. Software is trading at Rs. 315 presently, to multiple earnings, 15 times the per share earnings, for the period ended March.

The stock has declined by more than 2/3 in thirds value in the technology stocks sell-off since March. The stock of R. S. Software is certainly not the best available exposure, however, the stock is attractively priced at present levels. An investment in the stock can be made at current levels for fair appreciation over the medium term.

Suitability: For an investor seeking to build his own portfolio of stocks in the IT industry, the stock of R. S. Software appears to be a good buy. Risks involved in an investment in the second-rung software stocks such as R. S. Software, are higher compared to an investment in top quality software stocks.

Background: R. S. Software is a software service provider which has met with considerable success in scaling up its operations. Revenues over the past five years have grown at the rate of 55 per cent, more or less in line with the industry. For the year ended March 2000, R. S. Software reported a 57 per cent growth in software exports and a 85 per cent growth in profits. In the fourth quarter of FY 2000, R. S. Software recorded a 74 per cent growth in revenues and a 100 per cent growth in profits adjusted for non-recurring items.

R. S. Software presently derives 80 per cent of its revenues from the US markets. Around 60 per cent of its revenues is accounted for by onsite business. Software maintenance and supply, software development and testing presently account for 70 per cent of its total revenues.

Moving Up Value Chain: The company is now in the midst of a transformation that is necessary for most software companies aiming to move up the value chain. The strategy adopted by the company involves developing domain expertise in the areas of financial services, healthcare and retail services. Retail and financial services companies currently account for 77 per cent of total revenues.

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In terms of improving the contribution of value-added solutions, R. S. Software has made progress with e-commerce solutions accounting for 30 per cent of total revenues in the year ended March 2000. In terms of infrastructure, R. S. Software expects to spend Rs. 20 crores in the next six months to set up two new development centres in Chennai and Pune. The strength of technical personnel is expected to double from the present 550, in the next 12 months.

Key issues: The key to the growth prospects of R. S. Software lies in how it is able to make the transformation from a generic software solutions provider to a value-added solutions provider. The operating margins of the company at 23 per cent and net profit margins at 17 per cent, are at present quite low, compared to the standards set by industry majors. Without a move up the value chain, the pressure on margins could only escalate.

Another factor is that R. S. Software is also looking at joint-ventures as a route for achieving growth. It already has a joint-venture with the US based Hanover Direct, where it holds a 40 per cent stake. A crucial factor in terms of stock price prospects would be how synergies are achieved through such ventures without affecting the revenue growth of R. S. Software. This apart, the dependence on the US market for 80 per cent of its revenues and the means of funding for its capital expenditure programme are other crucial factors.