Wipro: Hold

Recommendation: Hold

Krishnan Thiagarajan

AS WIPRO gears itself for a $175-200 million American Depository Share (ADS) offering at a tentative offer price of $63.86 per ADS and listing at the New York Stock Exchange, the all too-familiar clamour over Wipro's `valuation' has begun to surface.

Based on the price at the Bombay Stock Exchange on September 15, the offer price of $63.86 works out to Rs 2,928 (assuming an exchange rate of Rs 45.85).

Although the stock declined by nearly 10 per cent since the filing of the registration statement by Wipro, it continues to trade at a healthy price earnings multiple of 201 times its 1999-2000 earnings and 141 times its annualised earnings of the 2000-01 first quarter. The PEM is significantly higher than its frontline peers such as Infosys Technologies and Satyam Computer Services. Is such a `premium' valuation (a valuation well above its peers for almost a year-and-a-half) justified on fundamentals?

Before evaluating the valuation riddle, Business Line tried to use the conventional SWOT model to better understand the Wipro's disclosure in the ADS offer document filed with the Securities and Exchange Commission, US. With a market capitalisation of around $14 billion (around Rs 60,000-65,000 crore), Wipro is the largest company in India in terms of market capitalisation. The key strengths and weaknesses are:

*Strong Global IT services division: Though Wipro is a diversified company, in the last two years, the global IT services division has emerged the fastest growing business segment and slowly captured a lion's share of Wipro revenues and operating income (profit before interest and taxes). For the year ended March 31, this division accounted for 45 per cent of the company's revenues and 76 per cent of the operating income. The contribution of this division improved further in the first quarter ended June 30 to 57 per cent of revenues and 92 per cent of operating income.

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*High growth focus areas: With a strong focus on telecom, networking and e-commerce, the three high-growth areas, the sharp rise in the contribution from the global IT services business over the past two years was only to be expected. According to the ADS registration statement, nearly 44 per cent and 48 per cent of the global IT services business was derived from clients in high-growth industries, which use IT services for networking and communication equipment, for the year ended March 31, 2000 and the quarter ended June 30, 2000.

Wipro operates 32 offshore development centres, and clients such as Compaq, Nortel and Seagate Technologies have had ODC's ranging from 5-8 years with the company. Wipro's other prominent clients were Lucent and NCR (apart from Nortel and Compaq) and each of these clients accounted for at least $5 million of the company's IT services business for the year ended March 31, 2000.

*Strong infrastructure and systems: With nearly 10 years experience in the software development business, 32 offshore development centres in India, SEI-CMM, -Level 5 certification and Level Four in the Six Sigma initiative, Wipro can ``build scalability and pricing power'' into its financials in the future. With revenues of over Rs 1,000 crore for the year ended March 31, 2000, Wipro is probably ideally placed to seize emerging growth opportunities in e-commerce, telecom and networking.

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*Diversified profile: Although the press has been speculating about restructuring within the Wipro group over the past year or so, at least in the run-up to the ADS offer, it has not materialised. As part of its diversified profile, Wipro has three divisions -- the Indian IT services division, which derives revenue principally from hardware and software support; maintenance and consulting services, the consumer care and lighting division, which has a presence in soaps, toiletries, lighting products and hydrogenated cooking oil, and `others' which represents Wipro Fluid Power, Wipro Biomed and unallocated corporate overheads.

While the contribution of the Indian IT services business was 35 per cent of revenues, it contributed only 12 per cent of operating income for the year ended March 31, 2000. Similarly, the consumer care and lighting business contributed 13 per cent of revenues and 14 per cent of operating income. The operating profit margins of these two businesses at 6.13 per cent and 18.37 per cent respectively for the year ended March 31, 2000 (5 per cent and 15.51 per cent for the first quarter) compared to 32.39 per cent (34.80 per cent) for the global IT services division may drag future valuations. Although Wipro has enjoyed premium valuation at the Indian bourses so far, it is possible that international investors may take a bearish view of the Wipro's diversified profile.

*Liquidity: As Wipro's chairman and managing director, Mr Azim H. Premji, is expected to beneficially hold an aggregate of approximately 84.26 per cent of the equity following the ADS offer (or 84.11 per cent if the underwriters' allotments are fully exercised), this concentration of ownership may reduce the ADS market price. Besides such concentrated ownership, only 1.36 per cent of the outstanding equity shares will be listed and traded at the New York Stock Exchange. While the concentrated ownership may have the effect of a single person exercising undue influence over corporate actions, the low floating stock may create the possibility of a relatively inactive and illiquid trading market in the Wipro stock. These two critical factors may exert an adverse influence on the ADS price fixation process in the US market.

*Operational contours: The operating profit margins of Wipro's Global IT services business at 32.3 per cent is significantly lower than its peers -- Infosys Technologies at 41 per cent and 37 per cent for Satyam Computer Services for the year ended March 31, 2000. Similarly, the time and materials contract generated nearly 89 per cent of Wipro's Global IT services revenues compared to 11 per cent from fixed price, fixed time-frame contracts for the year ended March 31, 2000. Unlike Wipro, the fixed-price fixed-time-frame contracts contributed nearly 33 per cent of Infosys' total revenues.

Although the contribution from fixed price contracts increased to 14 per cent for Wipro in the first quarter ended June 30 2000, it dipped sharply to 27 per cent from 33 per cent for Infosys. Despite the sharp fall in fixed price contracts, Infosys' high operating profit margins and per capita revenue productivity are attributable to the higher proportion of fixed price contracts in its total software contract portfolio. In relative terms, Wipro stands on a weaker footing compared to Infosys on this score.

*Client concentration: As a part of the overall risk mitigation strategy, Wipro consciously chose to reduce dependence on any one client. According to the ADR Registration Statement, for the year ended March 31, 1999, March 31, 2000 and the quarter ended June 30, 2000, General Electric, Wipro's largest client, accounted for 19 per cent, 15 per cent and 10 per cent of its Global IT services revenues respectively. For the same periods, the top five clients (and top 10 clients) accounted for 40 per cent, 39 per cent and 32 per cent (55 per cent, 53 per cent and 47 per cent). Besides, Wipro has also stated that it anticipates a significant reduction in the services performed for one of the top five clients over the next year.

As a diversified client base can hardly be overemphasised in a fickle and dynamic industry such as software, Infosys Technologies stands on a relatively better footing vis-a-vis Wipro. For Infosys, the largest client accounted for 6.4 per cent and 7.2 per cent of its total revenues for the year ended March 31, 1999 and March 31, 2000. For the same periods, the top five clients (and top 10 clients) accounted for 28 per cent, 30 per cent and 25 per cent (44 per cent, 46 per cent and 40 per cent) of the total revenues respectively.