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Suresh Krishnamurthy

SHAREHOLDERS of the Hexaware Technlogies stock can pare their exposures to the stock. The stock trades at a multiple of about 10 times its expected earnings per share for 2003.

The multiple appears high considering the quality of earnings, record of owners and the uncertainty regarding growth beyond 2003.

Hexaware's performance for the first quarter of fiscal 2003 was not impressive. Revenues and profits of Hexaware India — standalone entity — for the quarter ended March 2003 were sharply lower than that for the quarter ended December 2002.

At the consolidated level, revenues rose marginally while profits fell sharply.

However, this was not a surprise since the management had given such guidance in February. Hexaware's management expects revenues and profitability to scale up quickly only in the second half of 2003. The management, however, expects consolidated profits to be around $5 million for 2003.

In other words, Hexaware expects a four-fold rise in profits on the back of a 35 per cent rise in revenues. Margin expansion is expected mainly on the back of lower selling expenses.

Overall, consolidated profits of $5 million translates into a per share earnings of Rs 10.60.

The stock price performance hinges entirely on this guidance materialising. However, Hexaware appears to be facing stiff challenges in this regard.

Its major subsidiaries such as Hexaware US and Specsoft Consulting incurred huge losses in 2002. How successful Hexaware will be in paring these losses remains to be seen.

However, the stock appears relatively expensive, even assuming Hexaware will deliver on its promises for 2003.

First, the subsidiary model followed by the company reduces the quality of its earnings. Second, the performance of Hexaware India in 2002 on the cash flows front was significantly inferior compared to its profit performance.

A persistence of such a trend in 2003 will also reduce the quality of earnings. In addition, a multiple of 10 also factors in modest growth in cash flows beyond 2003. Will such growth materialise? Small and mid-cap IT companies have faced considerable challenges in growing in the past.

Importantly, the global economic outlook is not entirely positive. The record of the company's owners is another negative factor. The reorganisation of Aptech that resulted in the formation of Hexaware Technologies left the shareholders of the former with substantial losses.

Factors such as present level of low earnings, low earnings quality, growth challenges and ownership quality suggest that the price-to-earnings multiple for Hexaware needs to be low for considering an investment.

However, it is now at around 10 comparable to that of Satyam Computers. In this backdrop, investors can reduce their exposures to the stock notwithstanding the prospect of rapid profit growth in 2003.

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