Analysis: Datamatics Global Services Ltd

The current section of the “Analysis” series covers Datamatics Global Services Ltd, an Indian company providing Information Technology, business process management (BPM), engineering, data, and analytics services. The company provides IT products for robotics process automation (RPA), analytics, business intelligence, and automated fare collection (AFC). The company provides different products like TruBot, TruCap+, iPM, TruTest, Trade Finance, TruFare, TruBI, and TruAI.

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

Datamatics Global Services Ltd Research Report by Reader

Hello Sir

I am happy to share my analysis of Datamatics Global Services Ltd with you. Also privileged to get the revelation from your analysis of Globus Spirits.

I would be happy to learn/hear from you for further analysis.

Thanks & regards

Yours truly,

Gurjeev Singh Anand

A) Analysis of Datamatics Global Services Limited:

1) Sales Growth:

The company has grown at a 12-13% compounded annual growth rate (CAGR) over the last 10 years. Sales from 300 cr have come up to 910 cr in the last 10 years. Further, in last 4 quarters, the sales have further increased to 1010 cr. The sales have become 3 times in 10 years. There were two periods of sales dropping by 12-14%. Those were FY10 and FY16.

Datamatics Global Services Ltd caters to clients in America, Australia, Asia, the Middle East, and Europe and provides customized solutions. The key verticals for Datamatics Global Services Limited are Robotics / Artificial Intelligence and machine learning to make innovative customized solutions for their clients. About 60% + of their revenue comes from US markets.

• Wide Service Offerings: Finance & Accounting, Mobility, BI & Analytics, Collaboration & Enterprise Portals, Engineering & Embedded Services, Enterprise Content Management.
• Strong Domain Expertise across BFSI, Healthcare, Manufacturing, Market Research, Publishing, Retail & International Organizations.

BFSI and Publishing businesses generate around 50% of the revenue stream. Their products TruBot and TruBI are getting good adaptability in the market, which is giving them a revenue boost. Cloud computing is the need of the hour and growing at an immense pace. Datamatics Global Services has joined hands with Amazon AWS and Microsoft Azure and developed lots of products those interest the customers.

AFC (Automatized Fare Collection) has been a key focus for the company, which they are installing in Lucknow Metro and several key customers in tier 1 cities across the country.

The acquisition of TechJini gave Datamatics Global Services Ltd a foothold in Mobility and Web development technologies. With the acquisition of RJ Global in the Philippines, they are into voice and text-based services for their clients.

2) Profitability of Datamatics Global Services Ltd:

Let us look at the profitability of the company. The operating profit margin (OPM) has been in the range of 8-12%. OPM has been fluctuating almost every year. From the last 3 years, it looks to be stabilized at 9%. It does not have any significant raw material costs, as it is an IT company. The reason for the fluctuation of operating margins are

• Employee costs
• Selling and distribution expenses

The net profit margin (NPM) of Datamatics Global Services Ltd has also seen a fluctuating trend from 2% to 9%. In spite of the OPM stabilizing in the last 3 years, the NPM is still fluctuating. The depreciation amount has increased over the years as the company has continuously invested in fixed assets to generate growth.

A few important reasons for the low operating margins are clarified by the Chairman in his message to the shareholders. These are as under.

I believe that the IT Industry in India, and your Company is faced with several challenges and we need to address them.

First, the western world, our principal markets, are getting protectionist and creating barriers to trade, movement of our professionals, and a free flow of both goods and services.

Second, India is facing margin pressure with MNCs having high captive utilisation and financial institutions still leading the way with around 24%. Conventional IT Services and BPO are gradually becoming a commodity, with relatively low entry barriers, resulting in lower margins.

Third, there is a need to broaden our geographical reach and explore more markets. Today about 80% of our Software Exports are to the USA and UK, who on a combined basis form only 6% of the world population and contribute about 25% of the world’s GDP.

Fourth, to circumvent reducing margins in both BPO and Software Services, we need to move up the value chain through development of intellectual property and Software products. Traditionally, Indian Software professionals had been accustomed to providing services against developing Software products. Today, products need creativity, rigorous testing, ergonomic orientation, larger marketing / sales budgets, and longer gestation periods.

3) Taxation:

Datamatics Global Services Ltd has always paid taxes at a rate lower than the standard tax structure. The tax payout ratio over the years has ranged from 7% to 25%.

The company is getting

• adjustments for previous losses
• Some sales under subsidiary are in a tax-exempt zone
• Adjustments that are not taxable

One should check in detail for how long these adjustments/benefits are availed by the company as once these are over the net income could be lower.

4) Interest Coverage Ratio of Datamatics Global Services Ltd:

The company has a comfortable interest cover. Further, the interest cover has increased over the years showing some comfort as the size of business operations increased with respect to its debt.

The debt to equity ratio of Datamatics Global Services Ltd stands at 0.1 times.

5) Cash Flows:

The business has been able to generate positive cash flows in the last 3-4 years, which has been consistent in spite of the increasing size of operations.

The 10yr cumulative cash flow from operations (CFO) of Datamatics Global Services Ltd is 387 Cr v/s 10yr cumulative net profit after tax (PAT) of 356 cr. It indicates that the company has been able to get its receivables on time and the same are not being blocked in working capital.

Out of the 387 Cr CFO, the management invested 380 Cr in the business to grow the same going ahead. That leaves a very less amount of only 7Cr as free cash flow (FCF).

Datamatics Global Services Ltd paid dividends of 56 Cr in the last 10 years, which was eventually funded via debt. Two aspects make that evident

1. rising debt to pay dividends
2. trouble in paying dividends thereby decreasing dividend payout as a percentage of profits. The amount of dividend is kept constant at 4 Cr (without dividend distribution tax, DDT).

6) Business Efficiency of Datamatics Global Services Ltd:

a) Net Fixes Assets Turnover Ratio:-

The net fixed assets turnover (NFAT) for the company is in the range of 3.2 to 3.5. In addition, the fixed assets turnover is falling for the last 4 years. The NFAT from 3.56 in fy14 has come down to 3.17 in FY18. This means that the investment the company has been doing in its fixed assets is not giving the full potential for revenue generation for the company and are dragging its performance.

b) Receivable Days:

Datamatics Global Services Ltd is collecting money from its debtors in 2 to 2.5 months. The receivable days are stable in the range of 70-80 days.

B) Peer Analysis of Datamatics Global Services Ltd:

In comparing Datamatics Global Services on metric analysis with its peers, some key learnings are obtained. Mind Tree is a close competitor as they are also in BFSI services, which is the focus area for Datamatics Global Services Ltd.

C) Credit Rating Report of Datamatics Global Services Ltd:

The company has 66 Cr of debt and 111 Cr of Cash and liquid investments making it a net cash positive business.

The high debt coverage metrics and ample available liquidity with low gearing give a robust financial model for the company. Esteemed promoter Mr Lalit Kanodia who was also the co-founder of TCS Limited is with the said company. As per the report, the key focus areas (and 50% + revenue generation for the business) are Banking and Financial services & publishing business. Datamatics Global Services Ltd has a stable customer relationship, which is helpful in the long run.

Risks are the major proportion of the revenue come from the US where there are many companies in Silicon Valley, which could be tough competition for the verticals the business operates into. The company is expanding its technologies and geographical locations to mitigate the concentration risk. There is also intense competition from local players in the IT services business.

D) Margin of Safety in the business of Datamatics Global Services Ltd:

1) Self-Sustainable Growth Rate (SSGR):

SSGR of Datamatics Global Services Ltd is 8-9%. The company has grown about 12-13% over the last 10 years. The said growth has slowed down to 3% in the last 3 years (also consuming its cash on books from 193 cr down to 117 cr.)

The operating efficiency has gone down over the years as the net fixed asset turnover is continuously going down in the last 4 years with the collection days high at 2 – 2.5 months.

2) Free Cash Flow (FCF):

FCF of Datamatics Global Services Ltd for the last 10 years is 7 Cr. The business has barely managed to generate FCF as whatever cash they generated from their operations they had to invest back into the business for growth. The FCF generated was only 7 Cr.

E) Dividend Payout of Datamatics Global Services Ltd:

The dividend is a percentage of net profit after tax (PAT) i.e. the dividend payout ratio has decreased in the last 2-3 years.

F) Valuation Analysis:

Datamatics Global Services Ltd is available at a P/E of 8, which offers some margin of safety in the price.

G) Additional Points related to Datamatics Global Services Ltd:

1) About the Company:

The company was set up in 1987 by Dr Lalit Kanodia, to provide non–voice-based process outsourcing and software development services in the areas of content management, accounts and finance, research and analytics, telecommunications-embedded solutions, product management, independent testing, and enterprise applications. The group is headquartered in Mumbai and is present in the US, the UK, Germany, Australia, Mauritius, and Switzerland through subsidiaries. Strategic JV’s by the company are as under:-

CIGNEX Datamatics has entered into a partnership with Salesforce (leading CRM and Cloud Computing Platform), UiPath (leader in Robotic Process Automation), OutSystems (leading Low Code Development Platform) and Oracle MySQL (leading Open Source RDBMS Platform).

2) Management of Datamatics Global Services Ltd:

The founder chairperson of the company is Dr Kanodia who was also one of the founder members of TCS. Dr. Kanodia is the President of the IMC Chamber of Commerce & Industry and former President of the Indo American Chamber of Commerce (IACC). He was also the Honorary Consul General of Chile in Mumbai, India for over a decade (2002 – 2014).

Dr Kanodia has 4 children, 2 of them (the second generation) are actively involved in the business. His elder son Rahul Kanodia holds the post of Vice Chairman & CEO whereas his younger son Sameer Kanodia is the executive director. His two daughters are married. His wife Smt. Asha Kanodia is also the woman director on the Board (she has designed most of the offices of the company and holds an interest in designing).

It is good to see that the full family is actively involved in the workings of the business. With the second generation actively working in the day-to-day operations of the business, it is safe to presume that they take the company forward after Dr Kanodia retires. The family relationship is also mentioned in the annual report.

Dr Kanodia also holds several directorships in other linked companies the significant one is RPG Life Sciences.

Rahul Kanodia holds similar cross-linked directorships with a board seat on Safari (Industries)

Under their leadership, Datamatics Global Services Ltd has won several prestigious awards for product innovation, design and implementation, and solving problems in the complex fast-growing world.

The management holds 73% of the company, which gives us some comfort that there is enough skin in the game.

3) Opportunity Size:

The internet industry in India was likely to reach US$ 250 billion by 2020, growing to 7.5 percent of the GDP. The public cloud services market in India is slated to grow 35.9 percent to reach US$ 1.3 billion, according to Gartner. The Indian Healthcare Information Technology market is valued at US$ 1 billion currently and is expected to grow 1.5 times by 2020. India’s business-to-business (B2B) e-commerce market is expected to reach US$ 700 billion by 2020 whereas the business-to-consumer (B2C) e-commerce market is expected to reach US$ 102 billion by 2020.

4) Competitive Environment in Business of Datamatics Global Services Ltd:

The management states the following in their reports: During the financial year, the margins of the Company have been reduced because of the increase in various costs.

This shows that the business does not have the power to pass on these increases in costs to the customer. As stated, the company deals in a competitive environment.

5) Remuneration of Promoters/management:

Management remuneration for Datamatics Global is on the higher side of 4.5% of net profits. The business is growing on the revenue front with a 12-13% rate but all the cash flow the management is able to generate has to be invested back into the business for further growth. Taking salary on the higher side should be taken with a pinch of salt.

6) CSR Spends by Datamatics Global Services Ltd:

The net profits for the company were 640.9 million. The CSR Spend as per the stipulated rules should be 6.81 million. The company only spent 1.48 million and the balance 5.33 million, they are unable to find good virtues to spend or it indicates the lack the willingness of the management.

7) Related Party Transactions:

Datamatics Global Services Ltd has not entered into any significant related party transactions last year that could be considered significant as per companies related transaction policy as stated in AR. However, while reading the related party transactions detail notes, it is found that Datamatics Global Services Ltd has incurred expenses for their subsidiary to the extent of 3 Cr, which is not that significant seeing the operations of the company.

H) The points of concern related to Datamatics Global Services Ltd are:

• First, they incurred expenses for their related parties to the extent of 8 Cr in fy15 then 4.2 Cr in fy16 then 3.4 Cr in fy17. 15-16 Cr in 3 years.
• Second, Datamatics Global Services Ltd has provided corporate guarantees of 19-20 cr for loans given to subsidiaries.
• Third, they invest in their subsidiaries to the extent of and from next year onwards provides for diminishing value of investments by 6.5 cr then 13 cr, which adds up to 19.5 cr eventually they write off these investments in their subsidiary in 2016 by 2.3 Cr and 19.5 Cr in 2017.

Reading these notes in the reports gives the impression that the management is more concerned about their other business in their capacity rather than generating shareholder value in Datamatics Global Services Ltd.

Though reading the subsidiary reports can give one a better understanding of the said transactions.

I) Loans and Advances & Receivables of Datamatics Global Services Ltd:

1) Trade Receivables:

It looks like Datamatics Global Services Ltd has to face delays in collecting from subsidiaries. The quantum of which has risen over the years. Loans are given interest-free and then accounted for diminishing value.

J) Investments of Datamatics Global Services Ltd:

It is strange to see that the company has increased its investment in its subsidiary Lumina Datamatics Limited from 57 Cr in 2016 to 90.7 Cr in 2017 and the said subsidiary hardly generates any revenue.

Datamatics Global Services Ltd has also increased its investment in unquoted preference shares of this Datamatics Global Services Pty Ltd (DGSPL), which have increased from 9 Cr to 13 Cr over the years. DGSPL also has negligible (following revenue from fy16-17) revenue as compared to the size of the operations of the company.

The revenue was generated in FY17-18 by these investments. We should contact the management and ask for more clarity about these investments.

Dr Vijay Malik’s Response

Hi Gurjeev,

Thanks for sharing the analysis of Datamatics Global Services Ltd with us! We appreciate the time & effort put in by you in the analysis.

While analyzing the past financial performance data of Datamatics Global Services Ltd, an investor would notice that the company has created many subsidiaries and joint venture companies in India and abroad. As a result, Datamatics Global Services Ltd provides both standalone financials as well as consolidated financials in its annual reports.

We believe that while analysing any company, the investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire group. Therefore, while analysing Datamatics Global Services Ltd, we have analysed its consolidated financials.

Further advised reading: Standalone vs Consolidated Financials: A Complete Guide

Let us analyse the financial and business performance of Datamatics Global Services Ltd over FY2010-2019.

Financial and business analysis of Datamatics Global Services Ltd:

While analyzing the financials of Datamatics Global Services Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 15%-20% year on year. Sales of the company increased from ₹263 cr. in FY2010 to ₹1,133 cr in FY2019. The sales of the company have witnessed a consistent increase year on year over the last 10 years, except in FY2016 when the sales of the company declined marginally by 1.5%. However, when an investor analyses the profitability of the company, then she notices that the operating profit margin (OPM) of the company has seen large fluctuations in the past.

The OPM of the company was 8% in FY2010, which decreased to 6% in FY2011. The OPM then increased to 12% in FY2014 only to decline again to 9% in FY2016. In FY2019, the company witnessed the OPM increase to 12%. Such fluctuations in the OPM lead an investor to a deeper analysis of the annual reports to understand the reasons behind them.

Datamatics Global Services Ltd has provided its annual reports since FY2008 on its website. While reading these past annual reports of the company since FY2008, an investor notes that the decline in OPM of the company in FY2011 was not an isolated case of decline in one financial year. In fact, the OPM of the company has been in a consistent decline since FY2005.

FY2008 annual report, page 8:

As per the company, its OPM declined from 25% in FY2005 to 16% in FY2008. The company highlighted that the reasons for the decline in OPM are operating expenses like employee costs and rupee appreciation.

FY2008 annual report, page 12:

The profit after tax declined by 32.09% due to increase in manpower costs, higher tax provision and appreciation of the Rupee. The consolidated profit after tax was Rs. 91.99 million compared to Rs. 130.74 million.

An investor would appreciate that Datamatics Global Services Ltd witnessed a significant decline in its profitability due to an increase in key operating costs like employee expenses. It indicates that the company has a low negotiating power with its customers where it is not able to pass on the rising costs to its customers whether due to higher employee salaries or rupee appreciation. As a result, the company has to take a hit on its profit margins.

When an investor studies the past financial performance of Datamatics Global Services Ltd further, then she notices that the OPM of the company increased in FY2009; however, soon thereafter, it again started declining.

FY2010 annual report, page 6:

Further advised reading: Understanding the Annual Report of a Company

When an investor analyses the FY2009 annual report to understand the reasons for improved performance in FY2009, then she notices that the improved performance is primarily due to the amalgamation of many companies done by Datamatics Global Services Ltd as well as due to favourable movement of foreign exchange.

FY2009 annual report, page 2:

Some of the reasons for the good performance of the Company have been the merger of our Companies, which has reduced the common overhead expenses.

The investor notices that the improved performance is not due to the improved business strength/negotiating power of the company. Instead, Datamatics Global Services Ltd acknowledged in the same annual report (FY2009) that the company is facing pricing and margin pressure from its customers.

FY2009 annual report, page 2:

There have been pricing and margin pressures. Clients have reduced IT spends and protectionism in some countries is growing.

An investor would notice that the OPM of the company was in a consistent declining phase since FY2005. It witnessed an improvement in FY2009 due to the amalgamation done by the company of its subsidiaries. After FY2009, the profitability of the company again started declining and it continued the declining trend until FY2011. It indicates a long trend of declining profit margins of the company, which apparently seems due to low negotiating power in the hands of Datamatics Global Services Ltd over its customers. As a result, the company is not able to pass on increasing costs to its customers and whenever the costs increase, then it has to take a hit on its profit margins.

By analysing the declining profit margins of the company and noticing the inability of Datamatics Global Services Ltd to pass on the increase in costs to the customers, an investor would appreciate that its customers are well-established large players in banking, insurance, and securities segments. These customers are very large companies who always have many IT suppliers chasing them in order to a share of their business. Moreover, these companies have their own in-house research & development centres in low-cost countries like India, which also act as competition to other IT services companies.

CRISIL in its report for Datamatics Global Services Ltd in May 2017 highlighted that the IT services companies are facing intense competition among themselves as well as from the offshore units of their customers.

Indian IT players will need to scale up their operations, primarily because of intense competition among themselves and also from global multinationals that are expanding their offshore operations in India.

Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

As a result, it is not possible for the IT service providers who rely on the outsourcing of business from large players to increase prices whenever there is an increase in costs. Moreover, there is continuous pressure from the customers on IT service providers to reduce pricing in order to generate higher savings. Customers who are large established players in their industry frequently renegotiate contracts. In the light of intense competition, such renegotiations make it challenging for the IT service providers to retain business as well as profitability.

In FY2016, the revenue of Datamatics Global Services Ltd when one of the large customers significantly reduced its business to the company. FY2016 annual report, page A67:

Decrease in revenue is mainly on account of certain projects coming to a natural end and one of the largest revenue contributing client of one of our subsidiary Company’s reducing the business substantially.

As a result, an investor would acknowledge that the company is continuously under pressure from its customers to reduce its profit margins. The company acknowledged the pricing pressure from customers on multiple occasions like FY2010.

FY2010 annual report, page 24:

The major revenues of our Company are from US and some of our customers are in the Banking, Finance, Securities and Insurance segment. Your Company is also facing price reduction pressure from its customers in the wake of the global slowdown.

The company highlights that the key customers of the company are in the banking, securities and insurance sectors, which are putting pressure on the company to reduce its prices and profit margins. Investors would acknowledge that usually, the players in the banking and insurance segment who outsource their information technology business are very large players who wield a higher negotiating power over IT services companies (suppliers).

In FY2011, Datamatics Global Services Ltd again highlighted that its profits have declined due to an increase in costs. An investor can identify the inability of the company to increase prices to its customers to maintain its profitability during such times.

FY2011 annual report, page 7:

The decline in profit after tax was due to foreign exchange fluctuation and increased cost due to inflation.

FY2011 annual report, page 11:

The decline in profit after tax was due to foreign exchange fluctuation coupled with modest increase in revenues and increase in employee costs.

In FY2015, Datamatics Global Services Ltd highlighted that despite an increase in revenue, its profit margins declined due to higher costs. FY2015 annual report, page 17:

The operating margins came under pressure this year due to increase in costs, mainly on account of sales and marketing investments, finance cost of borrowing ECB and change in depreciation rates under the new Companies Act, 2013.

The credit rating agency, CRISIL, has also highlighted in its report of December 2015 that Datamatics Global Services Ltd is not able to pass on the increasing employee costs to its customers and as a result, has witnessed a significant decline in its profit margins.

Subdued revenue, coupled with increased employee costs, has impacted profitability as reflected by the reduction in operating margin to 7.0 percent from 12.5 percent during this period

Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

The pricing pressure on the company has been continuous and as a result, the company communicated to the shareholders in FY2018 that the profit margins in its business segments of business process outsourcing (BPO) and software services are declining.

FY2018 annual report, page 14:

Fourth, to circumvent reducing margins in both BPO and Software Services, we need to move up the value chain through development of intellectual property and Software products.

As per the above discussion, an investor would appreciate that IT service providers usually do not have strong negotiating power with their customers. As a result, the IT service providers like Datamatics Global Services Ltd, do not possess the ability to increase prices to their customers whenever their costs (like employee salaries) go up. This is because an increase in prices by an IT service provider may undermine the entire basis of outsourcing of business, which is to generate savings for the large customers. If a large customer is not able to see savings in outsourcing a part of its business to an IT service provider, then it may very well do that business in-house. Moreover, the IT service field is intensely competitive and if one IT service provider is not able to accept one business, then it is not very difficult for the customer to find another IT service provider to do the business at acceptable terms.

Further advised reading: How to do Business Analysis of a Company?

As a result, an investor would notice that many times an increase in the business performance of IT service providers is due to factors like mergers & amalgamations and the depreciation of INR against USD. Even in the case of Datamatics Global Services Ltd, an investor notes that the key factors leading to improved business performance are inorganic growth (mergers & amalgamations) and currency fluctuations. Many times, the organic business growth contributed very little to the business growth.

Let us see a few examples where the primary reason for the improved business performance of Datamatics Global Services Ltd was inorganic growth (mergers & amalgamations) and depreciation of INR against USD.

In FY2009, the revenue of Datamatics Global Services Ltd grew primarily due to amalgamations & depreciation of the rupee. FY2009 annual report, page 9:

The overall increase in the standalone and consolidated revenues is primarily due to amalgamation of other companies in the Datamatics group as elaborated later in this report and also due to rupee depreciating against US dollar combined with prudent forex management by the Company.

In FY2012, out of the total increase in revenue, 96% was due to acquisitions and rupee depreciation, and only 4% was due to organic growth of the business. FY2012 annual report, page 52:

Total business revenue increased by 60.5% from ₹ 2753.22 million in 2010 – 2011 to ₹ 4418.91 million in 2011 – 2012. Of the total increase of ₹ 1665.69 million, ₹ 1360 million is attributed towards increase in revenue due to inorganic growth via two acquisitions viz. CIGNEX and Vista. The balance is due to organic growth of ₹ 63.91 million and currency depreciation by ₹ 241.79 million.

The company has clearly highlighted that out of the total increase in revenue of ₹166 cr; only ₹6 cr (4%) is due to organic growth. The remaining ₹160 cr (96%) is contributed by two acquisitions (₹136 cr, 82%) and rupee depreciation (₹24 cr, 14%).

In FY2014, the revenue growth was driven primarily by the recent acquisitions done by Datamatics Global Services Ltd. FY2014 annual report, page 14:

A large part of this increased revenue has come from the businesses acquired by the Company in the last two years. The digital publishing business under Lumina Datamatics, formed by the merger of Pre Media Global and Datamatics’ eRetail & Publishing Limited in 2013, contributed handsomely to the revenues of the Company.

From the above discussion, an investor may notice that the core business of outsourcing information technology (IT) & software services has intense competition. Many IT service players and offshore units of multinational companies compete for the outsourcing business and in turn, undercut the profit margins of each other. As a result, IT services companies find it very difficult to maintain profit margins and grow the business.

Their customers continuously put pressure on them to reduce prices whereas their employees continuously put pressure on them to increase salaries (employee costs are one of the largest expenses for IT service providers). The result of this continuous tussle is that the companies attempt to keep employee costs as low as possible.

IT service companies attempt to keep the salaries of employees at the minimum possible levels, which leads to a lot of churn in their employees who leave the companies soon to join higher-paying opportunities. This is one of the reasons for higher employee attrition levels for IT service companies including Datamatics Global Services Ltd.

In order to keep the employee costs low, Datamatics Global Services Ltd has started to focus on hiring employees in tier-2 cities like Nashik and Puducherry where the employee costs are low.

FY2012 annual report, page 53:

To counter the adverse effect of increasing inflation and rising salary costs, we are actively moving work to tier II cities. The main cost in our business is people cost and, as salary costs are lower in tier II cities, it will help offset the rising salary and inflationary pressures.

Rising employee costs are one of the key challenges for IT services companies as it leads to lower profitability in light of their inability to pass on costs to their customers. Different companies resort to different strategies to keep employee costs low.

In the case of another IT services company, Cyient Ltd, we noticed that the company was focusing more on hiring as many engineering graduates fresh out of the college, as possible. The company focused so much on hiring fresh graduates that it finally faced delays in completing customer projects due to the lack of a workforce with sufficient experience and skills.

Analysis: Cyient Ltd

Therefore, an investor would notice that IT services companies operate in a very tough business environment. There is continuous pressure from the customers to reduce costs, as the lower cost is the biggest basis of the business in outsourcing; otherwise, the customer will get the work done from its own employees. On the other hand, the employees of IT service companies expect a better salary and leave the company soon after gaining some experience.

The quest to satisfy the customer with lower prices and retain the employees by paying higher salaries puts the IT services company in a difficult spot where many times, they are not able to fulfil customer orders due to a lack of relevant employee resources or have to compromise with lower profit margins by hiring experienced employees at a higher salary.

Further advised reading: Analysis Framework for IT Services Companies

Over the years, Datamatics Global Services Ltd has witnessed its profit margins decline and the organic growth slowed down. As a result, the company has consistently relied upon acquisitions, mergers, and amalgamations to generate business growth. It remains to be seen whether, in future, the growth of the company will be the organic growth from the expansion of its core services or it will be from more acquisitions and amalgamations.

Moreover, it remains to be seen whether Datamatics Global Services Ltd is able to improve its operating profit margins in the light of an intensely tough business environment faced by it.

The net profit margin (NPM) of the company has followed the trend of its operating profit margin except for the fact the relative decline in the NPM has been lower due to better management of tax payout by the company.

While analyzing the tax payout ratio of the company, an investor would notice that it has a tax payout ratio, which is lower than the standard corporate tax rate prevalent in India. The key reason for the lower tax payout ratio is the incentives that the company gets due to the export of services as well as the location of its development operations in special economic zones like SEEPZ (Santacruz Electronics Export Processing Zone).

FY2019 annual report, page 63:

Further advised reading: How to do Financial Analysis of Companies

Operating Efficiency Analysis of Datamatics Global Services Ltd:

a) Net fixed asset turnover (NFAT) of Datamatics Global Services Ltd:

Datamatics Global Services Ltd is an IT services company, where the revenue primarily depends on the design/software work done by computer engineers. In such cases, the fixed assets of the company are not a key determinant of the revenue-generating ability of the company. This is because the revenue-generating unit of the company is an engineering professional working on a computer system. The value of the fixed asset (the computer) is hardly a determining factor for revenue that can be generated by the employee working on the computer. Moreover, other fixed assets like buildings etc. also do not have a direct relationship with revenue-generating ability because companies can easily fit in more employees within existing buildings by optimally utilizing the space.

Therefore, we believe that in IT services companies the net fixed asset turnover (NFAT) may not be the best parameter to determine the revenue-generating ability.

Nevertheless, even if an investor wishes to assess the ability of Datamatics Global Services Ltd to utilize its assets efficiently, then she notices that the NFAT of the company has consistently been in the range of 3.00-3.50 over the last 10 years. A stable NFAT indicates that the company has maintained its efficiency of using its fixed assets over the years without any significant deterioration.

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

b) Analysis of inventory turnover ratio of Datamatics Global Services Ltd:

Datamatics Global Services Ltd is an IT services company, which provides software solutions to its customers. In its services business, it does not need to keep any inventory. Therefore, the company does not contain any inventory for any of the last 10 years from FY2010-FY2019. The lack of inventory has been highlighted by the auditor in its report of the company every year including FY2019.

FY2019 annual report, page 118:

The Company’s nature of operations does not require it to hold inventories. Consequently, clause 3(ii) of the order is not applicable.

Read on: How to Assess Operating Efficiency of Companies

c) Analysis of receivables days of Datamatics Global Services Ltd:

Over the years, the receivables days of Datamatics Global Services Ltd have been within the range of 70-75 days except during FY2012-2014 when the receivables days declined to 60-65 days. It indicates that largely, the company has been able to keep its receivables under control and as a result, it could save its money from being stuck in working capital.

Further Advised Reading: Receivable Days: A Complete Guide

This aspect of the business of Datamatics Global Services Ltd gets established when an investor compares the cumulative net profit after tax (cPAT) of the company with its cumulative cash flow from operations (cCFO) for FY2010-19. She notices that the company has been able to convert its profits into cash flow from operations.

Over FY2010-19, Datamatics Global Services Ltd has reported a total cumulative net profit after tax (cPAT) of ₹446 cr. and during the same period, it reported cumulative cash flow from operations (cCFO) of ₹466 cr.

It is advised that investors should read the article on CFO calculation mentioned below, which would help them understand the situations in which companies tend to have the CFO lower than their PAT and the situations when the companies tend to have a CFO higher than their PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

Margin of Safety in the Business of Datamatics Global Services Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Further advised reading: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

While analysing the SSGR of Datamatics Global Services Ltd, an investor would notice that the company has an SSGR ranging from 10% to 15% over the years.

While studying the formula for the calculation of SSGR, an investor would understand that the SSGR directly depends on the net profit margin (NPM) and dividend payout ratio of a company.

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

• SSGR = Self Sustainable Growth Rate in %
• Dep = Depreciation rate as a % of net fixed assets
• NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
• NPM = Net profit margin as % of sales
• DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

An investor would notice that the SSGR of Datamatics Global Services Ltd (10%-15%) is less than the sales growth of 15%-20% achieved by the company over the years. As a result, the company seems to have raised debt to meet its funds’ requirements for multiple acquisitions and expansions of its development centres in Nashik and Puducherry.

The total debt of Datamatics Global Services Ltd increased from ₹4 cr in FY2010 to about ₹90 cr during FY2014-2016. The total debt has declined to ₹36 cr in FY2019 indicating an overall increase of ₹32 cr over the last 10 years (FY2010-2019). The increase in debt is despite the presence of cash & investment of ₹130 cr available with the company on March 31, 2019.

Going ahead, an investor should keep a close watch on the debt levels of the company and monitor whether Datamatics Global Services Ltd continues to meet the fund requirements of its DLM business by raising more debt or it uses its cash balance for the same.

b) Free Cash Flow Analysis of Datamatics Global Services Ltd:

While looking at the cash flow performance of Datamatics Global Services Ltd, an investor notices that during FY2010-19, the company had a cumulative cash flow from operations of ₹466 cr. However, during this period it did a capital expenditure (capex) of ₹430 cr. As a result, it had a free cash flow of ₹36 cr. (466 – 430).

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Moreover, an investor would notice that Datamatics Global Services Ltd has kept debt on its books for the last 10 years (FY2010-19), which needs interest payments. Over the last 10 years, the company reported an interest expense of ₹45 cr. As a result, an investor notices that after interest payments, Datamatics Global Services Ltd did not have any surplus. On the contrary, it has a deficit of ₹(9) cr. after meeting interest expenses (36 – 45).

In such a situation, an investor would notice that the cash flow from operations (CFO) of Datamatics Global Services Ltd is not sufficient to meet its dividend payouts of ₹55 cr excluding dividend distribution tax, over the years (FY2010-2019). Moreover, during this period, the company has reported an increase in its cash and investments by ₹61 cr, from ₹69 cr in FY2010 to ₹130 cr in FY2019.

In the absence of any surplus from the CFO, an investor would notice that the dividends and increase in cash & investments are a result of its non-operating/other income. The company reported a non-operating income of ₹138 cr over FY2010-19.

Therefore, an investor would appreciate that Datamatics Global Services Ltd has consumed its entire cash flow from operations and a part of incremental debt to meet its capital expenditure & debt servicing over the years. As a result, the company did not have any surplus from operations to distribute to its shareholders. The company has relied upon its cash & investments to generate non-operating income, which helped the company to pay dividends to the shareholders. Therefore, entire payouts to the shareholders seem to be out of the non-operating income.

In light of the above position, it remains to be seen whether Datamatics Global Services Ltd would be able to generate surplus cash from its operations in the future or the non-operating income will be the source of payouts to the shareholders.

Free cash flow (FCF) is one of the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Additional aspects of Datamatics Global Services Ltd:

On analysing Datamatics Global Services Ltd, an investor comes across certain other aspects of the company, which are essential to know for any investor.

1) Management Succession of Datamatics Global Services Ltd:

While analysing Datamatics Global Services Ltd, an investor notices that Rahul Kanodia (aged 52 years), Vice Chairman & CEO of the company is the son of its founder promoter, Mr. Lalit Kanodia, (aged 78 years), who is currently working as Chairman of the company.

FY2019 annual report, page 54:

Mr. Rahul L. Kanodia and Mr. Sameer L. Kanodia are sons of Dr. Lalit S. Kanodia and Mrs. Asha L. Kanodia.

It indicates that Datamatics Global Services Ltd has put in place a management succession plan in which the new generation of leaders are being groomed in business while the senior members are still playing an active part in the day-to-day activities.

The presence of a well thought out management succession plan is essential in businesses as it provides for a smooth transition of leadership over the generations and provides continuity in the business operations of any company.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

2) The curious case of compulsory convertible preference shares (CCPS) worth ₹77 cr:

While reading the FY2014 annual report, an investor notices that Datamatics Global Services Ltd has raised money by issuing compulsory convertible preference shares (CCPS) worth ₹77 cr in one of the subsidiary companies.

FY2014 annual report, page 67:

Read: A Guide to Basics of Preference Shares / Preferred Shares

This issuance of CCPS comes as a surprise to the investor because as per the reported financials, Datamatics Global Services Ltd has always been a cash-rich company. At the end of FY2013, the company had a cash & investment balance of ₹87 cr, which increased to ₹136 cr at the end of FY2014.

An investor may believe that Datamatics Global Services Ltd might have raised the money by CCPS if it was a very low-cost source of funds. A low-cost source of funds may provide the company with interest rate arbitrage where the company can put this money in safe investments like fixed deposits with banks so that the company can earn a risk-free interest difference.

However, after reading further about the terms of the CCPS an investor notices that the CCPS provides for a reasonable return to the subscribers/investors in the form of an internal rate of return (IRR) of 9% to 16% per annum. FY2014 annual report, page 67:

Conversion / exit terms: In call option, the holders of the compulsorily convertible preference shares at any time after expiry of the lock in period and prior to September 30, 2015 (call option period), Datamatics Global Services Limited (DGSL) shall be entitled (but not be obligated) to exercise an option either by itself or through any affiliate  to call upon the investors to sell all (and not less than all) their respective preference shares to DGSL and/or its Affiliate, which shall be a price per share which will yield an IRR of 16% per annum on the investor amount.

In put option, in the event of DGSL does not exercise the call option prior to the completion of the call option period, the investors shall have (1) the right to convert their respective preference shares into equity shares of LPSPL at conversion price determined based on the conversion ratio as specified in the Articles of association or (2) at any time after expiry of the call option period, but prior to December 31, 2015 (put option period), the right to exercise an irrevocable option (the put option) to require DGSL to purchase, either directly or through an Affiliate, all (and not less than all) their outstanding preference shares held by the investors at a price per share which will yield an IRR of 9% per annum on the investor amount.

Notwithstanding anything contained herein preference shares shall be compulsorily converted into equity shares of LPSPL after a period of 20 years from the date of issue of such preference shares

The above information indicates that the CCPS have stipulated call and put option:

• Datamatics Global Services Ltd may ask the investors/subscribers of CCPS by September 30, 2015, to sell these shares to it and in turn, Datamatics Global Services Ltd will provide a 16% return per annum (IRR) to the investors.
• The investors may ask Datamatics Global Services Ltd to purchase the CCPS/convert them into shares by December 31, 2015, and in turn, Datamatics Global Services Ltd will provide them with a return of 9% per annum (IRR).

Therefore, an investor would appreciate that Datamatics Global Services Ltd has raised the money from CCPS by guaranteeing a short-term return of 9% to 16% to the CCPS subscribers.

On further analysis, an investor notices that in FY2017, Datamatics Global Services Ltd exercised its option to purchase the CCPS from the subscribers and as a result, the CCPS ceased to exist in the balance sheet.

FY2017 annual report, page 103:

The above information indicates that Datamatics Global Services Ltd has exercised its option (i.e. asked the subscribers to sell the CCPS to it). While reading the FY2017 annual report, an investor gets to know that the company had issued the CCPS for ₹77 cr and it had purchased/bought them back at a price of about ₹47 cr. (₹22 cr + ₹25 cr).

FY2017 annual report, page 90:

Attention is drawn to Note no. 34 wherein a subsidiary of the Company, had issued preference shares worth ₹ 771.76 million to outside shareholders in earlier year. During the year, the same was purchased / bought back by the Company/subsidiary for ₹ 217.80 million and ₹ 250 million respectively, resulting in total exceptional gain of ₹ 303.96 million. Considering the fact that preference shares are a financial liability and bought back from outside shareholders, the resultant gain is recognised as exceptional gain in the Consolidated statement of Profit and Loss

The above data indicate that Datamatics Global Services Ltd bought back the CCPS at a price of ₹47 cr. (₹22 cr + ₹25 cr) and as a result, it recognized a gain of ₹30 cr (30 = 77 – 47) on this transaction. The company reported a gain because it paid back only ₹47 cr against ₹77 received by it when it issued CCPS.

As per the original terms of the CCPS, an investor would remember that in the situation when Datamatics Global Services Ltd asks the subscribers to sell the CCPS to it, then it had to give a return of 16% per annum (IRR) to the subscribers. However, this guaranteed return was applicable only until September 30, 2015, whereas the company bought back the CCPS in FY2017. Therefore, it may seem to the reader that Datamatics Global Services Ltd is no longer bound to give the guaranteed return of 16% to CCPS subscribers.

However, if an investor notices that over the period during which CCPS were outstanding i.e. FY2014 to FY2017, the performance of Datamatics Global Services Ltd had improved as indicated by the following parameters:

• Total sales of the company increased from ₹734 cr in FY2014 to ₹852 cr in FY2017.
• Net profit after tax (PAT) of the company increased from ₹49 cr in FY2014 to ₹65 cr in FY2017.
• The total debt of the company declined from ₹91 cr in FY2014 to ₹55 cr in FY2017.
• The cash & investments of the company increased from ₹134 cr in FY2014 to ₹140 cr in FY2017.
• The share price of Datamatics Global Services Ltd increased from ₹49.30 on March 31, 2014 (closing price on BSE) to ₹128.15 on March 31, 2017 (closing price on BSE) representing an increase of about 160%.

In light of all these positive developments related to Datamatics Global Services Ltd from FY2014 to FY2017, it comes as a surprise that the subscribers of the compulsory convertible preference shares (CCPS) agreed to take a loss of ₹30 cr on their investment of ₹77 cr in CCPS.

It seems counterintuitive that the subscribers of CCPS had to take a loss on their investment while the business performance of Datamatics Global Services Ltd is improving and its share price is increasing. In addition, the CCPS subscribers had an option to convert the CCPS to equity shares and then sell these shares in the stock market to recover their investment. When the share price of Datamatics Global Services Ltd increased by 160% from FY2014 to FY2017, then it is difficult to understand why the CCPS subscribers took a substantial loss of about 40% on their investment (30/77 = 39%).

Further advised reading: How Companies Inflate their Profits

It is advised that investors may do further analysis of the CCPS transaction and may contact the company directly to understand more about the reasons why the CCPS subscribers accepted a loss while the business, as well as the stock price performance of the company, was improving.

3) Loans taken by Datamatics Global Services Ltd from its promoters despite being a cash-rich company:

While doing the financial analysis of the company, an investor notices that Datamatics Global Services Ltd has been a cash-rich company throughout the last 10 years (FY2010-2019). The cash & investments of the company have increased from ₹69 cr in FY2010 to ₹130 cr in FY2019. During this period, the cash & investments peaked at ₹193 cr in FY2016. Looking at such a cash-rich situation, an investor may believe that the company does not need to look for outside sources of cash to meet its requirements.

However, when an investor reads past annual reports, then she notices that Datamatics Global Services Ltd has taken loans from its directors, which are promoters of the company at an interest rate of 9%.

FY2016 annual report, page A85:

When an investor reads the related party transactions section of the annual report, then she notices that the above loan is provided by the promoters’ family members to the company.

FY2016 annual report, page A102:

The loans from the promoters appear in other years also like in FY2019.

FY2019 annual report, page 95:

These instances of taking loans from promoters and paying them interest seem counterintuitive for any cash-rich company. It may be due to any of the following situations:

a) Promoters want to make higher returns on their money by lending it to Datamatics Global Services Ltd:

Lending by the promoters to the company may indicate a situation where the promoters are flush with funds and are not finding opportunities to deploy those funds anywhere else at attractive rates of return. Therefore, they had lent this money to Datamatics Global Services Ltd and in turn ensured that they get an interest income from Datamatics Global Services Ltd, which is higher than the interest income available to them outside.

From the above discussion, an investor notices that the company paid an interest rate of 9% to the promoters for the loan taken by it. The interest rate available for deposits in the banking system currently ranges from 4.50% to 6.70% (August 26, 2019) (Source: SBI Website)

The lending of money by the promoters to Datamatics Global Services Ltd might indicate that the promoters are getting an interest rate of about 9% from the money put in by them into Datamatics Global Services Ltd against the interest rate of about 6%, which they might get when they put money as deposits in the banks.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

b) Liquidity stress in Datamatics Global Services Ltd:

One interpretation can be that the company faced liquidity stress, as it might not be making sufficient cash from its business to meet the requirements of its operations and the debt repayments to lenders. As a result, the promoters had to infuse money into the company to support its operations and debt repayments to outside lenders.

This interpretation would lead an investor to believe that if the promoters do not lend the money to the company, then the company would find it difficult to run its operations and it might default to the outside lenders.

Additionally, this interpretation will question the credit rating of A1 assigned by CRISIL and ICRA to Datamatics Global Services Ltd. The credit rating of A1 indicates a strong financial position with a low probability of default.

However, an investor would notice that in recent times, she would have seen cases where companies with a high credit rating as well as with high cash & investments defaulted to their lenders.

• IL&FS defaulted despite a high credit rating: An investor may remember the case of IL&FS, which defaulted to its lenders in FY2019. The company was rated AAA (highest safety) about two months before it defaulted. (Source Times of India: Why IL&FS was ‘AAA’ till two months ago)
• Cox & Kings defaulted despite having high cash & investments: An investor may also recollect the case of Cox & Kings, which defaulted recently on repayments of a few hundred crores rupees despite having cash & investments of thousands of crores rupees. (Source Moneycontrol: Defaults raise a curious case of mismatch at Cox & Kings)

The above two examples indicate that in the current environment neither a high credit rating nor the presence of high cash & investments can ensure a strong liquidity position for the company. Therefore, investors must stay vigilant when they analyse companies for investment.

Therefore, an investor would notice that the loan given by promoters to Datamatics Global Services Ltd might indicate a situation where the company is facing cash flow constraints to run operations and repay outside lenders. On the other hand, if Datamatics Global Services Ltd has a strong cash flow position to run its operations smoothly and has the ability to repay all its outside debt on its own, then the loans from promoters might indicate an attempt by them to get higher interest rates on their money than the deposit rates from banks.

We would suggest that the readers/investors may contact the company directly to seek clarification and should do further analysis to arrive at their own conclusion regarding it.

4) The curious case of “Other receivables” of Datamatics Global Services Ltd:

While analysing past annual reports of the company, an investor notices that Datamatics Global Services Ltd has shown large amounts of money as “other receivables”.

The company had other receivables of ₹65 cr in FY2010, which had increased from ₹45 cr in FY2009.

FY2010 annual report, page 34:

While reading the annual reports, an investor also notices that the company has not provided additional details about these receivables/loans in terms of the counterparties who have taken these loans, whether these are interest-bearing loans and whether the counterparties are repaying these loans & interest on time.

In FY2011, the other receivables declined to ₹38 cr from ₹65 cr in FY2010. FY2011 annual report, page 41:

Further advised reading: Understanding the Annual Report of a Company

After the application of the Companies Act 2013, an investor notices that in later years FY2012 onwards, the “other receivables” seem to have been reclassified as a combination of “Inter-Corporate deposits” and “other receivables”.

FY2013 annual report, page 62:

From the above data an investor would notice that in FY2010, the other receivables/loans & advances of the company increased by ₹20 cr (an outflow) and in FY2011, the other receivables/loans & advances decreased by ₹27 cr (an inflow). However, when an investor analyses the cash flow statement of Datamatics Global Services Ltd for these years, then she is not able to find relevant entries in the cash flow statement to reflect an outflow of ₹20 cr in FY2010 and an inflow of ₹27 cr in FY2011. The cash flow statement does not have such entry in cash flow from operations or investment or financing activities.

FY2011 annual report, page 52:

Further advised reading: Understanding Cash Flow from Operations (CFO)

As a result, an investor is not able to ascertain the nature of these advances/receivables where effectively crores of rupees are moving in & out of the company. Moreover, the absence of related entries in the cash flow statement confuses the investor further about the movement of money in the situations when the “other receivables” increased in FY2010 and declined in FY2011.

5) The curious case of frequent corporate restructuring/amalgamation by Datamatics Global Services Ltd and finally, public shareholders telling the company that they have had enough!

While analysing the past business performance of the company, an investor notices that over the years, the company has resorted to mergers/amalgamation of its subsidiaries, joint ventures, and acquisition of promoter group companies on a frequent basis.

Datamatics Global Services Ltd did many such mergers, demergers, and amalgamation transactions that finally in 2019, when the company approached public shareholders with another set of restructuring proposals, then they straightaway rejected it.

Let us see some of these restricting exercises concluded by the company in the past. As per the discussion above, on many occasions, these amalgamations have been the source of improvement in the reported performance of the company.

In FY2008, Datamatics Global Services Ltd resorted to a merger cum demerger cum amalgamation, in which multiple group companies and their divisions became a part of the restructuring of the group.

FY2008 annual report, page 26:

Scheme of Arrangement with Group Companies: 

The Scheme envisages the amalgamation of Sameer Microtronics Private Limited, Bellona Infotech Private Limited, Datamatics Limited and Datamatics Intercon Limited into Datamatics Technologies Limited and demerger of Export Division of Datamatics Software Services Limited into Datamatics Technologies Limited. Further, for consolidation of domestic operations, the Scheme also provides for amalgamation of Datamatics Softworld Limited and Datamatics Software Solutions Limited into Datamatics Software Services Limited [Without Export Division]. The Scheme provides that the appointed date shall be April 1, 2008. Pursuant to the Scheme, the equity shareholders of Datamatics Limited will receive 1.21 fully paid up equity shares of Datamatics Technologies Limited of Rs.5/- each in exchange of every 1 fully paid up equity share of Rs.10/- each of Datamatics Limited.

As per the disclosure:

• Sameer Microtronics Private Limited, Bellona Infotech Private Limited, Datamatics Limited and Datamatics Intercon Limited merged into Datamatics Technologies Limited
• Export Division of Datamatics Software Services Limited demerged into Datamatics Technologies Limited and
• The amalgamation of Datamatics Softworld Limited and Datamatics Software Solutions Limited into Datamatics Software Services Limited [Without Export Division].

After this complicated set of corporate rearrangements, the company reported an increased revenue next year in FY2009. FY2009 annual report, page 9:

The overall increase in the standalone and consolidated revenues is primarily due to amalgamation of other companies in the Datamatics group as elaborated later in this report and also due to rupee depreciating against US dollar combined with prudent forex management by the Company.

In FY2010, Datamatics Global Services Ltd did another round of mergers/amalgamation. FY2010 annual report, page 69:

Company’s two wholly owned subsidiaries in the US, namely Datamatics Infotech Inc and Datamatics America Inc merged with and into Datamatics Technologies Inc. [wholly owned subsidiary of the Company in the US] with effect from April 01, 2009. The name of Datamatics Technologies Inc. was subsequently changed to Datamatics Global Services Inc.

In FY2011, the subsidiaries of Datamatics Global Services Ltd entered into a slump sale agreement for transferring the business as a part of another restructuring exercise. FY2011 annual report, page 12:

The two subsidiaries of your Company, namely, Datamatics Technologies UK Limited and Datamatics Infotech Limited, entered into a slump sale agreement for transfer of business and assets as on March 31, 2011.

In FY2014, another exercise of merger and business restructuring was executed by Datamatics Global Services Ltd. FY2014 annual report, page 5:

We had merged our Digital Publishing and eRetail Solutions business with PreMedia Global of Chennai, since renamed as Lumina Datamatics Limited, to evolve as the 4 th largest company in the publishing BPO space in the world.

In FY2016, the company did another amalgamation involving a few of its subsidiaries. FY2016 annual report, page 14:

During the year under review, Datamatics Software Services Limited (DSSL) and Datamatics Vista Info Systems Limited (DVISL), subsidiaries of the Company were amalgamated with and into the Company under Sections 391 to 394 of the Companies Act, 1956.

An investor may note that these transactions are primarily rearrangement of businesses within the umbrella of Datamatics group and exclude the acquisitions done by the company of outside entities, which are done in order to gain access to newer technologies and clients.

During FY2019, the company proposed two more restructuring exercises:

• First, on April 27, 2018, a Composite Scheme of Arrangement was approved by the board of the company between Delta Infosolutions Private Limited, Datamatics Infotech Services Private Limited, Datamatics Global Services Limited and their respective shareholders.
• Second, on December 14, 2018, another Composite Scheme of Arrangement was approved by the board of the company between Lumina Datamatics Limited, Datamatics Global Services Limited, LDR ERetail Limited and their respective shareholders.

As per SEBI guidelines, such exercises involving promoter group entities need to be approved by a majority of public shareholders i.e. excluding promoters. In May 2019, the public shareholders rejected both these proposals and the company had to withdraw these proposals.

FY2019 annual report, page 29:

Composite Scheme of Arrangement: The Board of Director have, at their meeting held on April 27, 2018 subject to obtaining the requisite approvals/consents, approved the Composite Scheme of Arrangement under Section 232 read with Section 230 and other applicable provisions of the Companies Act, 2013 and the rules made thereunder between Delta Infosolutions Private Limited, Datamatics Infotech Services Private Limited, Datamatics Global Services Limited and their respective shareholders.

The requisite majority required under the SEBI Circulars for approval of the Scheme was not obtained since the votes cast by the public shareholders of DGSL in favour were less than the votes cast against the same. Hence, the Scheme was withdrawn.

FY2019 annual report, pages 29-30:

Demerger and Listing of Lumina Datamatics Limited: The Board of Director have, at their meeting held on December 14, 2018, subject to obtaining the requisite approvals/consents, approved the Composite Scheme of Arrangement under Section 232 read with Section 230 and other applicable provisions of the Companies Act, 2013 and the rules made thereunder between Lumina Datamatics Limited, Datamatics Global Services Limited, LDR ERetail Limited and their respective shareholders (hereinafter referred to as “Lumina Demerger Scheme”).

However, the requisite majority required under the SEBI Circulars for approval of the Scheme was not obtained since the votes cast by the public shareholders of DGSL in favour were less than the votes cast against for the Delta Scheme. Hence, the authorised representatives of Delta Scheme withdrew the Scheme.

Since the conditionality in relation to the approval of the Delta Scheme, was not met, application was filed before the Tribunal for withdrawal of the Lumina Demerger Scheme which was sanctioned by Tribunal on May 27, 2019

An investor may note that the frequent business rearrangements and restructuring exercises lead to the merging of accounts of different companies, which usually involve a lot of accounting assumptions and thereby makes understanding and interpreting the restructured financials a difficult exercise. It should not come as a surprise that many times, the companies that have been implicated in accounting frauds have had very complex corporate structures with a large number of subsidiaries.

Investors would remember a recent case of IL&FS, which had such a complex corporate structure with more than 300 subsidiaries that it took many days for the govt. appointed board to finalize the exact number of direct, step-down subsidiaries, and joint ventures.

• New IL&FS board finds 348 entities within the group (Business Line, October 4, 2018)
• Complex web of subsidiaries brought IL&FS to its knees (Financial Chronicle, September 25, 2018)

An investor should note that analysing a complex corporate structure is always a challenge for auditors as well as analysts. Therefore, investors routinely find that frauds go undetected for a long time under the umbrella of complex corporate structures.

An investor may believe that if a company is rearranging/restructuring business units among its subsidiaries, then it should not affect its consolidated financials. This is usually with the belief that the consolidated financials take care of intragroup transactions within subsidiaries and therefore, restructuring of businesses within subsidiaries should not have any impact on the consolidated financials.

However, an investor should note that the above belief of consolidated financials representing the entire business picture of the company’s operations is based on the assumption that the auditor is able to do a completely reliable job of ascertaining the actual business position of the company. However, an investor would appreciate that the auditors of the company only provide an opinion on the financials prepared and presented to the auditor by the company’s management. Moreover, the auditors only test a sample of the transactions and are not able to verify all the transactions of the company. Therefore, the mere incidence of financials being audited does not guarantee that the presented financial position of the company is true.

An investor would remember that in almost all the accounting frauds, the financials of the company have been audited by one or the other auditor and despite the regular audit; the company could perpetrate a fraud on investors.

In the recent case of CG Power, the company disclosed that the management had understated liabilities in its previous audited financials. CG Power also disclosed that the management has also underreported the loans given by it to the promoter group companies.

‘Suspect’ transactions detected at Gautam Thapar’s CG Power; stock tanks 20%. YES Bank suffers collateral damage (Economic Times, August 20, 2019)

The company said total liabilities of the company and the group may have potentially been understated by Rs 1,053.54 crore and Rs 1,608.17 crore, respectively, as of March 31, 2018, and by Rs 601.83 crore and Rs 401.83 crore, respectively, as of April, 2017.

Besides, advances to related and unrelated parties of the company and the group may have potentially been understated by Rs 1,990.36 crore and Rs 2,806.63 crore, respectively, as of March 31, 2018; and by Rs 1,479.34 crore and Rs 1,331.47 crore, respectively, as of April 1, 2017.

In addition, many times, the auditors of the company collude with dishonest management to defraud shareholders and the auditors certify the financials prepared by the company despite knowing that the financials are manipulated.

In the recent case of IL&FS, the auditors of the company have been charged by investigating agencies for colluding with the management of IL&FS to conceal information.

IL&FS auditors BSR, Deloitte facing probe heat from six agencies (Livemint, June 20, 2019)

The audit firms have also been charged with concealing of information by not raising red flags on the misstatements in the accounts of IFIN. The SFIO chargesheet has pointed to evergreening in IFIN accounts and alleges that the auditors colluded with the IL&FS management to conceal information.

This is not to indicate that Datamatics Global Services Limited is involved in any accounting manipulations. However, this point is being discussed here in the context that it is always advisable to keep the corporate structure simple from the start. This is because as the complexity of the corporate structure increases and when the management adds frequent restructurings with the merger, demergers, and amalgamations, then it becomes difficult for any auditor or analyst to properly examine the resultant financials. This leads to a decline in the confidence of analysts in their analysis as the number of uncertainties increases in the final investment decision.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

6) Frequent acquisitions of companies by Datamatics Global Services Limited:

While reading about Datamatics Global Services Ltd, an investor gets to know that, the company has relied upon acquisitions to further its business interests. It has acquired multiple companies to get certain technological capabilities to provide better solutions to its clients. It has acquired some of the companies in order to get access to its customers. Moreover, many times, Datamatics Global Services Ltd has acquired companies from its existing customers in order to gain additional business from them.

In light of different purposes for acquisitions, an investor notices that both for Datamatics Global Services Ltd as well as for other IT service providers, acquiring other companies is a routine activity.

Read: Analysis Framework for IT Services Companies

• In FY2010, Datamatics Global Services Limited acquired the “Accelerated Business Support Systems” division of Devoteam-Danet, a German IT company. FY2010 annual report, page 24:

Our Company acquired the “Accelerated Business Support Systems” division of Devoteam-Danet, Germany-based niche IT Services Company last year. This acquisition has given our Company a firm foothold in the territory.

• In FY2011, Datamatics Global Services Limited formed a joint venture in the US with CIGNEX Global Holding Corporation. FY2011 annual report, page 12:

During the year under review, Datamatics Global Services, Inc., the U.S. subsidiary of your Company and CIGNEX Technologies, Inc. the U.S. subsidiary of CIGNEX Global Holding Corporation, provider of commercial Open Source solutions globally, announced the creation of a Joint Venture called “Datamatics CIGNEX, LLC”.

• In FY2012, the company acquired two companies, Cignex (USA) and Vista (India). FY2012 annual report, page 9:

During the previous year, DATAMATICS acquired two companies–CIGNEX (USA) and VISTA (India). CIGNEX, a world leader in open source space, adds open source domain expertise to our business and gives us a stronger foothold in the enterprise content management and document management space. With VISTA, we have been able to increase our focus on Engineering & Embedded space, which is a rapidly growing market and also strengthen our Indian operations.

• In FY2014, Datamatics Global Services Limited acquired a 73.12% stake in Lexicon Publishing Services Private Limited. FY2014 annual report, page 30:

During the year, your Company, through its wholly owned subsidiary – erstwhile Datamatics eRetail & Publishing Limited acquired a 73.12% stake in Lumina Datamatics Limited (Formerly known as Lexicon Publishing Services Private Limited) by way of a Scheme of Arrangement/Amalgamation sanctioned by Hon’ble High Court of Madras

• In FY2015, the company acquired the 1Key suite from MAIA intelligence. FY2015 annual report, page 7:

Recently, Datamatics acquired the award winning 1KEY suite of BI solutions from MAIA Intelligence, which has been rechristened as nSights. nSights suite of products provides on-line as well as off-line BI, along with mobile dashboards for smart devices.

• In FY2016, Datamatics Global Services Limited acquired Appear IQ. FY2016 annual report, page 3:

We also acquired Appear IQ, a cloud based product in the Digital Eco Systems space, which we have rebranded as ‘iMobile’.

• In FY2018, the company acquired the 1Key suite from MAIA intelligence. FY2018 annual report, page 8:

Datamatics acquired Bangalore-based TechJini with the objective of further strengthening its mobility offerings through TechJini’s range of smart technology solutions.

Datamatics Philippines, a step-down subsidiary of Datamatics Global Services Ltd. acquired RJGlobus Solutions Inc., a voice-based BPO company headquartered in Manila, Philippines.

Investors would note that in the case of acquiring any company, especially those in the technology space, it becomes very difficult to assign an absolute value to them. Many times, technology companies are acquired for their future business potential in terms of integration of the newly acquired technology into existing products and solutions of the buying company. It is very difficult to assign an absolute value to such future business potential. As a result, most of the time ascertaining whether the payment done for any acquisition is a fair one becomes difficult.

It is this uncertainty in determining the fair value of the acquisitions that leads to the possibility of overpayments by the management for acquisitions, which may not be in the best interest of other shareholders.

An investor would notice that in the recent past in the case of IT service companies, there have been cases where investors raised questions to the management over the valuations paid for acquiring companies. One such case, which led to the resignation of the CEO of a large Indian IT services company, was the acquisition of a small Israeli IT company, Panaya for ₹200 million by Infosys Ltd in 2015. (Source: Infosys).

At that time, Vishal Sikka, CEO of Infosys said:

“The acquisition of Panaya is a key step in renewing and differentiating our service lines. This will help amplify the potential of our people, freeing us from the drudgery of many repetitive tasks, so we may focus more on the important, strategic challenges faced by our clients. At the same time, Panaya’s proven technology helps dramatically simplify the costs and complexities faced by businesses in managing their enterprise application landscapes.”

• However, after some time, a whistle-blower raised questions about this acquisition stating that the acquisition was overvalued. (Source: MoneyControl: Whistleblower questions Infosys board on accountability for Panaya acquisition)
• Mr Narayan Murthy, one of the founding promoters of Infosys Ltd., took up this issue with the board of directors. This incident created many issues for the company’s promoters, board, and management. Subsequently, Mr Vishal Sikka resigned from Infosys Ltd in 2017.
• In 2018, Infosys decided to sell off Panaya at a 59% discount on the purchase price (Source: Livemint: Infosys struggles to sell distressed asset Panaya)
• However, the company could not find a buyer for Panaya and it apparently shelved the plans to sell Panaya in 2019 (Source: Livemint: Infosys drops plan to sell Panaya, Skava)

Therefore, while analysing companies in the information technology (IT) sector, an investor should be prepared to witness a lot of mergers & acquisitions, which may prove valuable to the business in terms of new skills and customers. However, these mergers & acquisitions also bring with them the possibility of overpayments by the management for acquisitions, which need to be analysed very closely by the investors.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

Let us see an example of one acquisition done by Datamatics Global Services Ltd where it acquired a promoter group company, Datamatics Staffing Services Limited.

7) Acquisition of promoter group company Datamatics Staffing Services Limited by Datamatics Global Services Ltd:

In FY2019, the company acquired a 51% stake in a company, Datamatics Staffing Services Limited (DSSL). FY2019 annual report, page 103:

On March 17, 2019 one of the subsidiary, Datamatics Digital Limited acquired 51.00% of the issued share capital of Datamatics Staffing Services Limited (DSSL).

While reading the related party transactions sections of past annual reports, an investor gets to know that Datamatics Staffing Services Limited (DSSL) is one of the companies controlled by the relatives of key management personnel. FY2019 annual report, page 106:

Relatives of Key Managerial Personnel and Enterprise owned by Key Managerial Personnel:

• Mrs. Asha L. Kanodia
• Mrs. Aneesha Dalmia
• Mrs. Priyadarshini Kanodia
• Datamatics Staffing Services Limited (till March 17, 2019)
• Datamatics Business Solutions Limited
• Datamatics Infotech Services Private Limited

Therefore, an investor gets to know that in FY2019, Datamatics Global Services Ltd acquired a 51% stake in DSSL, which is a promoter group entity.

While reading the FY2019 annual report, the investor gets to know that Datamatics Global Services Ltd paid a sum of ₹7.4 cr to acquire a 51% stake in DSSL. This effectively values DSSL at ₹14.5 cr. (value of 100% stake 14.5 = 7.4/0.51).

FY2019 annual report, page 104:

The above data indicate that Datamatics Global Services Ltd paid an amount of ₹7.4 cr to acquire a 51% stake in DSSL, which amounts to net assets of about ₹2 lac (₹0.02 cr). This amounts to a payment of a price to book value ratio (PB Ratio) of 370 (= 7.4/0.02).

An investor may think that DSSL is a staffing/recruitment services firm and therefore, assets may not be the best representative of its true business/economic value. Therefore, the investor may believe that the price to book value ratio may not be the best judge of the fair value of DSSL.

Therefore, when an investor analyses the earnings of DSSL in FY2019, then she notices that in FY2019, it had contributed a profit of ₹4 lac (₹0.04 cr) to the consolidated profit after tax of Datamatics Global Services Ltd. FY2019 annual report, page 113:

It indicates that in FY2019, DSSL reported a total net profit after tax (PAT) of ₹7.8 lac (₹0.078 cr = 0.04/0.51)). It represents that out of 100% PAT of DSSL (₹7.8 lac), 51% share of Datamatics Global Services Ltd is ₹4 lac (= 7.8*0.51).

By taking the total PAT of DSSL as ₹7.8 lac, an investor may conclude that Datamatics Global Services Ltd paid a price to earnings ratio (PE Ratio) of about 185 to acquire DSSL (185 = 14.5/0.078). This is after assuming the valuation of ₹14.5 cr of the entire DSSL as Datamatics Global Services Ltd paid ₹7.4 cr for a 51% stake.

Whether an investor looks at the PB ratio of 370 or the PE ratio of 185, it seems that Datamatics Global Services Ltd has paid a rich valuation to acquire a 51% stake in DSSL.

Further, an investor may think that Datamatics Global Services Ltd has paid a rich valuation for acquiring DSSL considering its business potential, which may not be represented in its past performance.

However, when an investor analyses past annual reports of Datamatics Global Services Ltd, then she notices that DSSL was incorporated on April 25, 2003 (Source: Zaubacorp) and is present in the related party transactions section of Datamatics Global Services Ltd at least since FY2008 (the earliest available annual report at the website of Datamatics is for FY2008).

FY2008 annual report, page 39:

Relatives Of Key Managerial Personnel:

• Mr. Sameer Kanodia (upto 30.01.08)
• Mrs. Asha Kanodia
• Mrs. Anju Kanodia
• Datamatics Staffing Services

Therefore, an investor gets to know that DSSL has been in existence for the last 16 years and during this entire period, the company could reach a business profit of ₹0.078 cr in FY2019. Therefore, an investor may believe that the current profits of DSSL provide a reasonable idea about the business potential, which the promoters could achieve after running the company for 16 years.

Investors may contact Datamatics Global Services Ltd directly to get clarification about the valuation methodology used by the company for purchasing a stake in DSSL.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

8) Significant remuneration increase taken by the promoters in FY2015 despite a decline in profitability of the company:

While analysing the managerial remuneration of the promoters of Datamatics Global Services Ltd, an investor notices that in FY2015:

• Dr. Lalit S. Kanodia took an increase in remuneration of 21.4%
• Mr. Rahul L. Kanodia took an increase in remuneration of 15.1%.
• Mr. Sameer L. Kanodia took an increase in remuneration of 27.5%

FY2015 annual report, page 34:

An investor may note that in FY2015, the operating profit of the company had declined to ₹86 cr from ₹91 cr in FY2014. Similarly, the net profit after tax (PAT) of the company in FY2015 had declined to ₹43 cr from ₹49 cr in FY2014.

This represents a curious case when the promoters of the company have taken a steep increase in their remunerations while the business performance of the company has declined.

Further advised reading: How to identify Promoters extracting Money via High Salaries

9) Investments done by Datamatics Global Services Ltd to utilize its cash reserves:

An investor notices that as per the financials disclosed by the company, it has been a cash-rich company throughout the last 10 years (FY2010-2019). As a result, the company has invested its funds in various instruments. However, when an investor analyses the investments done by Datamatics Global Services Ltd in detail, then she comes across some observations.

a) Speculation in commodity futures by an information technology company:

While reading the FY2011 annual report, an investor notices that Datamatics Global Services Ltd has taken a position in Guargum commodity futures contracts.

FY2011 annual report, page 61:

On further reading of the FY2011 annual report, an investor notices that the company has taken a short position in the Guar gum futures contracts.

FY2011 annual report, page 78:

By reading the above information, an investor is left wondering why an information technology company is risking its money by speculating commodity prices.

Further advised reading: How to Identify if Management is Misallocating Capital

b) Investments in very high-risk debentures by Datamatics Global Services Ltd:

While analysing the investments done by the company, an investor notices that Datamatics Global Services Ltd had invested in debentures, which apparently have very high yields in the range of 18%-19%.

• In FY2012, Datamatics Global Services Ltd invested in debentures of an entity named LILY, which seemed to offer a yield of 19% on its debentures. FY2012 annual report, page 68:

• In FY2013, the company invested in debentures of a company named Devadatta Build Tech Pvt. Ltd, which seemed to offer a yield of 18% on its debentures. FY2013 annual report, page 58:

An investor would appreciate that the yield on any instrument is related to the underlying risk in the investment. A yield of 18%-19% on the debentures indicates that these are very high-risk investments with a high probability of default. Many times, when an investor invests her hard-earned money in such high yielding and high-risk debentures, then it becomes difficult to get her original invested money back instead of earning high returns.

It seems that Datamatics Global Services Ltd also had to bear the impact of such risky investments as in later years, it made many provisions of decline and write-offs of investments.

FY2014 annual report, page 77:

FY2017 annual report, page 112:

Further advised reading: Understanding the Annual Report of a Company

By looking at the above information, an investor realizes that investment & credit appraisal by Datamatics Global Services Ltd leaves scope for improvement. It has made risky bets by speculating money in high-risk investments like commodity futures and high-risk debentures (junk bonds?!). As a result, the company had to bear write-offs and diminution of the value of its investments, debt, and receivables.

c) Investments in portfolio management services by Datamatics Global Services Ltd:

While reading past annual reports of the company, an investor notices that it had been investing in the portfolio management services (PMS) of different providers at least since FY2008 (the oldest available annual report of the company at its website is for FY2008).

FY2008 annual report, page 31:

It seems that the investments by the company in the PMS services continued until about FY2014 when it disclosed that the company has invested in PMS services of Reliance and Trust Investment Advisors. FY2014 annual report, page 84:

Portfolio Management services are provided by the Portfolio Manager – Reliance Capital Asset Management Ltd (RCAML) registered with SEBI vide registration No.INP000000423 and Trust Investment Advisors Pvt. Ltd. (TIAPL) registered with SEBI Reg No. INP000001843. The portfolio Manager is engaged in investing funds in accordance with SEBI (Portfolio Managers) Regulations, 1993 of its client – Datamatics Global Services Ltd. in Securities and providing portfolio management services to its clients.

RCAML and TIAPL have been appointed as the Portfolio Manager for managing the investments of its funds on a discretionary basis to avail of investment advisory and portfolio management services for the purpose of investment to be made in securities. RCAML also holds the Power of Attorney to hold investments in its name for investments made on behalf of Company. Investments made by RCAML under the Portfolio Management Services are made in a pool account and therefore are not held in the name of the Company.

While looking at the investments done by Datamatics Global Services Ltd in avenues like commodity futures, high-risk debentures and PMS services of different asset management companies, an investor thinks that why the company is putting money in these instruments instead of repaying the lenders.

Further advised reading: How to Identify if Management is Misallocating Capital

An investor may seek information from the company about the reasons for the company prefering these investments to the repayment of loans.

10) Curious Case of Datamatics Employees Welfare Trust:

In 2010, the company established the Datamatics Employees Welfare Trust in order to execute its employee stocks options plan.

FY2011 annual report, page 24:

The following Special Resolutions were passed at the previous three Annual General Meetings:

3. AGM held on August 12, 2010:- (i) Formation of Datamatics Employees Welfare Trust for transfer of shares granted under the existing ESOP Schemes.

In the same year, Datamatics Global Services Ltd gave a loan of about ₹7 cr to Datamatics Staff Welfare Trust to buy equity shares of the company. FY2011 annual report, page 50:

Amount recoverable from ESOP Trust consists of ₹ 69,347,270 paid to Datamatics Staff Welfare trust during the year for purchase of 1,753,261 Equity shares of the Company.

While reading the annual reports of the company, it seems that the company has used the names of the trust: Datamatics Employees Welfare Trust and Datamatics Staff Welfare Trust. This is evident from the disclosures of the company in later annual reports, where the mentioned amount of loan to the names of both the trust is the same. E.g. in the FY2013 annual report, page 70, the amount of loan in the previous year (P.Y) as well as the number of shares purchased are the same in reference to Datamatics Employee Welfare Trust, which was in the FY2011 annual report in reference to Datamatics Staff Welfare Trust.

Employee Stock Option Scheme: The Datamatics Employee Welfare Trust (Trust) had purchased 1,753,261 shares of Company for granting stock options to the employees. The purchases are fi nanced by loans from the Company. Amount recoverable from Trust as on March 31, 2013 is ₹ 64,952,691 (P.Y. ₹ 69,347,270).

Therefore, we believe that the company has used these names interchangeably. For any further clarification, an investor may contact the company directly.

From the above disclosures, an investor realized that Datamatics Global Services Ltd has formed a trust and has given it a loan of ₹7 cr in order to purchase shares. Subsequently, the trust has purchased 1,753,261 shares in order to grant them to the employees who exercise their ESOPs (employee stock options).

It seems a situation where the trust has created an inventory of stocks of the company by purchasing it from the open market. Subsequently, whenever, any employee exercises its ESOPs, then the employee pays the exercise price (ESOP price) to the trust and the trust grants the required number of shares to the employee from its inventory of shares.

In such a scenario, an investor would appreciate that the income of the trust is the money paid by employees to exercise their ESOPs. Whereas the outflow for the trust has been the money paid by it to acquire 1,753,261 stocks for which it had taken a loan of ₹7 cr from Datamatics Global Services Ltd. The average cost of these shares to the trust comes out to be about ₹39.5 per share.

In such a situation, an investor would appreciate that the trust can repay the loan to Datamatics Global Services Ltd only when it takes more money from the employees when they exercise their ESOPs than the money that it had paid to acquire the shares. Therefore, the trust must charge at least ₹39.5 per share from the employees to grant them shares to make any money and repay the loan to the company.

However, when an investor analyses the pricing formula of the ESOPs of the company, then she realizes that the options granted by the company are exercisable at ₹5 per share.

FY2015 annual report, page 38:

An investor notes that out of the multiple ESOPs scheme approved by Datamatics Global Services Ltd, until FY2015, it had granted options only out of the Key ESOPs schemes of 2006 and 2007. The company did not grant any options out of the general ESOPs schemes of 2007 and 2011 as well as the Key ESOPs scheme of 2011. An investor may draw the following interpretations from this information:

• It may be that the Key ESOPs Schemes are only for senior employees and the General ESOPs schemes may include other lower designation employees as well. If this were the case, then an investor would note that out of different ESOPs schemes, the company granted options only to the senior management under Key ESOPs and did not grant any option to general employees under General ESOPs schemes.
• The options granted under Key ESOPs schemes are exercisable at a price of ₹5 per share whereas the cost price of each share to the trust is ₹39.5.

Therefore, in terms of the financial situation of the trust, it had to spend ₹39.5 per share to acquire equity shares of the company, which it had to grant to employees by accepting the exercise price of ₹5 per share from them.

An investor will appreciate that in such a situation, the trust can never repay the loan of ₹7 cr taken by it to acquire the equity shares.

Datamatics Global Services Ltd closed all its existing ESOP schemes in FY2016.

FY2016 annual report, page A22:

EMPLOYEE STOCK OPTION PLANS (ESOP): The Board of Directors, on the recommendation of Nomination and Remuneration Committee, have at their meeting held on May 27, 2016 approved the closure of Key ESOP Scheme 2006, General ESOP Scheme 2007, Key ESOP Scheme 2007, General ESOP Scheme 2011 and Key ESOP Scheme 2011. There are no existing granted options in any of the above-mentioned ESOP schemes

As a result, of the closure of all the existing ESOP schemes, the trust was rendered without purpose and it was liquidated in FY2016.

FY2016 annual report, page A102:

EMPLOYEE STOCK OPTION SCHEME: The Datamatics Employees Welfare Trust (Trust) had purchased 1,753,261 shares of the Company for granting stock options to the employees. The purchases are financed by loans from the Company. During the year Trust was liquidated and ₹ 48.59 million has been received and shown as extraordinary items. The amount includes ₹ 40.29 million towards profit on sale of investments and balance towards other income net of expenses over the years.

An investor notes that on liquidation of the trust in FY2016, Datamatics Global Services Ltd received back an amount of ₹4.9 cr. While reading the annual report of FY2015, an investor notices that on March 31, 2015, the outstanding loan given by the company to the trust was ₹6.3 cr.

FY2015 annual report, page 101:

In light of the above information, an investor would appreciate that the loan outstanding to the trust was ₹6.3 cr whereas the amount received on its liquidation was ₹4.9 cr. As a result, the company seems to have lost ₹1.4 cr out of its loan to the trust.

However, when an investor analyses the FY2016 annual report further, then she notices that Datamatics Global Services Ltd instead of recognizing the loss of ₹1.4 cr in its P&L statement, the company has recognized the liquidation value of ₹4.9 cr as an exceptional income in the P&L.

FY2016 annual report, page A68:

Exceptional income of ₹ 48.6 million received from Datamatics Employee Welfare Trust on its liquidation.

An investor is confused by this accounting treatment by the company. An investor may think that the company could recognize an income/profit in the P&L only when it received an amount higher than the loan outstanding. Therefore, Datamatics Global Services Ltd could recognize an exceptional income of ₹4.9 cr on the liquidation of the trust when it would have received a total of ₹11.2 cr from the liquidation of the trust (11.2 = 6.3 + 4.9 i.e. ₹6.3 cr of loan recovery and ₹4.9 cr of surplus exceptional income). However, as per the disclosure of the company in the FY2016 annual report, the amount received from the liquidation of the trust including the profit on the sale of investment is stated at ₹4.9 cr.

FY2016 annual report, page A102:

During the year Trust was liquidated and ₹ 48.59 million has been received and shown as extraordinary items. The amount includes ₹ 40.29 million towards profit on sale of investments and balance towards other income net of expenses over the years.

In light of the above information, it is not clear why Datamatics Global Services Ltd recognized a profit/exceptional income on the liquidation of the trust instead of the loss due to the under-recovery of the loan given to the trust.

Further advised reading: How Companies Inflate their Profits

An investor may contact the company directly to seek clarifications in this regard.

Moreover, an investor notices that the annual reports of the company declare the trust (Datamatics Employees Welfare Trust) as an entity controlled by the key management personnel (KMP) or the relatives of the KMP.

FY2016 annual report, page A100:

Relatives Of Key Managerial Personnel and Enterprise owned by Key Managerial Personnel

• Mrs. Asha L. Kanodia
• Mrs. Aneesha Dalmia
• Mrs. Priyadarshini Kanodia
• Mr. Vidur V. Bhogilal (w.e.f September 22, 2015)
• Datamatics Staffing Services Limited
• Datamatics Employees Welfare Trust

Does it mean that the KMP (primarily promoters) of the company and not the board of directors of the company controlled the trust and all its affairs? An investor may analyse this aspect further and may seek clarification from the company about the reasons the trust is disclosed as an entity controlled by KMP.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

11) Datamatics Global Services Ltd did not spend money on CSR to save money for growth:

While analysing the annual reports of the company, an investor notices that Datamatics Global Services Ltd has not spent the full eligible amount on corporate social responsibility (CSR). When an investor tries to find out the reasons for such non-spending, then she gets to know that the company has cited lower profit margins of the company, increasing costs and the need to conserve resources of the company to deploy in future growth as the reason for not spending full money on CSR.

FY2019 annual report, pages 35-36:

In case the Company has failed to spend the two per cent of the average net profit of the last three financial years or any part thereof, the company shall provide the reasons for not spending the amount in its Board report :-

……However, the global economic competition has induced the corporates to become cost conscious. During the year under review, the margins of the Company have been reduced on account of increase in various costs. The Company’s growth is dependent on the Company’s capability to use the Company’s resources in a channelized manner. Therefore, considering the financial condition and goals of the Company, the Board of Directors have thought it prudent to conserve the resources of the Company so that they can be deployed for various future growth initiatives and expansion plans by targeting new customer segments and markets across different geographies.

An investor notices that the company CSR expenditure liability of the company for FY2019 was ₹0.79 cr. Out of this amount the company spent only ₹0.12 cr and did not spend the remaining ₹0.67 cr so that it could be conserved to deploy in future growth plans.

FY2019 annual report, page 35:

Prescribed CSR Expenditure (2% of this amount as mentioned in Sr. No. 3 above): ₹ 7.85 million.

Details of CSR spent during the financial year:
(a) Total amount spent for the financial year: ₹ 1.21 million.
(b) Amount unspent: ₹ 6.64 million.
(c) Manner in which the amount spent during the financial year is detailed below.

An investor notices that Datamatics Global Services Ltd has been a cash-rich company and had a cash & investment balance of ₹130 cr on March 31, 2016. The company had a bank balance of more than ₹68 cr on March 31, 2019.

FY2019 annual report, page 92:

An investor may appreciate that the company has a large amount of ₹68 cr in the bank balance and it refuses to spend a comparatively minuscule ₹0.67 cr on CSR citing that the company needs to conserve these funds to deploy for future growth.

Similarly, the company did not spend comparatively minuscule amounts of ₹0.52 cr in FY2017 and ₹0.53 cr in FY2018 citing that it needs these funds for funding future growth plans. Datamatics Global Services Ltd had a bank balance of ₹67 cr in FY2017 and ₹81 cr in FY2018.

FY2018 annual report, page 109:

The hesitation of Datamatics Global Services Ltd in spending a comparatively minuscule amount on CSR despite having large bank balance may be interpreted in any of the following probable ways:

• The cash and bank balance of the company disclosed by it are suspect and the company is striving to conserve every penny to survive OR
• The company does not have the willingness to spend even comparatively minuscule amounts on CSR.

An investor may analyse these scenarios and draw her own conclusions.

If Datamatics Global Services Ltd does not have the willingness to spend money on CSR even though it is very small compared to its profits and bank balance, then it seems that such cases had led to the govt. to make non-spending of CSR money a criminal offence in its budget of July 2019.

India Inc worried over three-year jail provision for violation of CSR norms (Source: Business Standard, August 1, 2019)

However, recently, the govt. has proposed that CSR norm violations will not be treated as a criminal offence. Instead, these will be treated as civil offences.

Stimulus package: CSR norm violations not to be treated as criminal offence, says Nirmala Sitharaman (Source: Business Line, August 23, 2019)

Further advised reading: How Companies Inflate their Profits

12) Errors in the reported data by Datamatics Global Services Ltd:

While reading the various announcements and disclosures done by the company, an investor notices that Datamatics Global Services Ltd has made a few errors in some of the disclosure.

a) Error in the data in the December 2018 investors’ presentation on the demerger:

In the investors’ presentation of the company for explaining the “Lumina Demerger – Proposed Scheme of Arrangement” in December 2018, the company presented revenue and profit after tax (PAT) numbers for the H1-FY2019 that did not add up. An investor may see the same on page 11 of the presentation.

As per the presentation, in H1-FY2019, the revenue of the DGSL Ex-LUMINA was mentioned as ₹4,134 million whereas the revenue for the LUMINA unit was mentioned as ₹1,278 million. If an investor adds the two, then the total revenue of the entire DGSL should be ₹5,412 million (=4134+1278). However, the presentation mentions the revenue of the entire DGSL as ₹5,407 million.

Similarly, in the presentation, in H1-FY2019, the profit after tax of the DGSL Ex-LUMINA was mentioned as ₹369 million whereas the revenue for the LUMINA unit was mentioned as ₹86 million. If an investor adds the two, then the total PAT of the entire DGSL should be ₹455 million (=369+86). However, the presentation mentions the PAT of the entire DGSL as ₹452 million.

An investor may believe that it might not be an error but instead, it may contain the impact on inter-unit revenue or profits, which are cancelled out when the financials of the entire DGSL are prepared like in the case of standalone and consolidated financials. While preparing consolidated financials, many transactions within the subsidiaries of the company are cancelled/netted off and therefore, the consolidated revenue/PAT may be less than the sum of all the individual subsidiaries.

However, in the above case, it does not look like the case of inter-unit transactions. This is because when an investor adds up the data for EBITDA for the different units, then the data adds up properly. In the presentation, in H1-FY2019, the EBITDA of the DGSL Ex-LUMINA was mentioned as ₹511 million whereas the revenue for the LUMINA unit was mentioned as ₹119 million. If an investor adds the two, then the total EBITDA of the entire DGSL should be ₹630 million (=369+86). The presentation mentions the EBITDA of the entire DGSL as ₹630 million.

Therefore, it looks like the presentation of Datamatics Global Services Ltd contains some errors in the data of the revenue and PAT for the DGLS Ex-LUMINA and LUMINA units or the total data for DGSL.

b) Error in the data in FY2018 annual report while comparing share price with IPO offer price:

In the FY2018 annual report, while providing the data for the percentage change in the share price of Datamatics Global Services Ltd on March 31, 2018, when compared to the IPO price of May 07, 2004, the company made an error. The company reported that the price of the company on BSE on March 31, 2018 (₹102.65) is 19% lower than the IPO offer price of ₹110 and a similar figure for NSE (₹102.50) is 69% lower than the IPO price.

FY2018 annual report, page 36:

When an investor does these calculations on her own, then she notices that the BSE price of ₹102.65 is 6.68% lower than the IPO price of ₹110 and the NSE price of 102.50 is 6.82% lower than the IPO price.

c) Error in FY2013 annual report of Datamatics Global Services Ltd:

In the FY2013 annual report, on page 41, the company mentioned that it has provided ₹69.49 million as provisions for doubtful trade receivables in the management discussion and analysis section.

Trade Receivables: Debtors increased to ₹1074.39 million as on March 31, 2013 from ₹890.74 million as on March 31, 2012. The Company has provided for ₹69.49 million as provision for doubtful debts during the year under
review.

Whereas in the notes to the financial statements, an investor notices that the actual provision is ₹6.949 million and not ₹69.49 million as mentioned in the management discussion and analysis section.

FY2013 annual report, page 61:

13) Declining dividend payout over the years despite increasing profits of Datamatics Global Services Ltd:

When an investor analyses the trend of dividend payments done by the company over the years, then she notices that the dividend payments of the company have declined over the last 10 years despite a multifold increase in its profits and increase in cash & investments.

An investor notices that in FY2010, the company paid a dividend of ₹7.4 cr (excl. dividend distribution tax) when it had a net profit of ₹22 cr and a cash & investment balance of ₹69 cr. In FY2019, the company reported a net profit of ₹75 cr and a cash & investment balance of ₹130 cr; however, the company paid a dividend of only ₹5.9 cr (excl. dividend distribution tax) in FY2019.

The dividend payout ratio of the company declined from 33% in FY2010 to 8% in FY2019.

Margin of Safety in the market price of Datamatics Global Services Ltd:

Currently (August 26, 2019), Datamatics Global Services Ltd is available at a price to earnings (PE) ratio of about 5 based on consolidated earnings of the last four quarters from July 2018 to June 2019.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, taking into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

• Further advised reading: 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
• Read: How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
• Further advised reading: Hidden Risk of Investing in High P/E Stocks

In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be sign of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

In the case of Datamatics Global Services Ltd, an investor may note that over the last 10 years (FY2010-2019), the company has retained earnings of ₹392 cr whereas, during the same period, its market capitalization has increased by only ₹189 cr. The increase in market capitalization amounts to ₹0.48 for every ₹1 of the earnings retained by the company i.e. not distributed to shareholders by way of dividends. This indicates that the company has reduced the value of the profits that it retained with itself.

Moreover, if an investor analyses the movement of the market value of Datamatics Global Services Ltd from its IPO in May 2004, then she notices that over the last 15 years, the share price of the company has declined 38% from its IPO offer price of ₹110 in May 2004 to ₹67.95 at August 26, 2019. Such a performance indicates significant wealth erosion by the company for its investors over the last 15 years.

Analysis Summary

Overall, Datamatics Global Services Ltd seems like a company, which has been able to grow its sales at a growth rate of 15%-20% year on year in the past 10 years (FY2010-2019). However, the sales growth of the company has not witnessed similar growth in profitability. Over the last 10 years, the profit margins of the company have witnessed fluctuating cyclical trends when the operating profit margin (OPM) of the company has ranged between 6%-12%.

The long-term trend of OPM of the company has been declining. The OPM of the company used to be 25% in FY2005 just after the IPO of the company in that year. However, since FY2005, the OPM of the company has never reached those levels and in fact, it was on a consistent decline for the next 6 years until FY2011 when the OPM touched a low of 6%. Such a decline in profitability immediately after IPO concerns investors.

Since FY2011, the profitability of the company has been fluctuating due to intense competition and the pricing pressure from the customers. Datamatics Global Services Ltd is not able to pass on the increase in its operating costs, which primarily contain employee costs to its customers. The major path for the company to contain its costs is to reduce employee costs. As a result, it has opened development centres in tier 2 cities like Nashik and Puducherry.

Generally, it is assumed that the business of information technology (IT) service providers is asset-light and these companies are assumed to produce a lot of free cash flow. However, in the case of Datamatics Global Services Ltd, the company has consumed its entire cash flow from operations (CFO) in its capital expenditure and after meeting interest expenses, the company does not have any free cash flow left as a surplus. As a result, an investor notices that the company has witnessed its debt levels increase over the last 10 years. Moreover, the entire dividend payments and the increase in cash & investments over the last 10 years can be ascribed to the non-operating/other income generated by its investments.

Datamatics Global Services Ltd has reported significant cash & investment balance in each of the last 10 years where the cash & investment balance with the company increased from ₹69 cr in FY2010 to ₹130 cr in FY2019. However, despite such significant cash & investment balance, the company has resorted to raising funds by way of Optionally Convertible – Cumulative Redeemable Preference Shares in FY2011, Compulsorily Convertible Preference Shares in FY2014, and loans from promoters etc.

When an investor analyses these transactions, then she is not able to find an answer to why the subscribers of Compulsorily Convertible Preference Shares took a loss of ₹30 cr on their investment despite improvement in the business as well as the share price of the company over their investment period of FY2014-2017. Similarly, an investor is not able to understand the reasons why the company took loans from promoters at a 9% interest rate when it had surplus cash all the time.

Datamatics Global Services Ltd has resorted to a lot of corporate restructuring, mergers, demergers, acquisitions, and amalgamations over the years. As a result, frequently the new/merged financials become non-comparable with previous financials. Recently, the shareholders had rejected a demerger proposal put forward by the company. It is advised that investors should do an in-depth analysis while analysing any demerger/amalgamation proposals of the company.

In FY2019, the company acquired a 51% stake in Datamatics Staffing Services Ltd (DSSL), which was a promoter owned/controlled company. While analysing the valuation paid by Datamatics Global Services Ltd for DSSL, an investor notes that the acquisition price represents a price to book value (PB) ratio of 370 and a price to earnings (PE) ratio of 185. The acquisition price paid by Datamatics Global Services Ltd for DSSL looks high from both PB ratio and PE ratio perspectives.

When an investor analyses other avenues where Datamatics Global Services Ltd has invested its cash, then she notices some investments like commodity futures, high-risk debentures yielding 18%-19%, portfolio management services and inter-corporate deposits/other receivables. An analysis of the amount of write-offs and provisions for diminution of the value of investments & debt/receivables indicates that the investment/credit appraisal process of the company leaves scope for improvement.

The company established a trust for the execution of ESOPs and provided loan to the trust so that it may acquire equity shares of the company and grant them to the employees who exercise their options. It seems that at the end of existing ESOP schemes when the trust was liquidated, then it could generate a value less than the loan amount outstanding from Datamatics Global Services Ltd. However, an investor notices that instead of recognizing a loss on the under-recovery of the loan to the trust, the company recognized the liquidation value of the trust as an exceptional income. Investors may contact the company for any clarifications.

Despite being a cash-rich company, Datamatics Global Services Ltd did not spend relatively small amounts on CSR in order to save funds for future growth. Along similar lines, an investor notices that despite a significant increase in net profits of the company along with an increase in cash & investment balance the dividend payout of the company has declined. On the contrary, the promoters of the company have taken significant salary increases in the year when the profit of the company declined.

The stock market seems to have many uncertainties about Datamatics Global Services Ltd and as a result, over the last 15 years since the IPO of the company in 2004, the stock price of the company has declined 38% from ₹110 per share in May 2004 to ₹67.95 at August 26, 2019. This is a significant erosion of the wealth of shareholders over the last 15 years. Similarly, over the last 10 years (FY2010-2019), the company has generated an increase in the market value of only ₹0.48 for every ₹1 of earnings retained and not distributed to shareholders as dividends. This parameter also indicates wealth erosion by the company for its shareholders.

Going ahead, an investor should keep a close watch on the profit margins of the company, its investments, any merger, demerger, acquisition or amalgamation proposal, its debt levels, promoter remunerations etc.

These are our views on Datamatics Global Services Ltd. However, investors should do their own analysis before making any investment-related decision about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”

I hope it helps!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.