SIFY TECHNOLOGIES LTD -ADR SIFY S
February 13, 2012 - 12:42pm EST by
dionis589
2012 2013
Price: 4.32 EPS -$0.18 NM
Shares Out. (in M): 179 P/E NM NM
Market Cap (in $M): 773 P/FCF NM NM
Net Debt (in $M): 7 EBIT 5 10
TEV ($): 780 TEV/EBIT 148.0x NM
Borrow Cost: NA

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  • India
  • Misunderstood Business Model
  • Poor management
  • Potential Dilution
 

Description

“We don't give you any forecast numbers. And also, we are not going to stop building the data centers. So we are going to continuously [invest] because India is a good story. We have to invest. So that means we are not stopping after these data centers. We are going to continuously increase. And we will not give you – we are going to aggressively pursuing our business in the government, but we cannot tell you the numbers – we cannot forecast the numbers.”                            

----CFO of SIFY, May 2011

 

SUMMARY:   The quick pitch is that this is a commoditized ISP/internet café business trading at 5x revs and 60x run-rate EBITDA with no growth (6% revenue CAGR over the last 6 years). One of the reasons for the high valuation is that mgmt did an inside deal in late 2010 that diluted the equity by 300% (deal was done at a 70% discount to market at the time). This transaction was not highly publicized and went largely unnoticed until the company filed its F11 20-F in October 2011 after several delays. Even still, sites like Google Finance misreport the shares outstanding with only 50M shares when in reality the shares outstanding are closer to 180M with a resulting market cap of $770M. Meanwhile, the co. is associating itself with every buzzword out there from SaaS to social media to tablets…and retail investors are eating it up.  There is no street coverage. In reality, the majority of their business is an ISP with extreme pricing pressure and intense competition. Management says it best when they state in their 20-F that “margins are continually shrinking.”  Hype > Reality.  The added kicker is the resignation of KPMG as their auditor and recent CFO departure. The balance sheet is deteriorating and the company has a net debt position with no access to capital markets.  The latter situation is a result of an Indian regulation that prevents SIFY from raising capital in any market unless they are listed in India first. However, the requirement to list in India mandates at least three years of profitability which SIFY does not satisfy. So with capex running at $16M/year and limited room on their revolver, SIFY may be back to doing inside deals with the promoter group though that same group still hasn’t fully paid for the 125M shares they got in the Fall 2010. The stock can be a little volatile with the retail hype and frenzy from time to time over Indian Internet, but the fundamental value here in my view is significantly lower and probably around ~$1/share and that is probably aggressive given the recent dilution. Oh and I forgot to mention, they are starting an undersea fiber cable investment this year…

 

Short Thesis in a nutshell:

  1. Many investors are unaware of highly dilutive equity raise by management (i.e., 300% dilution) as no formal filings have been filed. The 20-F is due on 9/30 and should show substantial dilution and imply a market cap of over $770M vs. what some incorrectly believe to be only 230M today. Many data services today still show only 53M shares out vs. 179M in actuality. There is no sell-side coverage and the company still does not report its shares outstanding number in quarterly results.
  2. Implied Valuation due to dilution implies 5x revs and 60x run-rate EBITDA for a business that is not growing and is losing money each quarter.
  3. Balance sheet metrics are deteriorating – in the FY ending March 2010, revs grew 8.8% (an only 2% in most recent qtr) while receivables grew 28% and allowance for bad debts grew 47%.
  4. KPMG their auditor resigned in Nov 2010. New no-name auditor ASA & Associates fills the spot in May 2011 but is not consulted on prior filings or any interim periods since last year. They still have a material weakness / internal control deficiency outstanding.
  5. Business they are in is extremely competitive – one of their risk factors point blank reads “Margin squeeze may affect our operations”. Pricing is fierce and margins are declining. Per their 20-F…”margins in our business are continually shrinking.”
  6. Other Vagaries
    1. Increase in useful lives of networking equipment from 5 to 8yrs – largest depreciable asset category
    2. Impairment triggered in March 2010 for previous acquisition in portal category

 

Fundamentals – Revenue run-rate is roughly $140M run-rate with about $13M in run-rate EBITDA and -2M in Net Income in the latest quarter. The co. has burned through $100M over the last five years.

 

Quickly what they do – the company has had multiple re-orgs and “new business lines” that it even has a risk factor mentioning this. When you boil it down though 80% of the revs come from business connectivity which is another way of saying ISP and VPN services to businesses, 11% internet cafes and the rest is from an Internet portal and ‘other’.  If you want a good read though, print out the latest conference call transcript where management talks about everything from bandwidth last mile services, disaster recovery, “cloud” services, social media, VPN services, internet cafes, and eLearning.  In terms of assets they have about 600 PoPs with most of their data center space leased. Within business connectivity, the majority of bandwidth customers are already captured by the large telcos in the market like BSNL, Bharti, and Tata.  The Internet café business which used to be 40% of the co before has been a disaster (declining 40% YOY in most recent quarter) and depends on the success of the franchisees. In the last two years, operating costs have increased steeply, particularly rent for retail premises, eroding the margins of franchisees and making the business unattractive. Most of the competition for customers is from the unorganized sector with low rates that have become the industry norm. SIFY’s premium pricing of products/services offered through cybercafés is viewed as being more expensive.

 

Why has it run – In short, choose your favorite buzzword. Growth in the social networking, private and public cloud build outs, expansion of mobile network and related smartphone and tablet services, rise in video traffic, exploring the growth in web conference, web commerce, and also some of the major trends that are driving strong growth in our market.”

 

Share count dilution of almost 300% - In September 2010, management put out a simple 6-K saying the company was offering 125M shares at 69c/share to the founders. This was a 70% discount to the market price and the explanation was that there was no active market for the shares in India. Of the $86M “infusion” only $21.7M was actually funded upfront with another ~$20M or so funded this past year. The remaining $40M mgmt expects to call over the next year despite already issuing the shares. Pro-forma for the deal the diluted shares outstanding is around 178M shares or over 300% higher. Oddly, many of the market cap references (factset, google, yahoo) still cite a lower shares outstanding and a market cap of $230M-$360M when in reality the market cap is over $770M. All quarterly earnings since then have a simple income statement with no shares outstanding number.

 

Pricing – substantial pricing pressure on bandwidth

  • “the one concern has been the drop in pricing on bandwidth on accounts of which that has a fair amount of competition. But the way we are able to hold up on that front is in terms of acquiring a larger customer base”
  • “pricing trends on the Internet Bandwidth segment are extremely competitive”evt

 

Consumer business failed – now “re-engineered as an enterprise player”. Per above the Internet café is down 40% YOY and pricing competition from unorganized labor is fierce. Per the 20F, they are competing now on “ambience”.

 

Investments in Undersea Cable + Capex – unclear how this will be funded from a money losing business without further equity dilution. They have invested $8M in undersea cable so far and expect to invest $52M over the next couple years. One of the reasons in the 6-K the co cites for the equity raise is due to “tight liquidity position”.

 

October 2010 – SIFY was unable to file audited statement for the fiscal year end March 2010 due to incomplete audit results from a minority owned venture.

 

November 2010 – 20F is filed but KPMG says that it will resign and not stand for re-election as auditors for the fiscal year ending March 2011. ASA & Associates was appointed in the interim to fill KPMG’s spot.

 

November 2010 – as part of the 20F Company had a material weakness in internal controls relating to the failure of a control intended to carry out an accounting evaluation of certain transactions relating to the purchase of goods for onward sales. Certain transactions which otherwise qualified for being accounted on a net basis were reported on a gross basis as “revenues” and “cost of goods sold”. The root cause of the error was the result of a failure in the operating effectiveness of an internal control relating to carrying out an independent accounting review of the trading transactions of the System Integration business.

 

2011 – Company again delays timely reporting of 20-F until October 2011.

 

History of SIFY

  • Founded in 1995 and was majority owned by Satyam (SAY) until 2002
  • 1995-1997: developed and tested private data network for businesses (EDI, email, VPN)
  • 1998: developed portal and launched ISP business
  • 2000: launched Internet café business and colo business
  • 2010: provide data connectivity to 2500 businesses and run 1200 Internet cafes

Catalyst

Realization of higher sharecount number.
More dilution from insider deals.
Continued business deterioration.
    sort by    

    Description

    “We don't give you any forecast numbers. And also, we are not going to stop building the data centers. So we are going to continuously [invest] because India is a good story. We have to invest. So that means we are not stopping after these data centers. We are going to continuously increase. And we will not give you – we are going to aggressively pursuing our business in the government, but we cannot tell you the numbers – we cannot forecast the numbers.”                            

    ----CFO of SIFY, May 2011

     

    SUMMARY:   The quick pitch is that this is a commoditized ISP/internet café business trading at 5x revs and 60x run-rate EBITDA with no growth (6% revenue CAGR over the last 6 years). One of the reasons for the high valuation is that mgmt did an inside deal in late 2010 that diluted the equity by 300% (deal was done at a 70% discount to market at the time). This transaction was not highly publicized and went largely unnoticed until the company filed its F11 20-F in October 2011 after several delays. Even still, sites like Google Finance misreport the shares outstanding with only 50M shares when in reality the shares outstanding are closer to 180M with a resulting market cap of $770M. Meanwhile, the co. is associating itself with every buzzword out there from SaaS to social media to tablets…and retail investors are eating it up.  There is no street coverage. In reality, the majority of their business is an ISP with extreme pricing pressure and intense competition. Management says it best when they state in their 20-F that “margins are continually shrinking.”  Hype > Reality.  The added kicker is the resignation of KPMG as their auditor and recent CFO departure. The balance sheet is deteriorating and the company has a net debt position with no access to capital markets.  The latter situation is a result of an Indian regulation that prevents SIFY from raising capital in any market unless they are listed in India first. However, the requirement to list in India mandates at least three years of profitability which SIFY does not satisfy. So with capex running at $16M/year and limited room on their revolver, SIFY may be back to doing inside deals with the promoter group though that same group still hasn’t fully paid for the 125M shares they got in the Fall 2010. The stock can be a little volatile with the retail hype and frenzy from time to time over Indian Internet, but the fundamental value here in my view is significantly lower and probably around ~$1/share and that is probably aggressive given the recent dilution. Oh and I forgot to mention, they are starting an undersea fiber cable investment this year…

     

    Short Thesis in a nutshell:

    1. Many investors are unaware of highly dilutive equity raise by management (i.e., 300% dilution) as no formal filings have been filed. The 20-F is due on 9/30 and should show substantial dilution and imply a market cap of over $770M vs. what some incorrectly believe to be only 230M today. Many data services today still show only 53M shares out vs. 179M in actuality. There is no sell-side coverage and the company still does not report its shares outstanding number in quarterly results.
    2. Implied Valuation due to dilution implies 5x revs and 60x run-rate EBITDA for a business that is not growing and is losing money each quarter.
    3. Balance sheet metrics are deteriorating – in the FY ending March 2010, revs grew 8.8% (an only 2% in most recent qtr) while receivables grew 28% and allowance for bad debts grew 47%.
    4. KPMG their auditor resigned in Nov 2010. New no-name auditor ASA & Associates fills the spot in May 2011 but is not consulted on prior filings or any interim periods since last year. They still have a material weakness / internal control deficiency outstanding.
    5. Business they are in is extremely competitive – one of their risk factors point blank reads “Margin squeeze may affect our operations”. Pricing is fierce and margins are declining. Per their 20-F…”margins in our business are continually shrinking.”
    6. Other Vagaries
      1. Increase in useful lives of networking equipment from 5 to 8yrs – largest depreciable asset category
      2. Impairment triggered in March 2010 for previous acquisition in portal category

     

    Fundamentals – Revenue run-rate is roughly $140M run-rate with about $13M in run-rate EBITDA and -2M in Net Income in the latest quarter. The co. has burned through $100M over the last five years.

     

    Quickly what they do – the company has had multiple re-orgs and “new business lines” that it even has a risk factor mentioning this. When you boil it down though 80% of the revs come from business connectivity which is another way of saying ISP and VPN services to businesses, 11% internet cafes and the rest is from an Internet portal and ‘other’.  If you want a good read though, print out the latest conference call transcript where management talks about everything from bandwidth last mile services, disaster recovery, “cloud” services, social media, VPN services, internet cafes, and eLearning.  In terms of assets they have about 600 PoPs with most of their data center space leased. Within business connectivity, the majority of bandwidth customers are already captured by the large telcos in the market like BSNL, Bharti, and Tata.  The Internet café business which used to be 40% of the co before has been a disaster (declining 40% YOY in most recent quarter) and depends on the success of the franchisees. In the last two years, operating costs have increased steeply, particularly rent for retail premises, eroding the margins of franchisees and making the business unattractive. Most of the competition for customers is from the unorganized sector with low rates that have become the industry norm. SIFY’s premium pricing of products/services offered through cybercafés is viewed as being more expensive.

     

    Why has it run – In short, choose your favorite buzzword. Growth in the social networking, private and public cloud build outs, expansion of mobile network and related smartphone and tablet services, rise in video traffic, exploring the growth in web conference, web commerce, and also some of the major trends that are driving strong growth in our market.”

     

    Share count dilution of almost 300% - In September 2010, management put out a simple 6-K saying the company was offering 125M shares at 69c/share to the founders. This was a 70% discount to the market price and the explanation was that there was no active market for the shares in India. Of the $86M “infusion” only $21.7M was actually funded upfront with another ~$20M or so funded this past year. The remaining $40M mgmt expects to call over the next year despite already issuing the shares. Pro-forma for the deal the diluted shares outstanding is around 178M shares or over 300% higher. Oddly, many of the market cap references (factset, google, yahoo) still cite a lower shares outstanding and a market cap of $230M-$360M when in reality the market cap is over $770M. All quarterly earnings since then have a simple income statement with no shares outstanding number.

     

    Pricing – substantial pricing pressure on bandwidth

    • “the one concern has been the drop in pricing on bandwidth on accounts of which that has a fair amount of competition. But the way we are able to hold up on that front is in terms of acquiring a larger customer base”
    • “pricing trends on the Internet Bandwidth segment are extremely competitive”evt

     

    Consumer business failed – now “re-engineered as an enterprise player”. Per above the Internet café is down 40% YOY and pricing competition from unorganized labor is fierce. Per the 20F, they are competing now on “ambience”.

     

    Investments in Undersea Cable + Capex – unclear how this will be funded from a money losing business without further equity dilution. They have invested $8M in undersea cable so far and expect to invest $52M over the next couple years. One of the reasons in the 6-K the co cites for the equity raise is due to “tight liquidity position”.

     

    October 2010 – SIFY was unable to file audited statement for the fiscal year end March 2010 due to incomplete audit results from a minority owned venture.

     

    November 2010 – 20F is filed but KPMG says that it will resign and not stand for re-election as auditors for the fiscal year ending March 2011. ASA & Associates was appointed in the interim to fill KPMG’s spot.

     

    November 2010 – as part of the 20F Company had a material weakness in internal controls relating to the failure of a control intended to carry out an accounting evaluation of certain transactions relating to the purchase of goods for onward sales. Certain transactions which otherwise qualified for being accounted on a net basis were reported on a gross basis as “revenues” and “cost of goods sold”. The root cause of the error was the result of a failure in the operating effectiveness of an internal control relating to carrying out an independent accounting review of the trading transactions of the System Integration business.

     

    2011 – Company again delays timely reporting of 20-F until October 2011.

     

    History of SIFY

    • Founded in 1995 and was majority owned by Satyam (SAY) until 2002
    • 1995-1997: developed and tested private data network for businesses (EDI, email, VPN)
    • 1998: developed portal and launched ISP business
    • 2000: launched Internet café business and colo business
    • 2010: provide data connectivity to 2500 businesses and run 1200 Internet cafes

    Catalyst

    Realization of higher sharecount number.
    More dilution from insider deals.
    Continued business deterioration.

    Messages


    SubjectMF Global India
    Entry02/15/2012 12:37 PM
    Memberyellowhouse
    Great idea. Any idea how they acquired a 30% stake in MF Global India? It seems like their interest has been kept in tact, do you have a thought on what this could be worth?

    SubjectPrivate Placement Monetization and Catalysts
    Entry02/15/2012 04:03 PM
    Memberyellowhouse
    Do you have any thought on whether the founders are able to monetize their investment in the company?
     
    Besides the fact of this being clearly overvalued and fraudy, do you have any thought on potential hard catalysts?
     
    Thanks

    SubjectRE: MF Global India
    Entry02/16/2012 12:36 PM
    Memberdionis589
    Ironically, the MF Global JV used to be a JV with Refco that was started in 2000. When that blew up...MF Global bought the stake and took over. With MF now bankrupt, it sounds like they are looking for a buyer again. I haven't dug in on what that stake could be worth, yet.
     
    You can find a cached version of the press release from 2000 if you do a google search. I pasted it in below:
     

    Sify, Refco form JV for online trading

    MUMBAI, MAR 23: Satyam Infoway (Sify) has formed a joint venture with the US-based Refco group, the world's largest non-bank futures commission merchant. The joint venture will offer online equity and futures trading for retail customers, and execution clearing services for financial institutions.

    This is the first initiative for online futures trading in the country. Futures trading in securities is expected to be introduced shortly. Sify holds 40 per cent in the new venture and Refco 60 per cent.

    Addressing a press conference to announce the venture, Sify CEO R Ramaraj said Refco would bring in the domain expertise while Sify would chip in infrastructure and its 1.5 lakh strong internet subscriber base to the new company. This is Sify's second joint venture after its tie-up with ICICI group for ICICI-Sify.com. The company is now in the process of getting registered.

    The internet service provider has also entered into strategic alliance with the US-based TechnologyNet.com for buying and selling infotech products, along the lines of cyberITmall.com. On whether Sify would list on a domestic bourse, Ramaraj said, "Merchant bankers have advised us to explore the option...but it is not possible under the current regulatory framework."

    The Refco group has an asset size of $ 9 billion. It has applied forForeign Investment Promotion Board approval to set up a wholly owned subsidiary, Refco India Pvt Ltd, for providing risk management services to Indian corporate customers to manage commodity price risk exposures using future and options. Vineet Bhatnagar has been appointed country head and managing director of the subsidiary.


    SubjectRE: Private Placement Monetization and Catalysts
    Entry02/16/2012 01:06 PM
    Memberdionis589
    In terms of monetize, if you mean a secondary, I'm not exactly sure if the current Indian regulations that prevent raising capital in other markets also prevents a secondary technically. That said, I'm not sure who the natural buyer in such a transaction would be with current fundamentals and the fact that you would be taking management out of a significant stake. It would seem like if they were able to pull something off it would have to be with a related party of some sort. If you/others have alternative thoughts on this...would love to hear them.
     
    In terms of catalysts, I think the 20-F which isnt due technically until Sept 30th (6mos post March year-end) could shed more light on some related party transactions, a more thorough auditor review, and cash flow deterioration. Other than that I think you continue to see poor results and poor answers on margins from the co. If you haven't already, i suggest reading the last couple transcripts...particularly the one from July 2011. They are quite entertaining.
     
    Lastly, if management doesn't continue to cough up cash owed for the large dilutive deal (they still owe $42M of the initial $86M) then I think you see more of a liquidity crunch and need for outside capital. That need would require jumping through some hoops though given the current regulations. Ultimately, such and event if it occurred would come with even more dilution.

    SubjectRE:Private Placement Monetization and Catalysts
    Entry02/16/2012 02:30 PM
    Memberyellowhouse
    Thanks dionis. 
     
     
    On the monetization, I guess I am just trying to understand how Raju and friends are making money here. Pricing the stock at $0.69/share would value the business at ~$123MM, which is something around 11x run rate EBITDA (though I have low confidence in this valuation meaning anything). It seems that to make money the founders are either turning around and selling their shares at inflated prices (which does not appear to be the case) or they genuinely believe the business it worth more than $0.69/share. Given my brief look at the business, I don't see how the business is worth much at all so I feel like I might be missing something here.
     
     
    Raju probably has the money to contribute from his days with ServerWorks/Broadcom. If there is any sign of hold up on delivering the cash then I would take it as a big red flag.
     
     
    I have read the call transcripts. They certainly are entertaining.
     
     
    I also was able to get in touch with someone who has worked with Raju for many years. She said he was one of the most dishonest people she had ever met. However, she also said he is remarkably capable. 

    SubjectRE: RE: MF Global India
    Entry03/27/2012 10:21 AM
    Memberyellowhouse
    any idea what the 30% interest in mf global india is going for?
     
    thanks

    SubjectRE: RE: RE: MF Global India
    Entry03/27/2012 11:22 AM
    Memberdionis589
    My guess is not much. The JV had revenues of about $1.5M and profits of about $220K (not adjusted for their 30% ownership). Total assets are about $5M and total equity of $2.5M as of 9/30. With the stock up 22c or +39M in market cap...I'm not sure how that is being justified...

    SubjectEarnings
    Entry04/25/2012 12:18 PM
    Memberyellowhouse
    Any thoughts? I don't get the jump at all. 63x EBITDA?
     
    If cash at year end was INR 928MM, a yoy increase of 385MM, and 500MM was the next slug of dilution then  115MM in cash was spent. With capex of 928MM, cash from operations was probably something around INR 813MM. So that's around $15.5MM in cash flow for a $590MM market cap (38x) that:
     
    1) has a CEO that is stealing the company by purchasing stock at a 70% discount to market;
    2) has non-existant ROIC for the last ten years, spending $96MM in capex over the last five years to generate cumulative cash from ops of $9MM
    3) continues to spend well in excess of internal cash flows and cannot raise outside capital;
    4) is nearing max capacity in its data centers, which I estimate constitute ~50% of revenues and likely a higher percentage of EBITDA
     
    This still seems like a very good short. Would be curious to get others' perspectives.

    SubjectRE: Author Exit Recommendation
    Entry06/25/2012 11:28 AM
    Memberyellowhouse
    great idea, thanks a lot. we've also covered a lot, but still short a small amount and will look to add on any strength.

    SubjectRE: RE: Author Exit Recommendation
    Entry06/25/2012 01:39 PM
    Memberdionis589
    Thanks. Valuation still inflated for what it is, but risk/reward not nearly as great. Inevitably this will bounce with some India internet rumor so just wait for that.
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