The title of this article says everything you really need to know about Subex’s results for the year ending March 31st 2016. Announced this week, their FY16 figures reveal a continuation of the trends manifest in previous years: management have successfully shaved expenditure in order to offset the decline in revenues.
Revenues were down 10 percent compared to last year, coming in at INR323cr (USD48mn). Investors will not be surprised given the quarterly revenue figures announced during the year, though the Q4 figures showed a slight uptick compared to those for Q3.
The drop in revenues was matched by cuts to operating expenditure. Expenses excluding finance costs and exceptional items were INR263cr (USD39mn), which was 7.2 percent less than in FY15. Forex fluctuations added to the operating costs in both years, though Subex benefited from a significantly favorable swing during the final quarter of FY16.
One potential warning sign is that the Q4 cost of hardware, software and support charges was recorded as negative in Subex’s books. Unless Subex have sold all their employees’ laptops this peculiar number reflects a reversal of excess provisions carried forward from last year. Subex will not be able to cut this category of costs any more than they already have. The hardware and software costs for FY16 were just 2.5 percent of what they were in FY15, which means that Subex has either done some clever deal-making or they no longer need computers to do their job!
Another red flag relates to employee costs. These costs consume 55 percent of revenues, and the problem with this category of expenditure is that people really want their cash or they tend to stop working. Staff and subcontractor costs were up by 7.6 percent compared to FY15. However, the costs would have been higher if it were not for the reversal of provisions for employee incentives that are no longer required. It is not clear why such provisions would be reversed but we might speculate the reasons will either be that staff are not being paid bonuses, staff are accepting cuts to their remuneration packages, or headcount is being cut.
Finance costs were also reduced, weighing in at INR46cr (USD7mn). This represented a reduction of 24 percent compared to FY15. As a consequence, the profit before exceptionals was little changed since last year at INR14.7cr (USD2.2mn).
The major coup for the business was that it successfully persuaded most of its remaining foreign currency convertible bond (FCCB) holders to convert their debt into equity. Surjeet Singh, Managing Director and CEO, observed that:
…Subex has been able to convert [the] majority of its FCCB debt into equity. With this, the long term debt overhang and related interest cost on the balance sheet of the company is substantially removed. This was a complex process and is a significant milestone for [the] future of Subex as this shall provide much needed avenues for investment in the core business and enable long term growth…
He will not get much argument from me. The disastrous acquisition of Canadian business Syndesis left the Indian vendor straddled with a mountain of debt. The hope of converting this debt into equity was soon dashed as Syndesis proved to be highly overvalued and every uncontrollable factor swung against Subex. This left Subex carrying the debt burden for much longer than they anticipated, though they progressively renegotiated terms with the FCCB holders to ensure the business remained solvent.
Subex will benefit from this weight finally being lifted from its back, which also resulted in a very large one-off exceptional gain as the accrued FCCB interest expenditure was reversed. However, this boost masked a considerable write-down in the carrying value of Subex’s American subsidiary. An impairment provision of INR89cr (USD13mn) suggests that Subex’s plan to generate substantial growth in this region has come to an effective end. In contrast there was no write-down of the investment in Subex’s UK-based subsidiary.
The positives in Subex’s press release concentrated on the continued transition towards predictable revenues generated from long-term managed service contracts. This is a positive for the firm, because it means the business can plan for the future with some confidence, and investors know they can rely on these contracts to generate sustained income. On the other hand, this news also fits with a picture of steady retrenchment. Subex is more secure because it knows existing customers will be tied to it for years, but there are few signs they are rediscovering the ability to make new sales and enjoy regional expansion of a sort that was common during their golden phase.
Cleared of its FCCB burden, some will speculate that a purchaser may now swoop in to acquire Subex. However, any potential buyer must look at the market cap and ask if the share price is truly representative of the value of the company, or if it is still being buoyed up by speculative investors. The market cap is currently around INR500cr (USD74mn). If we put this into the context of Amdocs’ acquisition of cVidya earlier this year then I believe the Indian firm is still trading at a premium to its real market value. Whilst the restructuring of the FCCBs is a relief, and the long-term contracts represent a reliable source of future cash inflows, this year’s figures suggest Subex would need a significant turnaround to recapture the USD60mn per year revenues it previously attained and had long surpassed. Any potential purchaser would need to realize considerable synergies in order to generate consistent profits that supported the current stock market valuation, especially as this year’s figures were boosted by some one-off positives that will not be repeated in future.
In the parlance of stock market analysts Subex should be considered a ‘hold’, rather than a ‘buy’. Whilst revenues are down the management team continues to show itself adept at grinding out profits. I expect they will continue to do so, despite the uncertainties and headwinds they face. But investors should be under no illusions; Subex’s market is only fit for grinders, and is not creating shooting stars like it once did. There is no sign that Subex will return to the stellar growth that once led to revenues over USD120mn per year and which encouraged its top team to go on a global shopping spree for other technology firms. This business is sound, and it should persist. But anyone hoping to get rich quick should probably think again.