The Hindu Business Line : Growing on IP

Since its merger with products company Xius, Megasoft has had a taste of success. For eWorld, it dwells on the path taken and its plans for the future.

"This is a new strategy aimed at becoming a 100 per cent domain-driven, IPR-led solutions company."

G.V. Kumar, CEO, Megasoft. - K. GAJENDRAN

In February 2004, the Indian IT industry was yet to fully recover from the impact of the slowdown in the US' IT spending. Those companies that did swim quickly against the tide were invariably the large Indian IT firms. The smaller ones struggled to change their business model.

Megasoft, in that month, announced its merger with XIUS India, a software products firm. As a pure-play software services firm prior to this merger, its revenues for the eighteen-month period ended December 2003 was Rs 53.1 crore and post-tax earnings of Rs 1.24 crore (both annualised).

Since then, Megasoft has focussed on transforming itself from services to an IP (intellectual property)-driven solutions company in the telecom and life sciences vertical.

For the year ended December 2005, its revenues have touched Rs 115.4 crore, with post-tax earnings at Rs 20.1 crore.

Interestingly, the IP-driven telecom and life sciences vertical has contributed 34 per cent of the overall revenues, with 30 per cent coming from telecom alone. The balance was contributed by consulting services. The PBIT (profit before interest and tax) margin from the telecom segment was a robust 43 per cent compared to 14 per cent from the services segment for the year.

G.V. Kumar, CEO of the merged entity, Megasoft, spoke to eWorld recently, dwelling on the journey thus far and the path forward. Excerpts:

How have you positioned your telecom domain skills?

Post-merger, our strategy was to become a domain-led IPR-driven solutions company. We wanted to develop skill sets, know-how and intellectual property that are specific and unique to certain niches.

We were already ahead, thanks to the telecom domain under XIUS. Subsequently, we took the life sciences domain because it fit the broad framework. Today it is still a small practice.

Moving forward, 35-50 per cent of our revenues will happen in telecom. As a part of our strategy, 50-100 per cent will happen in multiple domains. The idea here is not just telecom. This is a new strategy aimed at becoming a 100 per cent domain-driven, IPR-led solutions company. Then, pure services should become zero. That's what we'd be pursuing. If you take a five-year vision of the company, I see Megasoft as a company that owns IPR and skillsets, technology and process advantages in 3-4 chosen domains.

Several products companies in India seem focused on the telecom domain. What category do you belong to and why?

Telecom has four broad categories of vendors that converge on the services providers:

Customer premise equipment (CPE) - handset, SIM cards, SIM applications, embedded applications

Operational Support System (OSS), Network support - call routing, transmission

BSS (Business Support System) - fraud managementdistribution, CDR-based billing, customer-care

Content area - ringtones, actors' photo and the like.

We deal in the OSS space and handle the technology during and before the call.

We focus on:

Real-Time subscriber authentication

Real-Time subscriber charging and interoperability.

We notice a significant growth in telecom revenues. What has happened this year compared to last year? Did new service offerings help or was it pre-merger Megasoft business networking that helped?

No, not from pre-merger Megasoft client lines. Today, it has come purely from disruptive expansion. We leveraged the geographic presence of Megasoft. We started selling in higher value and better price realisation markets such as West Asia and Europe. India and East Asia are ridiculously low priced markets - no one pays for products in India.

Pricing patterns you follow...

We evolved from being a licence-based company to a solutions provider. Typically, there are 3-4 elements to pricing even with a single customer. First is the consulting phase where we tell the customer to `scope' his business. I have this platform that can bundle various services - say for one segment of customer that is prepaid, another that is for students... . Consulting still forms only a small portion, maybe 10 per cent of revenues. Then there is the licence revenue, based on scoping, followed by the operations revenue, where I operate this platform.

Earlier, we used to walk away after selling the licence. Sometimes, the client also says that he does not want to pay for the whole technology. He would pay a certain fee upfront, but incrementally through the ASP (Application Service Provider) model - per month or per subscriber. We have avoided infrastructure management - we haven't reached a stage where the operator or we want to do it. We aren't big enough for that yet.

Factors that helped telecom contribution to increase from 17 per cent in 2004 to 30 per cent in 2005... ?

Our prepaid and Instaroam (which offers global roaming agreements to an emerging operator in different geographies) platforms helped us. When we started marketing it outside India, the deal size went up 3-4 times. New customers in new geographies have driven last year's (2005) revenues. This year too, we will see more of this.

We will also look at new product platform offerings such as VOISE (which is a pure plug-and-play convergent service delivery platform developed by Megasoft for Mobile Virtual Network Operators and virtual carriers). VOISE has given us a new segment to tap. The ASP revenues will see acceleration end of 2006. We have signed an ASP with Teleglobe, which will give us more revenue this year.

PBIT margins too are up, from 27 to 43 per cent for the telecom segment alone. Once you switch from Licence to ASP model, will there be an impact?

ASP is typically a larger-margin business. In licensing, there are third-party costs involved such as hardware, software packages, taxation and the like. In ASP, it's pure transaction pricing. So, the margins are larger. However, the jump you see now is because the top-line has jumped significantly and in the products business, the variable cost is not based on manpower cost.

What could put pressure on margins is dramatic price reduction due to competition. As you get into new geographies, branding costs would increase. But we don't see pricing pressure (round the corner) because we have just gone from a low-priced market.

To that extent, I don't see telecom margins falling because ASPs would increase my margins - am getting into markets where prices could be higher and expenses in India could remain the same with expected growth. In sum,43 per cent PBIT margins might not become 53 per cent, but it is sustainable.

Could you elaborate on manpower costs in percentage terms, assuming 35-40 per cent revenue growth this year?

Manpower cost in the products business is 16 per cent. That might hover around 18 per cent next year (in 2006).

That is a significant jump since revenue is also rising. Marketing expense is 5-8 per cent. Last year, it was 4-5 per cent.So, we see an overall 5 per cent increase from these two fronts. This will be more than offset by revenue going up, especially thanks to ASP revenue, which is higher realisation revenue.

What are your target markets? How have you approached them?

Let us look at it differently. We are in less than 30 per cent of known telecom markets. That is, 70 per cent of our markets don't know we exist. That's why we are desperate for alliances.

Who are your competitors in the core telecom space?

Comverse is a competitor but their size is so much more than ours. However, I see that we are ahead of them in some areas.

What is the kind of market penetration in your target markets? What are the key markets in future?

We tried West Asia, the Middle East, Central Asia, Africa, Eastern Europe and Asia-Pacific in '05. In A-P, we have not made big progress; we have picked up customers in each of the other regions. Now, while we were sort of getting into these markets, we looked at Western markets. That's why we acquired the German company (beam AG) and now we are looking at acquiring a US company. We are already selling in the US. But an acquisition would give us a start up as a registered vendor supplying to US vendors; to understand local market and consulting and ASP services. So, we need that type of company.

While we were entering other markets, we were looking at European and US markets. In '06, that's the area. We are also focused on forming alliances x Teleglobe is an example. Many of them are front-ended by partners. Their focus is on where their strengths are geographically.

What did beam AG bring in?

Market access. What we think we are getting is a set of smart sales and project management people that helps us jumpstart in a new market. Two, we get a registered vendor for major telecom companies. telecos. If you aren't registered, it is difficult to access them. The process of registering itself takes a long time. We are doing something in telematics for DaimlerChrysler. It's a nice team with customer access x that's what we are looking for in a new acquisition in the US as well. Any domain speciality also is welcome.

Why did you pick up 64 per cent there? What was available?

We wanted the promoters to remain. We did not want to buy out fully x we were buying the team since it was good. We also allow for options dilution and still remain in control. Going forward, we might buy them out or sell out, depending on what creates most value at that point.

Are you in talks for the US acquisition? What size would you be looking out for?

Between revenues of $10 million and $20 million. .$ 10-20 million. Valuation is typically half of revenues. We are noticing that lots of Indian companies buying in Germany. Valuations are suppressed there. So we are leveraging that. If it is an unlisted company there, valuations are even worse. Also, we will be able to structure it accordingly. Part stake, part equity, pay out later. It allows for cash flow improvements along the line. Even if you buy a $15 million at three-fourths valuation, we don't pay the whole amount. We could even borrow a bit.

We would also be happy to acquire a company with domain-led IP in a third sector. In the area of life sciences, the second area, we would like to establish ourselves before we look out.

For the US acquisition, is the domain focus on telecom?

Yes. The mandate Mandate to investment bankers is also the same. There is no massive step-up for Life Sciences yet. Where we are spending more is in implementation and on the sales team. We have good technology capability already, so, there is no investment on that count. If that takes off this year, we could expand next year and then look at acquisitions and new markets.

Where do you stand in life sciences? Anything happening domestically?

In the next two years, it's a pure US market. Nothing will happen in India. They are all small here and don't have resources to invest, It's like SAP users. It requires certain maturity. About 80 per cent of drug discovery happens in the US. Almost all our revenues are from the US this year.

Your choice of verticals does not seem complementary.

We are not looking at related verticals, but at domain led, IPR-driven domination of a particular niche and solutions in that space.

We got that both in telecom and in Life Sciences. We are open to a third or even a fourth such domain. We need to prove it in Life science. Last year was promising. We crossed $1 $ one million. This year looks promising. We are not projecting big time for the bottom line. I think it would grow well.

In the consulting pie, we see that margins are about 13-14 per cent. What does this actually represent?

Consulting is what we inherited acquired from Megasoft. Theirs is not much from telecom. We have not analysed it from a sector point of view. What we are focused on is process consulting, quality certification, etc. So, it is difficult to give domain specifics. I feel that margins are under pressure from the IT side. With H1Bs squeezing out (this interview was conducted before the recent passage of the H1B Bill by the US Senate), margins are squeezed. Next year, margins might have 1-2 per cent impact. Revenue growth and repositioning of services to niche domains should offset this impact. For example, in process consulting, we could specifically consult for SLA (service level agreement) management of all vendors. We are trying to productise there also. As of now, we are trying to give the IT services part of our offering the `niche' tag, too. We don't have big plans in IT services x in terms of improving topline.

How do you view Megasoft's performance in the next 2-3 years? Any signals you see?

For 2006, margins would be at the same level or more but definitely at this level. Services margins would be under pressure x offset by better telecom and product revenues.

maverick@thehindu.co.in

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