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Desirable dilution

Sanjay K Pillai

A year ago, when Hyderabad-based Satyam Computers revealed that it wanted to dilute equity in its Nasdaq-listed offspring Satyam Infoway, the line-up of suitors was impressive. The marquee had the likes of Reliance Telecom, Warburg Pincus and the Tatas. But last fortnight, when Sify finally announced its strategic partner, it took everybody by surprise.

The new investor, Softbank Asia Infrastructure Fund, through its arm SAIF Investor, along with London-based VentureTech Solutions will invest $20 million for a 52 per cent stake in Sify. VentureTech's Sandeep Reddy was an early investor in Sify's American Depository Receipts on the Nasdaq.

SAIF is a 50:50 joint venture between Softbank, one of the largest investors in technology companies promoted by the dynamic Japanese investor Masayoshi Son and Cisco, the leader in equipment supply for network and IP infrastructure worldwide.

For Softbank, which manages 11 funds with net assets totalling yen 182.2 billion at the end of June, the Sify investment comes at a time when the global stock market downturn has affected its hefty investments in dot-com startups across the globe. Its worldwide revenues have slumped 38.5 per cent.

Clearly, the investment couldn't have come at a better time for Sify, which listed on the Nasdaq in October 1999. Over the last year, its CEO R Ramraj has been luring suitors by reiterating that "Sify has a strong story to tell and it is doing well".

The fresh infusion of funds will help Sify bolster its finances and expand its service offerings. For consecutive quarters, the company had been reducing its cash burn from Rs 586 crore (Rs 5.86 billion) in the year ending March 2001 to Rs 63 crore in the year ending March 2002.

In this fiscal, the cash burn includes a $1.1 million payment for bandwidth arrangements, the acquisition of Wipro's corporate connectivity business and the advance for procuring fibre bandwidth paid to VSNL.

At the same time, it closed last fiscal with revenues of Rs 157.75 crore (Rs 1.58 billion). The cumulative net loss upto June this year stood at Rs 1,083 crore (Rs 10.83 billion). This includes a goodwill write off of about Rs 700 crore (Rs 7 billion), which according to US GAAP is part of net loss. It carries forward an operating loss of Rs 383 crore (Rs 3.83 billion).

Despite this, Sify managers claim that there are adequate reserves which will help it break even and go forward. Sify has been able to reduce costs because of better control over expenses and increased revenues. In the quarter ended September 30, 2002, the company posted a 15 per cent revenue growth from Rs 40.46 crore (Rs 404.6 million) in the previous quarter to Rs 46.40 crore (Rs 464 million).

The enhanced performance is largely from the corporate services which bring in better margins. In the consumer business also the company is witnessing an increase in the average revenue per user.

What they do not say is that Sify's future ambitions would have stayed put without equity dilution. There are plans to expand the infrastructure of revenue generating business lines like Internet parlours and its corporate connectivity business.

Today, 70 per cent of Sify's 700 Internet cafes are on wireless broadband. It is also focusing on high margin and high growth businesses like corporate connectivity/data services like VPNS (virtual private networks), Internet bandwidth, Internet telephony, hosting, messaging services, network security, offer managed services, content development (web site development and maintenance of content). Ramraj admits that most of the fresh funds will go towards infrastructure expansion to further Sify's broadband initiatives.

According to the International Data Corporation report, the market for VPNs is expected to grow at 62 per cent compounded annual growth rate between 2001-2005. Its 2001 report shows Sify having more than 70 per cent of the market, with Wipro and HCL Infinet coming a distant second and third. Sify has acquired Wipro's customers since then and further consolidated its position.

For Satyam Computers, the expansion in Sify's equity has seen its stake shrink from 52 per cent to 35 per cent. This means that Sify's results will no longer reflect on its balance sheet. "So Satyam now becomes a 'pure play' software services company as per the objective," says a Sify manager." As of now, there is no such provision in the agreement for Softbank to pick up a further stake.

In fact, Satyam's move is more market driven. Ever since it listed on the New York Stock Exchange on May 15, 2001, becoming a 'pure play' software services company has become imperative. Large funds and institutional investors who apportion a percentage of their funds for investment into particular sectors were bypassing the Satyam counter.

By December this year, Sify will be an independent company and is expected to carve out its own identity and image. Pending shareholder approval, it will be rechristened Sify Ltd. According to Paul Zimmerman, managing director of the Softbank Asia Infrastructure Fund, its latest move is a clear indication of Sify's potential.

He claims that the investment decision was taken on the basis of a host of factors. One, India is anticipated to be one of the highest growth telecom and network markets in the Asia Pacific region over the next five years. And SAIF believes that Sify is well poised to capitalise on that growth. "Finally, it is the market timing which we believe provides attractive valuations in the telecom and networks sector," says Zimmerman.

The focus now will be to accelerate the growth of its high margin corporate business, and the profitability of its consumer business. "We believe we have invested in Sify at the right time-at the point of inflection where Sify's leadership in a high growth market will see growth in revenues and profitability," he adds.

SAIF is expected to lend Sify its expertise to tap global markets. "The idea is to leverage the company's skills and expertise in the Internet space and network management to provide remotely managed services from India across the world," says Ramraj.

According to Ramraj, the strategic investment would help Sify reach out to places like Singapore and Hong Kong, where existing connectivity is high and which would be an ideal place to expand its business. The additional cash according to Ramraj gave Sify the handle to be more aggressive in its approach and also being able to focus on reorienting the loss-making ISP towards profitability.

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