January 10, 2005 | Press Release

While tech heavyweights have propelled the Sensex rally till now, there are some mid-caps, which still look like value propositions.The last time we wrote about mid-cap IT stocks in August 2003, the setting could not have been more different. For starters, the Sensex was trading around the 3500 levels and big investors were pulling out of IT stocks.In fact, positive developments in other sectors like banking, oil, pharma and steel had seen infotech's share of trading turnover (on BSE and NSE) fall from 75 per cent in January 2003 to 35 per cent in August 2003. Large-, mid- and small-cap IT stocks witnessed a 33-50 per cent y-o-y decline in market-cap in the period.

Cut to the present and the disparity hits you in the face. The Sensex has touched the highest-ever levels and is not showing any signs of descending below the rarefied 6,000 mark and make no mistake, IT has been the backbone of the rally, say analysts.The market-caps of large- and small-cap IT stocks have risen by 41 per cent and 56 per cent respectively while that of the mid-cap segment has surged around 23 per cent."There is a lot of euphoria among IT stocks on the whole, thanks to the inflows," says Sandeep Shenoy, strategist, Pioneer Intermediaries. Although gains in stocks were across the board, the buyers differed.The top-rung IT stocks were snapped up by FIIs while a lot of retail money seemed to have gone into mid- and small-cap players. Apart from the euphoria in the stock market, IT firms have other reasons to cheer.Client additions among the larger companies have been impressive, and analysts view that as an indication of the optimism lying ahead. The trend among the IT bellwethers is generally known to be a proxy for the prospects of the industry as a whole. The moot question is - would the gains in the sector percolate to mid- and small-caps?

Micro view

A striking contradiction has been the sales and net profit figures across the IT industry. While mid-caps moved up the least in terms of market-cap, their cumulative sales growth of 19.6 per cent and bottomline growth of 84 per cent were not a far cry from the 30 per cent sales growth and 26 per cent bottomline growth of large-caps.Small-caps, on the other hand, posted an impressive bottomline growth of 542 per cent on tepid sales growth of just over 9 per cent (see chart on page 6). Clearly, the tunraround in the performance of some mid-caps is not captured in the stock prices.Taking the trailing 12 month (ended September 2004) sales and bottomline figures into consideration, iGate, Mastek, Visualsoft Technologies and Blue Star Infotech turned in shabby performances while Geodesic Information Systems, Aztec Software, Tata Elxsi, CMC, Zensar and Rolta posted inspiring numbers.VisualSoft and Transworld International, too, witnessed a 45 per cent and 38 per cent decline in their market-cap. On the other hand, companies like Mascon Global and Aztec Software bounced into the black this year and posted smart gains on the market-cap front, too.

All has not been well in large-caps as well with i-flex solutions and Polaris slipping 28 per cent and 21 per cent respectively in terms of market-cap. Moser Baer and MphasiS BFL also witnessed a slippage in market-cap.

All the four companies had seen a 4-30 per cent slippage in bottomline. On the small-cap front, Nucleus Software, Onward Technologies, Zicom Electronics, Zenith Computers and KGL Systel were among prominent gainers in terms of market-cap, thanks to decent financial performance.

Expansive vistas

"The addressable market in IT is huge," says Dheeraj Sachdev, portfolio manager at ASK Raymond James Securities.
"No doubt that small- and mid-tier companies are losing out to the larger IT companies on scalability and size, but specialisation and differentiation are two watchwords that would stand them in good stead and, combined with competent execution skills, make for a killer combination that cannot go wrong," he adds.

But potential investors in mid- and small-caps should hold their horses. Most analysts admit that the lack of predictability in earnings of mid-cap stocks has not changed. Large-caps' scalability, size and revenues, which have been growing at a faster clip than mid- and small-caps, turn the tide in their favour, they add.

So what do mid- and small-cap companies have going for them? Sachdev admits that most mid- and smallcaps are witnessing an improvement in clients and order size as in the case of Zensar Technologies. Billing rates have also been firm to stable.

"There is a lot of business out there, especially for niche players in the IT space," says Priya Rohira, IT analyst at Refco Securities.

In August 2003, Shenoy had predicted that the wheat would be separated from the chaff going forward and the rest would be bought by the large-caps.

The scenario today is not radically different but Shenoy insists that companies are definitely moving in that direction. "A shakeout among mid- and small-caps is imminent and one can look forward to a lot of acquisitions and mergers."