However, when you pursue growth for the sake of growth - without paying too much attention to whether this is profitable growth - you end up with a situation where more and more capital is required to support the top line growth.
Such seems to be the case of Cranes software, a software products company I otherwise like. It has niche focus on scientific and engineering software; the products (Sigma, Systat etc.) enjoy a worldwide reputation; are already in use by thousands of scientists and engineers and have high switching costs thanks to the learning curve involved.
Unfortunately, Cranes seems to be on an acquisition overdrive. There are 2 red flags that emerge after going through annual reports (posted on the Cranes Software web site).
(small red flag) Sales are growing mainly through acquisitions. There doesn't seem to be any organic growth.
| FY05 | FY06 | FY07 | |
| Sales (Cr) | 163 | 210 | 284 |
| Growth in Sales (Cr) | 50 | 47 | 74 |
| Amt Paid for Acquisitions(Cr) | 86 | 56 | 125 |
The amount spent for acquisitions is hardly giving rise to commensurate growth in top line. Maybe it will pay off in the long run as Cranes claims. But if the acquisitions made in FY05 and FY06 are not paying off yet, I have my doubts.
(BIG RED FLAG) Software development expenses are being Capitalized. Search for 'Capitalizing software development expenses' in Google and you will be presented with a bunch of results and case studies.
On page 21 of FY07 annual report, Cranes says:
During the year, the Company invested Rs. 3,117.23 million (net of Income), the main components of which were Rs. 1,610.55 million towards product development investments for upcoming versions of the range of proprietary products ...
Note that this 161 Cr was spent for creating new versions of existing products. This is separate from the 125 Cr that is spent on acquisitions (shown in the table above).
In the software products business, releasing new versions of your software is the equivalent of keeping your shop tidy and clean. It is the requirement of staying in business and can hardly be classified under creating a new asset that is above and beyond the asset you already have.
The depreciation charged for FY07 is only 44 Cr - not even within the ballpark of 161 Cr that was required to just stay in the place. If the entire 161 Cr were expensed, Cranes would have shown a big loss for FY07 instead of the 86 Cr of PAT that it has shown.
So where did this 161 Cr go? You have to stuff it some place under the carpet and that place happens to be Capital WIP (work-in-progress) entry on the balance sheet. This is 161 Cr for FY07. Add to that last year's similar entry of 67 Cr and there is a monstrous 230 Cr of capital WIP sitting on the balance sheet.
Of course, you can't keep shoving stuff under the carpet. It has to come out some time. Either it will be coming off as big depreciation charges in the future (unlikely, as that will make Cranes unprofitable for years) or as one time big bath write-off.
Indeed, it is more appropriate to call Capital WIP as Capital Write-off-in-progress or Capital Wreck-in-progress.
Well, I guess, time to move on and turn other rocks to see what is hiding under them.
1 comments:
Very nice analysis Ravi, I do not hold the stock but and after reading this I really will not be keen to invest in it!! Such cases keep remiding me to invest in companies with high proven moral fiber.. a smart accountant can save the life of a dumb business owener or at least delay the death!!
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