Chennai: It is a double-whammy for Polaris Software Lab, which acquires OrbiTech Solutions (a Citigroup company). The stripping of OrbiTech by a whopping $15 million as interim dividend by its shareholders (Citigroup Venture Capital and OrbiTech employees), coupled with the downward revision of information technology (IT) services rate by Citigroup, has taken the sheen out of the acquisition that Polaris announced in May 2002.
Ending the four-month merger suspense, representatives of Polaris and Citigroup Venture Capital formalised their May memorandum of understanding (MoU) by signing the shareholder's agreement, but under different terms.
As per the new terms, Polaris will issue 42.65 shares of Rs 5 paid up for every100 shares of OrbiTech (Rs 2 paid-up). OrbiTech has 107-million outstanding shares, with 6.75 per cent held by its employees. Post-merger, Polaris shareholders will hold 52.75 per cent, while OrbiTech shareholders will own 47.25 per cent. The revised equity of Polaris will be Rs 48.5 crore - up from Rs 25.59 crore.
''However, Citigroup's voting rights has been capped at 29.9 per cent,'' says Polaris chairman and managing director Arun Jain. As per the original MoU the swap ratio was fixed at 14:25, resulting in a post-merger equity-holding of 54:46 in favour of OrbiTech shareholders, with no cap on their voting rights.
After the MoU in May, it took an inordinate time to formalise the same. Jain attributed the delay to legal intricacies involved in transferring the 57 intellectual property rights (IPR) / banking products owned by Citigroup. However, the markets were rife with various speculations.
Now it transpires that additional factors like the hefty interim dividend declared by OrbiTech and the billing rate revisions effected by Citigroup for its IT vendors weighed heavily on Polaris going ahead with the acquisition.
Soon after the MoU with Polaris, Orbitech closed the first half of the current fiscal with revenues of $ 40 million and a profit after tax (PAT) of $13 million. The company declared $15-million interim dividend, more than double that of the previous year's dividend amount. In the last fiscal, the company had declared a turnover of $66 million and a PAT of $22 million.
Didn't Polaris object to the interim dividend after the merger MoU was signed? ''When the interim dividend was declared, OrbiTech was still a privately-held company and the management control was not with us. The interim dividend is entirely legal,'' says Jain.
Adds Polaris senior vice president and chief finance officer N Vaidyanathan: ''We were informed about the interim dividend, and everything was transparent.'' Perhaps to facilitate the interim dividend decision the effective merger date was changed to 1 November 2002 from 1 April 2002 announced in May 2002.
The next surprise for Polaris is the rationalisation of the IT rates by Citigroup. In July Citigroup effected an 18-per cent reduction in IT services per hour rates, impacting its IT vendors like i-Flex, OrbiTech and others. The rate revision resulted in OrbiTech reducing its projected revenue to $33 million and PAT estimates halving to $6.5 million for the second half of the current fiscal. ''We signed the merger MoU in May when the new situation could not be foreseen. However, we reacted to the situation,'' says Jain, citing the revised merger terms.
Responding to the query as to whether Citigroup paid its associate companies higher than the prevailing market rates, Jain says: ''It was an ignorant rate (higher rate paid by banking customers ignorant of market conditions), which was paid by Citigroup to OrbiTech. Since both belonged to the same group, not much importance was given to that.''
Curiously, Citigroup or its associates didn't pay such ignorant rates to Polaris and other outside vendors. Further, Citigroup's rate revision came only after i-Flex went public and after OrbiTech's merger announcement.
The high-profile consultants at the time of the MoU - Salomon Smith Barney (a Citigroup company) Kotak Mahindra Capital, and Ernst and Young - didn't question the sustainability of high or 'ignorant' service rates charged by OrbiTech. Had that been factored into account, the enterprise valuation of OrbiTech would have been much more realistic.
For instance, the company's realistic turnover would have perhaps equalled or been lower than Polaris. Retail investors (who had invested in May) and had burnt their fingers could have either avoided the Polaris stock or at least made an informed decision.
When questioned about the sanctity of OrbiTech's financial numbers (turnover: Rs 321 crore; PAT: Rs 107 crore) what with the 'ignorant rates' paid by Citigroup and major American companies embroiled in accounting and other scandals (including Citigroup outfit) and redrawing their books, Jain says: ''There cannot be any changes in whatever has been announced, as the revenue has actually been realised.''
But what is still kept under wraps is OrbiTech's cash reserve (after $15 million interim dividend) and debtors' position. Similarly, in May, OrbiTech managing director Ram S Bhagwat declared that the company owned assets worth Rs 170 crore and has a built-up space of 1.5 lakh sq ft (five software development centres and one corporate office). Whether there has been any change in the asset ownership post-May is not known.
With the new twists and turns post-May, Ernst and Young was again asked to revalue OrbiTech. This time the consultant estimated OrbiTech's enterprise value at $188.1 million - a sharp fall from the earlier valuation of $246.75 million. Jain says 57 products / intellectual property rights (IPR) owned by OrbiTech were not valued separately. Incidentally, some of the much-touted IPRs / products are yet to be tested commercially.
Another curious aspect of the merger deal is the capping of Citigroup's voting rights at 29.9 per cent. Though Jain says this was done to show other banking customers that Citigroup was merely a financial investor, he couldn't explain as to why the cap was not pegged below 26 per cent, preventing the latter from stalling any special resolution sought to be passed by the Polaris management.
Though Jain is categorical today that Polaris wouldn't have gone ahead with the merger had Citigroup refused to accept the new terms, it is doubtful whether he had the leeway. Firstly, Citigroup is one the major clients for Polaris whom he couldn't affront and secondly, he cannot afford another takeover fiasco like Data Inc, which would permanently dent his future acquisition attempts.
Finally, ask about the human resources integration strategies that are now practised (OrbiTech has around 1,300 employees and Polaris around 2,800), and Jain and other officials slip away like greased eels.
Goes to China The Polaris group (Polaris and its wholly-owned subsidiaries) closed the first half of the current fiscal with a revenue of Rs 146.43 crore and a PAT of Rs 23.63 crore as against Rs 143.74 crore and Rs 29.89 crore, respectively, clocked during the previous year.
''The exchange loss, increased depreciation, sales and marketing expenses dragged down the profits,'' says Jain.
As part of expanding its global reach, Polaris has decided to float a Chinese subsidiary to take care of the Japanese and local markets. ''The outlay will be around $3 million. While our Japanese subsidiary will take care of the marketing, the Chinese outfit will be the delivery centre,'' adds Jain. He hopes to have around 100 Chinese software professionals with the top management sent from India.
On 25 October 2002, getting a whiff of the revised merger deal and the poor half-yearly results, the markets decided to give a thumbs-down to the Polaris stock. On the National Stock Exchange Polaris stock opened at Rs 204 and tumbled down to close at Rs 186.
also see : Knight