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Wipro: A Good Company at the Wrong Price

Erik Kobayashi-Solomon

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, one of the co-editors of Morningstar OptionInvestor, and today it's my great pleasure to welcome Swami Shanmugasundaram, who is an analyst for business services at Morningstar. Thanks for coming, Swami.

Swami Shanmugasundaram: Thanks, glad to be here..

Kobayashi-Solomon: Now, back in December, I wrote an article talking about how to make a bearish bet on Wipro, the Indian outsourcer, and as soon as I wrote this, somebody writes in to me and says, "Wait a second. I thought Morningstar thought Wipro is a good company."

So, I know that you like Wipro. I just want to understand better why you think it's a good company. What is it about it?

Shanmugasundaram: See, if you look at any IT outsourcer, it's primarily driven by the management and the processes. So if I look at the top-tier companies--which includes Wipro, Infosys, and Cognizant--all of them have a very strong management. Most of the time they are able to stay ahead of the curve, in terms of when you compare them with their competitors.

So I would say that's what differentiates, because at the end of the day it's a services business. So it's driven by the people.

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Kobayashi-Solomon: So they just have very good managers and a well-established process.

Shanmugasundaram: Exactly. And they are able to see things ahead of time. So, for example, one of their acquisitions--they did it in 2008, I think, Infocrossing--which was actually on infrastructure management, which was just picking up at that time. Now they have been establishing themselves in the market, which is really good for them, because their growth rate was ahead of the market.

Kobayashi-Solomon: I see. OK, so they're a well-run company. They have good processes and they're good at what they're doing. My point was, when I wrote this reader, was simply that it looks overvalued right now. Or this is actually when it was trading at 22.50, something like that. I just want to understand a little bit of the bear case. So it is a well-run company, but what could go wrong from this point?

Shanmugasundaram: I think it is overvalued, because people... Historically, it has grown at 30%, 35%. I think the market is expecting the company to grow at that same rate, which I'm not very sure would happen, one, primarily, because of the recession. Most of the companies have cut their IT expenses.

Second thing is, they have the law of large numbers. They started at $1 billion and now its revenue is $4 billion to $5 billion, somewhere in that range.

Kobayashi-Solomon: It's hard to grow $4 billion to $5 billion at 30% a year.

Shanmugasundaram: Exactly, 30% growth.

Kobayashi-Solomon: Yeah.

Shanmugasundaram: I would say that would be the major thing.

Kobayashi-Solomon: I see. And so this brings me to my next question, which is, in your model, what are you projecting for this company in terms of revenue growth, in terms of profitability? And how do you kind of get there?

Shanmugasundaram: My expectation is that revenue growth on an average, my cumulative growth, would be in the teens for the next four or five years. That's primarily because they are dependent on the financials of these companies. So that should drive the growth forward.

Kobayashi-Solomon: Sure, but still, 15, mid-teens, that's still a high growth rate.

Shanmugasundaram: It's still high. But if you look at the industry assets, the IT services industry, you go with Gartner or IDC. Those are the research firms. The market is about half a trillion. So you're talking of a $600 billion market, $700 billion market, which is highly fragmented. So you're still able to gain market share from your smaller competitors. That's one of the reasons I think they should be able to grow.

Because now these days, when companies are looking for outsourcing providers, they're looking for people with credentials. They're looking for people, companies, with an expertise in the market. So I think Wipro is kind of standing out in that.

Kobayashi-Solomon: I see. So to kind of to summarize, basically what you see is, Wipro is growing, and it's going to grow, but it just can't grow as fast as the market thinks that it's going to grow.

Shanmugasundaram: I think one other thing which I would mention is, if you look at the spread, right--and it is. Wipro is 80, which is being traded over here. So there is a huge spread between the Indian share and the US thing. So I'm not sure what is rationally behind that, because it's still a one is to one. When I last looked at it, it was closer to 30%-40% spread, which is huge.

Kobayashi-Solomon: So maybe there is some sort of liquidity. I know the Indian market has some sort of capital restrictions, something like that, perhaps.

Shanmugasundaram: Could be. The second thing is the owner, the founder, of the company still has 80% to 85%. So your flow to assets is very much less. So I'm not sure what are the reasons.

Kobayashi-Solomon: Now, do you think that there would ever be a case where the founder would start selling off shares?

Shanmugasundaram: He is actually, but at the present rate is still low. You're talking of 0.5%, so I don't think he's going to unload his entire thing, I would say, a significant percent of his holding in the next few years. They're doing it, but it's going to take some time.

Kobayashi-Solomon: But in general, it seems like the bearish sources of uncertainty overwhelm or outweigh the bullish sources of uncertainty.

Shanmugasundaram: I would say that. Even if I look at P/E multiples. It's trading at higher multiples compared to its peers. So in high 20s, but its peers are trading, I would say, low 20s. Which, again, I don't see any reason for that.

Kobayashi-Solomon: It doesn't seem to deserve that extra kind of multiple.

Shanmugasundaram: Exactly.

Kobayashi-Solomon: Well, Swami, thanks for coming in and chatting with me about it.

Shanmugasundaram: Thank you.

Kobayashi-Solomon: And thank you for joining us. Please stop by the Morningstar OptionInvestor website where we have many more great fundamentally based option ideas.