Stock spotting: How to analyse a software products company?

image

By Arun Mukherjee & Soumya Malani(Kolkata’s Arun Mukherjee, a college dropout by choice, and Soumya Malani, a London School of Economics passout, have come to be known as smallcap aficionados in India’s investor community. They would show up at most AGMs, visit the remotest factories of a company and go chasing end-users to understand their experiences with a product in their passionate hunt for good smallcaps. Soumya and Arun would be sharing their experiences with companies and from the ground in this space every now and then. Keep watching…)

When you think of a software products company, think of a toll road. Once the toll road is built, all that needs to be done is collect toll from all those that use it, and maybe some regular maintenance.

Same is the case with a software products company. Once a product is developed, it can be scaled up significantly (Think Microsoft Windows). So huge rampups (read operating leverage) are possible in the milking phase, with little or no incremental cost. (We concede that the analogy with a toll road is not accurate, as there are implementation costs, custom modifications to fit clients, plus constant changes that make it dissimilar to a toll road. The analogy is just for illustration purposes to aid those who do not have an IT background.)

Ramco Systems seems to be in the right place at the right time. It has an impressive product portfolio, an extremely capable execution team as evidenced by the 1,000+ customers in over 40 countries.

It, however, operates in a fiercely competitive and rapidly changing environment, which makes forecasting almost impossible, as it is pretty much unknowable as to where the technology will take us, how the industry will evolve and how Ramco will be positioned in this rapidly changing space. The company has superb operational leverage potential, as the product once created can be rolled out worldwide and across industries with minimal incremental costs.

While operating leverage is generally a positive, in this case, it can be a double-edged sword, as not only does Ramco enjoy this, but so do its competitors. In such a scenario, a firm’s go-to-market strategy and speed of market capture become paramount due to the stickiness of clients once on-boarded.

Ramco’s sales team has proven its worth by aggressive acquisition of marquee customers across industries and geographies.

A quick study of the Kano model of a product’s life cycle shows Ramco can be a great takeover candidate for any IT company with deep and entrenched client relationships across industry verticals and geographies (think Cognizant, TCS, which have extremely strong and powerful sales forces that can cross-sell Ramco’s suite of products and reach out to clients before competition).

Irrespective of whether Ramco goes alone, or gets acquired, given its futuristic product portfolio and an extremely competent management team, there is a probability that Ramco will be worth higher than the current market price in the coming years.

Source: Economic Times