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Sunday, April 15, 2007

Go for bull-spread


In an uptrending market, the near-term contract is likely to develop more of a premium versus the mid-term given that there are two weeks to settlement.
The rise on Friday sparked by Infy’s results may be deceptive and cause a bull-trap. This is results season and a downtrend could as easily be triggered by poor workings from some other bellwether. However, the likelihood is that the market will hit settlement without major losses.
Index strategies:
The spot Nifty is at 3917 points with the April Nifty futures contract settled on 3897 while the May futures contract was settled on 3894. Open interest rose in both contracts. There isn’t enough of a differential to make calendar spreads obviously worthwhile. Assuming that the market stays up, long positions in either contract would work.
Also, in an uptrending market, the near-term contract is likely to develop more of a premium versus the mid-term given that there are two weeks to settlement. Hence a bullspread with long April –short May should work.
The positions in the CNXIT and Bank Nifty are also interesting. Both indices jumped on Friday. The BankNifty is at 5362 in spot with the April future trading at 5353. The CNXIT is at 5353 in spot and the future is trading at 5335. Open interest increased in both futures contracts.
The discount is unusual when there’s an apparently bullish perspective. Most of the time, the futures tend to run at premium in these two indices. This discount could mean that the market is still not particularly confident that the trend is good in these two indices.
The strong rupee and rising rates are negative factors for both industries. In terms of specific heavyweights, TCS and Satyam look bullish, Wipro and HCL Tech less so where the CNX IT is concerned. In the bank universe, Syndicate and Bank of India are the two bullish stocks.
Rather than go long on either index, one would prefer to track and go long on the individual stock futures. In the Nifty options segment, the put-call ratio was positive on Thursday and accentuated on Friday as winning calls were cashed while more long puts were opened. By definition, a high PCR means that the market is more likely to advance than not and the priceline suggests that as well.
Technically, there’s likely to be an upside till the 3975-4000 level at least. On the downside, there’s support at 3850 and lower down all the way till 3775. Based on the movements since early March, we are likely to see extra-high-volatility every fourth or fifth session. So be prepared for that.
If you take a long 3950c (44) and a short 4000c (29.35), you commit a net premium of about 15 and hope for a maximum payout of about 35. That’s a very good risk:reward relationship. A wider bullspread with short 4050c (15.1) will cost 29 and offer a maximum payout of 71.
On the downside, a bearspread of long 3900p (71) versus short 3850p (51.3) costs 20 and pays a maximum of 30. That’s also an excellent risk:reward ratio.A wider bearspread of short 3800p (38.3) costs about 33 and offers a maximum payoff of about 67. Again, fairly decent ratios
My gut-feel is that close-to-money options are underpriced at this instant because the recent historic volatility is much higher than we would assume from the implied volatilities. Both bullspreads and bearspreads could be struck and fully realised. The bullspreads in particular seem underpriced.
Also, there is a case for wide strangles with a long 3800p and a long 4050c. This position costs 53 and it will start yielding profits if the market goes beyond 3750-4100.
If it’s capped by a short 3700p (18.9) and a short 4200c (4.5), that cuts initial costs down to about 30. The resulting positions would offer returns if the market moved beyond 3770-4080. That could occur inside the settlement given the tendency to big swing sessions.
STOCK FUTURES/OPTIONS
Given that its results season, single-stock positions assume more importance. Long positions in TCS and Satyam have already been suggested – TCS could be make-or-break since the results are due on Monday and SCS on next Friday.
If these two results are well-received, the IT sector could be a major gainer in terms of sentiment. I-Flex and Polaris are two other tech-stocks that might repay long traders. Polaris’ results are due on 27 April – right after settlement.
Infy itself has an ambiguous chart position despite having sparked the bull run. The stock saw a high-low range of 2026-2132 but it opened (2100) and closed (2086) at nearly the same levels.
This sort of “star-doji” indicates an undecided market according to candlestick analysts and a big swing in either direction is possible. A possible hedge for IT-traders would be long Satyam, long TCS, short infosys position.
The other sector that looks really interesting is two-wheelers. The macro-outlook is unfavourable – auto sales have slowed due to rising rates of financing.
However stocks have been hammered down and appear to have found support – maybe the downside has been discounted. Reasonable results could enthuse the market about Bajaj and Hero Honda in particular.
In banking Syndicate Bank seems set to provide a surprise given the number of bulls who have been chasing the stock. Otherwise, there isn’t too much excitement about the sector – the rise last week was a technical correction following a massive sell off.
Both SAIL and Tata Steel appear to be in bullruns. Despite promises to keep product prices stable in April, institutional buying seems to be occurring in both stocks.
There’s reasonable liquidity in the Sail 125c (4.3) and the 130c (2.45). A bullspread would cost about 2 and pay a maximum of 3. A naked long call is also a possibility –the premium might jump since this is almost on the money.

Multi flex


Aggressive expansion into non-metro markets will turn the wheels of fortune for the multiplex industry.
Five years back, it would have been a job of a visionary to imagine large format retail malls, hypermarkets and multi-screen film exhibition theatres or multiplexes all at one place, in all the prime locations of every city. Today with most prime locations in the metros boasting of multiplexes, the spotlight is on the film exhibition industry.
The cinema exhibition segment has traditionally been the dominant contributor to the rising prosperity of Indian film entertainment industry, the size of which is estimated to be about Rs 8,400 crore currently.
According to a recent FICCI-Pricewaterhouse Coopers report titled Frames 2007, this industry is expected to grow at a compounded annual rate of 16 per cent over the next five years, roughly doubling to Rs 17,500 crore by the year 2011. Exhibition of films contributes over 85 per cent to this kitty, with the domestic box office revenues bringing in about 75 per cent plus, traditionally.
Macro optimism
In 2006, domestic box office revenues grew by about 21 per cent, as blockbusters like Dhoom 2, Lage Raho Munnabhai, Krrish, Fanaa and Rang De Basanti amassed over Rs 300 crore. At present, the domestic box office market is pegged at Rs 6,400 crore, and is expected to grow at a compounded rate of 13.5 per cent.
At this rate, the market would double in size to Rs 11,900 crore by 2011. With the multiplex boom, the average ticket prices (ATPs) on an all-India basis have grown from Rs 20 to Rs 35 per ticket, and close to Rs 100 per ticket in metro cities.
On the flipside, it is expected that the share of box office revenues will reduce in the overall entertainment business, considering the growth of home video and exhibition of films over broadcast networks.
However, the segment will remain strong, contributing nearly 70 per cent, due to increasing demand in Tier II and Tier III cities where multiplexes are just being rolled-out.
“Tier II and Tier III cities would now be the new playground to compete on, for almost all the multiplex companies,” claims Sanjeev Hota of Emkay Shares and Stockbrokers. “Over 65 per cent of the total box office collections in the country come from non-metros,” he adds.
The boom in the sector will not just ride on high demand. The advent of digitisation of cinema exhibition too, will help a great deal. More and more producers and distributors are emphasising on digitisation to combat piracy.
Digital prints are less prone to illegal duplication as well as cheaper compared to their analogue counterparts. In addition to this, satellite delivery of prints too, will help curb piracy, thus attracting higher footfalls in theatres.
Reaching out
In order to reach out to a wider geography all the players are aggressively expanding into new locations. Adlabs, the largest player by market capitalisation and revenues, currently operates 13 multiplexes in eight cities with 50 screens and over 16,000 seats.
It plans to set up another 200-plus screens by 2010. PVR Cinemas too, is looking at adding about 50-60 screens in 8 locations in east India within the next five years.
“We expect to exceed our projections and launch about 100 screens at 32 locations, taking the count of seats to around 25,000 by the end of FY08,” says Rasesh Kanakia, chairman, Cinemax India.
Inox too, plans to launch about 10-12 new multiplexes in tier II cities such as Lucknow, Raipur and Faridabad in FY08. Pyramid Saimira, a dominant player in south India, is planning to set up around 300 mall-cum-multiplex projects over the coming few years.
Among the unlisted players, Apollo Group’s United Film Organisers (UFO) has about 585 digital cinemas, which it plans to increase to 2000, at an investment of Rs 300 crore. Essel Group’s E-city Ventures which operates Fun Cinemas and Fun Republic projects to increase its current count of 125 screens to 150 by December 2008, thus boasting of over 35 multiplexes across the country.
Micro pessimism
Indeed, for multiplex companies to flourish, it is necessary that they roll-out new multiplexes on a continual basis. Rising interest rates and sky-high real estate prices pose a roadblock to expansion.
“Since the existing multiplex companies have by and large tapped the equity markets, they now need to procure debt in order to make capital expenditure. This would raise the cost of their projects due to high interest rates,” says Gaurav Chugh, analyst, IL&FS Investsmart.
A delay in execution too, could postpone the launches of new multiplexes. “Inability to execute projects in time would further delay the break even of projects, and thus hold back the company’s future earnings,” says Chugh. Here, companies with experience in developing their own properties will have an edge over the rest.
“Therefore, players like Cinemax, Inox and PVR will manage to ride the tide of high real estate prices and delays in execution,” points out an analyst. On the other hand, players like Shringar Cinema, which have less experience in real estate as compared to peers, may take a hit.
“We have already tied up all the properties required for our expansion until the year 2009, and hence are almost immune to high real estate prices currently,” claims a confident Rasesh Kanakia, Cinemax.
Alok Tandon, chief operating officer, Inox Leisure says: “Most of our properties are on a long lease of around 20-24 years. Four out of 14 of our properties are owned. In addition, in the new properties that we sign, we get considerably lower rentals as compared to other occupants of a mall or a property being the anchor tenant.” An anchor tenant is the main tenant in a shopping centre.
Besides, there are certain state governments, which pose regulatory restrictions in terms of capping of ticket prices for multiplexes. “At present, Rajasthan does not allow multiplexes to increase ticket prices for more than once a year, and not more than 15 per cent, while Tamil Nadu has capped the price to Rs 120 per ticket,” says Tandon of Inox.
However, considering the increasing contribution of food and beverage sales and other revenue streams such as gaming which provide higher margins, lower ticket prices would be compensated. Usually, food and beverages contribute around 30 per cent of the total revenues of a multiplex player.
Some players are going a step further to augment revenues and margins. For instance, Cinemax launched Red Lounge in Mumbai, a premium multiplex in an exclusive lounge format with reclining seats, massage chairs and karaoke facilities which commands an ATP of around Rs 350 and above, along with launching Giggles Gaming Zones at all its multiplexes to augment footfalls.

SHOW ME THE MONEY

Rs crore

Revenue Net Profit EPS (Rs) PE(x)
FY08E FY09E FY08E FY09E FY08E FY09E FY08E FY09E
Adlabs Films 365.30 413.00 73.10 82.60 18.40 20.80 23.50 20.70
Cinemax 182.00 206.00 32.60 37.10 11.60 13.20 11.00 9.70
Inox Leisure 185.80 209.90 30.30 34.20 5.10 5.70 23.00 20.60
PVR 195.00 220.40 13.70 15.40 5.40 6.00 32.50 29.30
Pyramid Saimira 131.10 157.30 12.50 15.30 4.40 5.40 68.80 56.00
Shringar Cinema 69.30 78.30 11.40 12.90 3.60 4.00 14.80 13.30
Adlabs is making a foray in the content production business, by picking up stakes in companies like Synergy Communications (and plans to pick up a stake in Miditech), which have a proven track record. Players like Shringar and Inox have forayed into film production and distribution.
Inox is also setting up low-cost multiplexes, in order to tap growth in smaller towns. Pyramid Saimira has plans to set up retail malls and budget hotels along with multiplexes in partnership with Baderwals Infraprojects and Shriram Malls.
Compete more
Even as there seems to be huge demand for multiplexes, increasing competition is a concern. In order to woo higher footfalls and augment occupancy levels some multiplexes are offering discounts on ticket prices, which may hold back a rise in ATPs and margins, in turn.
“The differences in ticket prices are too specific to various locations. Similar is the case for our costs,” says Alok Tandon, Inox, adding that it is not a serious threat.
“ATPs are rising steadily in metros. In non-metros, although ATPs are low, they are compensated by high incremental demand,” says Hota of Emkay. IL&FS’ Chugh is optimistic suggesting that, “newer players entering the business confirms the healthy state of the sector for the coming years.”
Valuations
Over the past year, all the players in the segment have taken a beating. The valuations of Inox and PVR, for instance, eroded more than 40 per cent over the year. Adlabs however has managed to stay afloat riding on a fairly diverse composition of business, with forays in film production, distribution and FM radio.

FRESH BLITZ
Multiplexes Current
Screens
Seats Projected in
next 5 years
PVR 17 67 16,578 208
Inox Leisure 11 41 12,299 165
Cinemax 9 29 8,260 141
Shringar 7 30 9,051 168
Adlabs 7 26 9,146 225
Source: FICCI-PwC Report: Frames 2007
Due to varied composition of businesses, it is difficult to compare these companies going solely by price-earnings multiple. In spite of this, Adlabs and Inox at about 23 and 20 times their expected FY08 and FY09 earnings, respectively, appear to be reasonably valued considering their expansion plans and their proven ability to execute their plans. Adlabs however has a significant upside potential, in case it hives-off its radio business into a separate unit, thus unlocking value.
In comparison, Cinemax appears cheap, but it has to improve its operating margins from around 14 per cent currently to about 18 per cent, which is normal across the industry. The upside from Pyramid Saimira’s aggressive expansion and diversification plans appears to be already factored in its valuation.
On the other hand, even though Shringar Cinema appears fairly valued, concerns loom large over its turnaround efforts as well as its ability to execute its expansion plan. With continuing uncertainty prevailing across the board in broader markets, investors may want to bet on this sector as it offers enough variety to suit different tastes.

Jet, Sahara, go


The Air Sahara acquisition will strain the balance sheet of Jet Airways but its international operations should drive earnings.
The stock market is not flattered with the deal Jet Airways, India’s number 1 private airline, has finally struck with competitor Air Sahara. But the Jet stock has not been hammered the way some analysts were predicting when talks of the deal going through first emerged on April 10.
The stock, which lost 5.57 per cent on April 11 on reports that the deal value would be closer to what Jet Airways had offered to acquire Air Sahara when it first bid for the company a year-and-a-half ago, gained 3.24 per cent when the final announcement was made on Thursday. The stock ended the week at Rs 629.90.
Jet currently flies 44 domestic and 6 international operations and has one of the youngest fleets globally boasting of an average age of less than five years. Apart from the domestic routes, Jet now flies to destinations like London, Singapore, Bangkok and Kuala Lumpur. The airline commands a 25 per cent market share in the domesic market.
While Jet claims that the deal comes 40 per cent cheaper than its earlier aborted attempt, there are hidden numbers which make the deal more expensive. Eitherway, analysts are divided on the stock.
Those bullish are relying on Jet’s flourishing international operations and a more benign domestic climate to accelerate its earnings. The bears on the contrary fear that the Sahara buy-out will strain Jet’s balance sheet unnecessarily.
Even though Sahara’s 27 aircraft, parking bays, staff and other infrastructure apart from its ready eight per cent market-share will be a definite plus, the benefits do not seem to be commensurate with the price Jet is paying for it, they feel.
A leading foreign broking firm put a sell on the stock with a target price of Rs 390. But two other firms, which have been positive on the counter since January this year, reaffirmed their bullish stance with a target price of over Rs 720.
Apart from the Rs 500 crore that Jet paid as upfront payment for the aborted merger attempt, the company would pay Rs 400 crore by April 20 and another Rs 550 crore through four equated annual instalments between 2008-2011. One good part of the deal is that the staggered payment eases the cash flow burden somewhat and reduces the acquisition price going by the net present value of Rs 1250 crore.
The total cost to Jet Airways for control of the Air Sahara however comes to Rs 1950 crore considering the money Jet had spent on Sahara before the deal was called off in June last year and certain other liabilities.
The valuation seems high for a company whose losses have soared and market share halved since the first aborted merger attempt in January 2006. If the stock market has still forgiven the company for this, it is because analysts were expecting a dead loss of Rs 700 crore for Jet Airways considering the litigation would have worked against Jet in all probability.
With intense competition from Low Cost Carriers and price undercutting becoming the order of the day, Sahara’s financials have only worsened since January 2006.
According to reliable sources, Air Sahara incurred a loss of Rs 300 crore on a revenue base of around Rs 1800 crore with accumulated losses totalling to Rs 700 crore. Jet has also seen its realisations fall in the past year and is estimated to close FY07 with a loss of Rs 120 crore.
“Though the current indicated deal size is lower than the amount Jet was ready to pay for Air Sahara, when the deal was first announced, since then the overall competitive environment hasn’t improved. As on December 2006, Jet Airways and Air Sahara both reported running in losses and lost a significant market share after the deal was announced. At the current valuations, we believe the merger would strain the profitability and balance sheet of Jet Airways in the near to medium term, before the merger can fully realize the benefits arising out of the synergies” says Surbhi Chawla, Research Analyst, Angel Broking.
Already, Jet Airways financials look streched with a debt-equity ratio of more than 2. In all the company will need to raise in excess of Rs 5000 crore in order to fund the acquisition and avail of export credit to pay for the aircrafts it proposes to buy for its international operations over the next couple of years.
The company plans to add 20 wide-body aircrafts for its international fleet expansion. All this only means that the need for additional capital would entail equity dilution creating an overhang on the stock.
But there are a few critical positives as well. Given the acute shortage of trained airline staff especially pilots, Jet gets a ready pool of experienced staff from Sahara. Besides, access to Sahara’s parking bays will come in handy as it increases its international fleet.
“The synergies that we see from the merger of two entities will arise from the commonality of fleet (B-737), reduction in spares, maintenance cost, infrastructure facilities,” adds Chawla of Angel Broking.
Critical to the financial performance of Jet would be how the domestic environment pans out. For now the reality is that most domestic airlines are adding to their existing fleet and increasing capacity. Unless the fleet addition slows and price competition eases, domestic yields may continue to be under pressure. But there are analysts who feel that the worst may be over.
According to Nikhil Vora, research analyst, SSKI, fears of price wars, low load factors and oversupply seem to be a thing of the past. He estimates that gross yields which were hovering under Rs 6.0 till 2006 are expected to improve to Rs 6.6 (FY08E) and Rs 6.8 (FY09E). Average load factors are also expected to improve from 69 per cent to 74 per cent in FY09 even as the aviation industry growth at 20-25 per cent per annum, the domestic air travel is expected to touch 60 mn passengers by FY09.
Much would depend on how Jet utilises Sahara. The talk doing the rounds is that Jet would convert Sahara into a LCC and it would remain focussed on business travellers as a premium carrier. This should help Jet hold up both realisations and market share. Eventually, Jet should be able to extend its higher level of operational efficiency to Sahara and turn it around within the next eighteen months.
The biggest plus is that the acquisition of Sahara strengthens Jet Airways’ international operations as Sahara has permit to operate in Gulf market and operations could commence in early 2008. International operations enjoy higher realisation, load factor and better margins.
And in just a few months since launch Jet has been able to achieve yields and load factor comparable to that of global peers like British Airways and Singapore Airlines. The commencement of India-US operations later this year and the Gulf route through Sahara will further boost business and margins.
“Profitability in the business will be driven by rapidly surging international operations,” says Vora who has put an Outperformer on the stock. He estimates that international revenues will help Jet double its total revenues over the next couple of years.
Overall, analysts estimate that Jet could incur a loss close to Rs 170 crore in the current fiscal, as much as in FY07 (estimated). Estimated earnings for FY09, at roughly Rs 40 crore is half of what it would have been without the merger. Rise in crude prices also remains a key risk.
But with buoyant economy, driving demand for air travel up at 20 per cent per annum, and international operations on a par with the best in the world, Jet’s business looks a good story to buy. But one will have to wait patiently for gains to trickle in.

A good KS


Traditionally, the domestic edible oil industry has been dominated by unorganised players. However, with rising demand for packaged food, revolution in the retail space, growing health consciousness amongst the Indian consumers and the implementation of Value Added Tax (VAT), the organised players are gaining ground.
KS Oils, the largest producer of mustard oil in the country, is aggressively foraying into the retail segment. The company is spending more on brand building and distribution of its products. Apart from making efforts to integrate its plants and streamline its operations, the company also aims to grow its business through the organic and inorganic route.
“We command a market share of three per cent of the total edible oil market and are targeting to increase this to 10-15 per cent over the next three years. We aim to achieve a revenue target of Rs 3000 crore by 2010 as compared to Rs 600 crore in FY06,” says, Sanjay Agarwal, managing director, K S Oils.

FINANCIALS

Rs crore

FY06 FY07E FY08E
Net sales 604.25 1050.00 1700.00
Operating profit 29.12 105.00 195.50
OPM (%) 4.82 10.00 11.50
Net profit 16.02 63.00 119.00
NPM (%) 2.65 6.00 7.00
P/E (x) 39.70 10.09 5.35
On firm footing
KS Oils is one of the leading manufacturers of mustard in the country. It commands a strong position in edible oils like mustard oil, refined oil, vanaspati oil and non edible solvent oil.
The company has its manufacturing facility at Morena in Madhya Pradesh, which is in close proximity to oil seed cultivating states such as Rajasthan, Uttar Pradesh and Haryana.
The company is a dominant player in eastern and north-eastern India, and accounts for three per cent of the total edible oil market and about 25 per cent of the organised segment.
Under the mustard oil segment, the company’s flagship brand Double Sher commands 40 per cent market share in the north-eastern states. Besides, its premium mustard oil brand Kalash is sold in Delhi, Chattisgarh, Uttaranchal and UP and also enjoys 50 per cent market share in Madhya Pradesh. KS Oils also manufactures vanaspati oil under the brand name KS Gold and KS Gold Plus.
It sells soya refined oil branded KS Crystal Clear. Also, the company is the largest supplier of edible oil to the defense sector, supplying almost 8000-10000 tonne of refined edible oil annually, generating Rs 40 crore.
To achieve its Rs 3000 crore sales turnover by 2010, the company is looking at both the inorganic and the organic growth path. Agarwal, says “We will double our existing capacities by FY08, which we will achieve through investments in green field projects and 2-3 acquisitions.”
The firm has already acquired one unit in Jodhpur in Rajasthan, which has a daily capacity of 225 tonne of oil mill and 150 tonne of refinery. The company is looking for some more such units.
Getting organised
The domestic edible oil market is controlled by a large number of regional and unorganised players. In terms of size the Indian edible oil market is estimated to be around Rs 60,000 crore and out of this mustard oil accounts for about Rs 12,000 crore. But despite being a huge market, organised players constitute only 20 per cent of the total market. Packaged and branded oil constitute only about 10 per cent.
“We expect to sell branded edible oil products to grow faster at about 20 per cent as compared to the overall industry growth of six per cent,” says, Agarwal. The growing preference for branded edible oil and quality products will augur well for the company.
Besides, KS Oils is increasing its focus on the packaged oil segment. The company is actively in talks with leading retail chains, hypermarkets and foreign companies for supplying its products. It also intends to strengthen its retail presence by selling its products in smaller sachets and pouches which are more affordable.
The company plans to invest Rs 12 crore in brand building and distribution this year. It added about 300 distributors last year, which will be increased to 1000 by the end of current fiscal. In FY05, branded sales contributed almost 48 per cent to the company’s total income and is likely to increase to over 60 per cent this fiscal.
The bottomline
Increase in the proportion of branded sales will not only result in higher volumes, but also help in improving the company’s profitability. Presently branded products have a margin of about 15-16 per cent compared to 11 per cent from the non-branded segment.
Further, the implementation of four per cent VAT will take away the undue advantage unorganised players enjoyed so far by paying nil taxes. Organised players will thus become more competitive.
In March 2006, KS Oils established a power plant of 2.5 MW for captive consumption to slash power cost. Such initiatives have helped in improving margins. The operating margin in FY06 was merely 4.8 per cent, which has gone up to 10 per cent in Q3FY07. The company is expecting this to further improve to 12-13 per cent.
Besides, the company has commissioned a 6 MW wind power plant to sell power in Gujarat. The company will sell power at Rs 3.3 per unit providing an additional revenue of Rs 5-6 crore annually. Driven by higher operating margin and income from other sources, KS Oils will also witness an expansion in net profit margin from 6.6 per cent in Q3FY07 to 7-8 per cent over the next two years.
At Rs 288, the stock trades at price to earnings multiple of 10.1 times and 5.35 times its estimated earnings for FY07 and FY08 respectively.Apart from favourable industry dynamics, KS Oils’ retail plans and expansion over the next 2-3 years makes a case for investment. Considering the consistent growth in volumes and expected margin improvement in future, the valuations seem reasonably attractive.

Get Connected


With Sasken's E series getting its first customer in Lenovo, the products business looks firmly on track for a turnaround in FY08.
What would be a mobile phone without its screen beaming out colourful images or reflecting scores of messages. Well it would very much be in technical jargon, hardware without its software. And if telecom software is really something which gets the investor in you interested, then you needn’t go far beyond Sasken Communication Technologies.
Over the past year, the scrip has had a great time at the bourses rising over 38 per cent y-o-y as compared to the BSE Teck index which has risen about 27 per cent and the BSE Midcap index which has actually fallen nearly three per cent in this same period.
And while services, contributing about 95 per cent of the revenues at present, have been the major growth driver so far; the Lenovo deal announced last week along with other trends suggest that the beleaguered product business may be finally raising its head to support future margin growth.
The E series foray
With Sasken’s telecom software product, Sasken Application Framework being chosen by Chinese Lenovo mobile as its application solution of choice for the development of its feature phones, the much touted “E series” has finally made a splash in the international market.
The E series refers to an integrated framework of mobile software applications including video record and play, touch pad, bluetooth, audio streaming etc.
“While these not only affirm the credibility of the product, it marks the introduction of a high royalty bearing product,” says Rishi Maheshwari, research analyst, Networth Stock broking.
Estimates suggest that while the E series phones enjoy royalties of more than $1 per phone; its other product series like the M series (modem related software for 2.5G to 3G technology) and S series (multimedia codex for smart phones) earn royalties of anywhere between 40 cents to $1 dollar. Though the actual roll-out of the phones could take anywhere between 7-12 months, the deal spells good news for what has been in the past couple of years a loss making products business.
In recent times, the products business has been the Achilles heel for Sasken mainly due to the segment being in an investment cycle with burgeoning R&D expenses and not commensurate product design wins.
For example, even as R&D expenses have risen from nine per cent of sales to nearly 11 per cent of sales in FY06, the product segment reported losses of Rs 4.4 crore in FY06. For the first nine months of FY07, the segment losses were Rs 13.4 crore.
Analysts predict substantial revenues from the Lenovo deal given the reputation enjoyed by the OMAP Vox platform and the Lenovo’s standing in the Chinese market.
Between FY04 and FY06, while domestic Chinese mobile companies saw their combined market share nose-dive from 50 per cent to 29.8 per cent, Lenovo was able to sustain its marketshare at around seven per cent.
The E series deal is however just one part of the slow transformation in the products business. For example, royalties as a proportion to product revenues which had stagnated to about 10 per cent in FY06 has risen significantly to 24 per cent in the first nine months of FY07.
And while the company witnessed two design wins (when the end product is launched and royalty starts kicking in) in FY07, it is expecting two more in the first quarter of this fiscal. Currently, the company has eight design ins (when the agreement for the software is signed) of which four appear to be on a sure footing. Overall however analysts do expect the product business to turnaround in FY08 and contribute significantly to the margins in FY09.

FINANCIALS

Rs crore

FY06 FY07E FY08E FY09E
Revenue 308.1 484 706.6 954
Operating profit 48.2 80.8 131 183.4
OPM (%) 15.6 16.7 18.5 19.2
EPS (Rs) 10.6 17.4 31.2 42.5
P/E at Rs 521.25 49.2 30 16.7 12.3
Source: Analysts estimates
Servicing growth
In the difficult days of Sasken’s product business, it was however the services segment with present margins of around 23 per cent which proved to be the manna for bottomline and topline growth. In the December quarter, service revenues grew about 72 per cent y-o-y, supporting a 73 per cent growth in total revenues.

PEER COMPARISON
OPM(%) P/E(X)
Infotech Enterprises 25.70 25.40
KPIT Cummins 17.70 21.40
Hexaware 19.50 17.90
Sasken Communications 14.80 38.21
Operating profit margin (OPM) for 9MFY07
P/E: Trailing 12 months ending Dec ‘06
Overall for the nine months period, the topline expanding by about 48 per cent while operating margins hovered around the 14.8 per cent mark in this period. The company’s domain viz R&D services and solutions is also beset with tremendous opportunities.
“With all major telecom OEMs (original equipment manufacturers) facing cost pressures and R&D being a major element of costs, a large number of global companies will shift to low cost locations,” says Harmendra Gandhi, research analyst, BRICS securities.
Estimates suggest that while R&D offshore services outsourcing to India would increase by 16 per cent CAGR between 2005 and 2010 to reach $ 6.6 billion, a significant chunk of this would accrue to the telecom segment.
Sasken’s presence across network infrastructure, handsets, semiconductor and terminal devices have made it develop a strong working relationship with a range of Tier I companies from Nokia and Alcatel in the equipment space to Texas instruments and Philips in the semiconductor arena.
Moreover Sasken’s strategy of near shoring or setting up a strong geographic presence near manufacturing centres of global giants should also stand it in good stead.
“For example the acquisition of Finnish Botnia in June last year has not only brought in complementary expertise in the RFID and hardware design space but also given access to lucrative Nokia contracts which account for 92 per cent of Botnia’s revenues”, opines an analyst tracking the sector.
Similarly the company is in the midst of a massive ramp up at its Mexico centre as the traction with one of its key clients Texas instruments continues to grow.
For example the employee strength here which was merely five at the beginning of FY07 increased dramatically and stood at 57 by the end of 2006. Overall most analysts expect the services revenue to grow at a CAGR of 40-45 per cent in the next two years.
However key challenges remain too. The company is plagued with an attrition rate of 21 per cent, one of the highest in the industry. Moreover the rupee appreciation is bound to hurt. For example, this was responsible for at least a three per cent impact on operating margins in the December quarter FY07.
As regards valuations, Sasken’s trailing twelve month valuations at about 38 times is at a premium to peers (see table).Estimates for the standalone service division ranging from 10-12 times FY08 EV/EBITDA however appear more reasonable.
But though the company’s margins remain lower than peers, analysts believe that the benefits of the R&D focus on the products side and increased traction in the services segment support strong future prospects.

Religare - Weekly Technicals


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Asia’s Most Livable Cities


China and India may represent Asia’s economic future, but the most desirable cities in which to live, for foreign executives and their families, are elsewhere. Cities in New Zealand, Australia, and Japan are far more comfortable places to reside, according to a new ranking by Mercer Human Resource Consulting, which provides advice to multinational companies on international assignments.



No. 1
Auckland, New Zealand

(Global Ranking: 5)

Situated on the North Island of New Zealand, it’s home to about 1.2 million people -- about 25% of the country’s population. It also has a sizable Polynesian population, low crime rate, and more yachts per capita than any other city in the world. There are plenty of opportunities for retail therapy in the various shopping districts around town.




No. 2
Sydney, Australia

(Global Ranking: 9)

Sydney’s sheer beauty and lively night life make this town a tourist magnet. The city of 4 million-plus is the country’s business and cultural nexus, home to iconic architecture such as the Sydney Opera House and some fabulous weather. It’s also the country’s financial center, where both the Australian Stock Exchange and the Reserve Bank of Australia are located. Most of the major banks and more than half of Australia’s biggest companies call Sydney home, as well.



No. 3
Wellington, New Zealand

(Global Ranking: 12)

It’s a city with a picturesque natural harbor and green hillsides, and it supports a thriving arts scene, cafĂ© culture, and nightlife. In addition to being New Zealand’s political capital, Wellington is also home to the country’s film and theater industry.



No. 4
Melbourne, Australia

(Global Ranking: 17)

Melbourne prides itself on being a key cultural and sports hub of Australia. It’s an attractive locale full of Victorian architecture, parks, and gardens. Another selling point is one of the most extensive tram networks in the world. Melbourne’s extensive sporting grounds were well-suited to the city’s role as host for the 2006 Commonwealth Games.



No. 5
Perth, Australia

(Global Ranking: 21)
Perth is the largest city in Western Australia and the fourth most populous urban center nationwide. It enjoys a thriving folk-music culture, and is home to other cultural venues, such as the West Australian Art Gallery and Perth Concert Hall. Perth is also the site for numerous international sporting events



No. 6
Adelaide, Australia

(Global Ranking: 30)
This southern coastal city with a 1 million-plus population is the capital of the state of South Australia and a major manufacturing and defense-technology sector. News Corp. was founded here, and Adelaide is also home to Coopers brewery. Adelaide boasts world-class orchestras and a thriving arts community.




No. 7
Brisbane, Australia

(Global Ranking: 32)
The capital city of Queensland and third largest city in Australia is a major business hub and biotechnology center. It’s home to the Institute for Molecular Bioscience at the University of Queensland. Global companies such as Samsung, LG, Matsushita, and DHL have offices there. The country is also a major tourism center.




No. 8
Singapore

(Global Ranking: 34)

This economically-vibrant city in Southeast Asia is known for its immaculate streets, excellent services, and melting-pot culture of Chinese, Indians, and Malaysians. It boasts excellent shopping outlets and restaurants, and is a major financial center in the region. To draw more tourists, the Singaporean government recently legalized gambling, and a major casino and resort-development projects are under way.




No. 9
Tokyo, Japan

(Global Ranking: 35)
This world-class city is the cultural, business and political capital of Japan. Just about every multinational that matters has a presence in Tokyo, which boasts excellent private, public, and international schools. Sony, Canon, Nissan, Honda, and scores of other Japanese global companies are based there. Public transportation is excellent, and Tokyo is among the safest cities in the world.



No. 10
Yokohama, Japan

(Global Ranking: 38)
This thriving port city boasts some spectacular architecture and cultural amenities and is a short commute from the center of Tokyo. Its harbor-view area contains plenty of shopping and restaurants, and Yokohama is also home to the largest Chinatown in Japan. The Yokohama Marine Tower is the tallest lighthouse in the world.



No. 11
Kobe, Japan

(Global Ranking: 40)
This port city of elegant buildings and fashionable restaurants and boutiques is one of Japan’s most cosmopolitan cities. It’s also a major business hub and home to the global headquarters of such Japanese companies as Kawasaki Heavy and Kobe Steel. Procter & Gamble has a major operation there. The city is known for its succulent Kobe beef and sake.



No. 12
Osaka, Japan

(Global Ranking: 42)
Japan’s second city is a major business center, home to such companies as Sanyo, Sharp, and the Sumitomo Group, with a distinctive culture of its own. The city is known for its fabulous local dishes, such as okonomiyaki (pan-fried batter cake) and octopus dumplings called takoyaki. Local school systems and public transportation are top-notch, and this is a fanatical sports town.




No. 13
Nagoya, Japan

(Global Ranking: 54)
Nagoya is the center of Japan’s automotive manufacturing industry. Toyota’s global headquarters are in a nearby city, and many of the nation’s major suppliers are in the region. The city boasts some famous historical sight-seeing spots, such as the Atsuta Shrine and Nagoya Castle.






No. 14
Tsukuba, Japan

(Global Ranking: 55)
If you’re a science buff, Tsukuba is the place for you. It’s a planned city, only 20 years old and home to more than 60 research institutes. There’s a major university, a high-energy research center, and the Japan Aerospace Exploration Agency has a major operation there.




No. 15
Yokkaichi, Japan

(Global Ranking: 63)
Situated on Ise Bay southwest of Nagoya, Yokkaichi is a major manufacturing center that produces porcelain, auto components, computer parts, and memory chips. Its public transportation and school systems are considered top notch.





No. 16
Omuta, Japan

(Global Ranking: 69)
This used to be a major coal-mining town, but this city, situated in the southern part of Fukuoka prefecture, is better known as a center for the development of alternative energy and its greenery. It’s bordered by the Ariake Sea to the west and the Yamagi and Miike mountains inside the city lend a natural beauty to Omuta.





No. 17
Hong Kong, China

(Global Ranking: 70)
This former British colony boasts one of the most distinctive skylines in the world, plenty of hiking trails, fabulous restaurants, and all the cultural amenities to keep a foreign executive and his or her family engaged. It’s a major Asian financial center, and the business gateway into Mainland China. Its deteriorating air quality though, has been a negative in recent years




No. 18
Katsuyama, Japan

(Global Ranking: 73)
This resort city is known for its temples, castles, and other cultural treasures, and nearby ski resorts. Katsuyama Castle has been converted into a museum, with Japanese and Chinese art dating back hundreds of years





No. 19
Kuala Lumpur, Malaysia

(Global Ranking: 75)
The business and political capital of Malaysia enjoys a year-round warm climate and excellent public transportation. Kuala Lumpur’s commercial hub, called the Golden Triangle, contains the sky-hugging Petronas Twin Towers and an interesting nightlife. The city is emerging as an important center for Islamic finance, and both inside the city and nearby, there are numerous cultural activities to enjoy.



No. 20
Taipei, Taiwan

(Global Ranking: 75)
The capital city of Taiwan is the island’s primary commercial and cultural center and also home to the world’s tallest skyscraper: Taipei 101. The National Palace Museum has one of the largest collections of ancient Chinese artworks. Taipei is also a major regional financial center.

Here's how to rework your tax strategy


Hello, this is a call from your bank. May I help you with your investment planning, sir? Haven’t you been bothered by such persistent calls? Indeed, the new financial year is here and it’s again time to freshen your investment outlook and rejig the portfolio, particularly in view of the budgetary changes and new opportunities knocking at your door.

True, with the Indian economy on a secular growth path, there have been opportunities galore. Experts too believe that the same can sustain in the current as well as the coming years at more or less the same level, if not higher ones, driven by multiple economic growth drivers which include favourable demographics, consumption demand and investments in infrastructure, which may result in robust corporate earnings. Still, things like volatility in the markets and the uptrend in interest rates have to be factored in before taking a call on investments.

Says Dinesh Thakkar, CMD, Angel Broking, “At the outset, investors should bear in mind that the current phase of spiralling interest rates is bound to have a deflationary effect on all asset classes, including equity and real estate, thus bringing prices of all assets lower to justify relative valuation to returns on risk-free assets like bank FD and bonds. Also, as the cost of money increases, there will be less demand for assets due to less investable surplus, thus putting downward pressures on the prices of all the assets.”

Therefore, to be on the safer side, individuals should first utilise the existing tax-savings avenues fully, i.e. one should make investments up to Rs 1 lakh to avail the benefit of Sec 80C deduction. “These include PF, PPF, NSC, repayment of principal amount of housing loan, and life insurance policy premium, among others,” informs Vikal Vasal, director, KPMG India.

It is advisable that adequate life insurance cover is taken by the individuals, especially where the family is mainly dependent upon the sole earning member. Further, one should also try to avail the tax benefit in respect of mediclaim policies for self and dependants, he says.

From long-term perspective, systematic investment plans (SIP) of mutual funds are also considered a good option as individuals do not have the expertise of analysing the stocks/monitoring the same on regular basis. Also, irrespective of one’s age/income level, one must plan for some regular income after retirement.

Some experts, however, are of the view that budget hardly matters, except for the changes in personal tax structure.
For instance, Devendra Nevgi, CEO & CIO, Quantum Asset Management Company, says, “It’s advisable for an individual not to respond to the daily changing investment scenario. Individual investors have to understand their own risk appetite & time horizon before they take a call on any investment. The costs associated with such investments also have to be lower.”

Rahul Aggarwal, CEO, Optima Risk and Insurance Management Services, agrees. “Good investment planning should be with a long-term view. Any investment, at whichever stage of life, should foremost be done with the objective of long-term financial goals. If this is kept in mind, then the influence of current investment scenario and budgetary changes diminishes on the investment outlook. It is our view that individual investors should look at fixed return securities like fixed deposits, reasonably-priced IPOs and real estate in growth areas of the country. The mix of these will depend upon the risk bearing capacity of the investor,” he says.

But despite the current high volatility in the markets, experts still seem to be bullish on stocks. “Stocks will continue to deliver reasonable returns from the long-term perspective, though it’s difficult for the asset class to repeat its 2006 performance in 2007. Even though the rates of 9% plus growth may not be sustained, India’s growth story continues to remains attractive compared to its global peers, even at a trend growth rate of say 6.5-7% for the next decade. Investors, thus, have to balance there risks & return expectations and be patient in wealth creation,” says Nevgi.

Sivasubramanian K N, senior portfolio manager-equity, Franklin Templeton, also seems to be of the same view. “The rapid upward and downward movements in the stock markets in recent times mean that over the short term, further volatility cannot be ruled out. However, India has much better balance in its growth model than the rest of the Asian region -- giving it a built-in macro resilience that other emerging economies lack. We believe this would help Indian markets over the medium to long term, as investors recognise the underlying strong fundamentals. Any sharp corrections from these levels can be used to increase exposure to equities,” he says.

Surprisingly, the overheated real estate, which has been the darling of investors for the last couple of years, seems to be fast losing its sheen, at least for the time being. “We would advise investors to stay away from the real estate for a year or so due to the recent sharp run-ups in prices. Furthermore, owing to thin liquidity in this asset class, it will take some time for it to get adjusted to a high interest regime,” advises Thakkar.


Likewise, bank deposits seem to be attractive, thanks to the rising interest rates. But, once again, some experts believe it to be a temporary phenomenon as once supply issues are addressed and inflation is tamed, we may see a drop in interest rates.

NEW AVENUES

The good news for investors, however, seems to be the emergence and growth of new investment avenues which till a few years back were missing in a rather controlled economy.

Says Tushar Pradhan, chief investment officer - equities, AIG Global Asset Management Company (India), “Investment avenues become available either when regulation allows a certain class to enter the markets or if by rotation some asset classes become attractive for various reasons. The regulators are evaluating the possibility of allowing real estate mutual funds, and investing in art has already become somewhat popular. However, such alternative investments are peculiar to their class and lay investors should be armed with enough research on them before considering investing in them.”

Also, with the Indian being increasingly integrated with the global economy, “we might see demand developing for sophisticated investment products such as absolute return funds, alpha strategies (including portable alpha), tactical asset allocation (across asset classes/currencies) and quantitative strategies. amongst the institutional segment. From a retail investor perspective, we believe final guidelines for real estate and infrastructure funds will see the emergence of new investment avenues that will help them in participating in the growth potential of the infrastructure/real estate sectors. Also, formulation of overseas investment guidelines might see the launch of dedicated overseas funds and feeder funds,” says Sivasubramanian.

Recently, the government permitted individuals to investment in international markets to the tune of $50,000 per annum, giving them an opportunity to invest in international markets. “Although this option is still nascent and in its first year of operations, we see this avenue opening up significantly over the coming years. People must use it to de-risk themselves from investing in just one country,” advises Thakkar.

Amongst the new avenues that have emerged for individual investors are also the Gold ETFs & capital protection-oriented funds. “Real estate managed funds & ETFs, when allowed, will offer access to retail investors’ exposure to the real estate market. Gold ETF remains a good long-term investment and an inflation hedge. Mutual funds are now offering funds which invest in international markets,” informs Nevgi.

NEED-DRIVEN INVESTMENTS

But whatever be the avenue, experts advise investors to have a medium-to-long-term view while investing in growth markets like India, besides taking into account individual needs also. “We subscribe to the life-cycle theory of investment wherein the stage of one’s life decides exposure to various asset classes, added to the pressures of maintaining a dwelling unit,” says Pradhan.

For example, younger people should have more exposure to equities as they are in the accumulation stage. As one gets older and incomes grow, there is a need for capital preservation and allocation to fixed interest (as opposed to fixed income investments) could be added to.

“In addition, one should also have liquid investments to meet short-term contingencies by way of either bank deposits or liquid funds. However, tax slabs, quantum available for investments and sundry other issues really do make this a very individual affair. Last, but not the least, is the individual’s appetite for risk,” he adds.

HEDGING RISK

However, hefty returns alone should not be the sole criteria for investments. Says Pradhan, “In any scenario, investors should be aware of the products they are buying. Even in equity mutual funds all funds are not alike. One should read the various offer documents to ascertain the appropriateness of the investments to one’s portfolio. Investors will also be well served by educating themselves about expectations of returns to ensure not getting carried away by false claims. For example, there doesn’t exist any investment in the world which can sustain a 25% rate of growth for ever!”

Besides, one should be cautious while making any investment and not just be guided by the trends in the market. Diversifying investments also helps. “One should strive to invest in at least four to five different investment options so that downfall in one does not have a major impact on the long-term plans/funds requirements of the individual,” advises Vasal. No need to mention that precautions and the right approach to investments alone may yield you the desired result.

The kid who turned down $1 billion!


"I'm just lucky to be alive." Mark Zuckerberg, the 22-year-old founder and CEO of social-networking site Facebook, is talking about the time he came face-to-face with the barrel of a gun. It was the spring of 2005, and he was driving from Palo Alto to Berkeley.

Just a few hours earlier, he had signed documents that secured a heady $12.7 million in venture capital to finance his fledgling business. It was a coming-of-age moment, and he was on his way to celebrate with friends in the East Bay.

But things turned weird when he pulled off the road for gas. As Zuckerberg got out of the car to fill the tank, a man appeared from the shadows, waving a gun and ranting. "He didn't say what he wanted," Zuckerberg says. "I figured he was on drugs." Keeping his eyes down, Zuckerberg said nothing, got back into his car, and drove off, unscathed.

Today, it is an episode that he talks about only reluctantly. (A former employee spilled the beans.) But it fits the road he has taken--an adventure with unexpected, sometimes harrowing, moments that has turned out better than anyone might have predicted.

Zuckerberg's life so far is like a movie script. A supersmart kid invents a tech phenomenon while attending an Ivy League school--let's say, Harvard--and launches it to rave reviews. Big shots circle his dorm to make his acquaintance; he drops out of college to grow his baby and Change The World As We Know It.

Just three years in, what started as a networking site for college students has become a go-to tool for 19 million registered users, including employees of government agencies and Fortune 500 companies. More than half of the users visit every day. When a poorly explained new feature brought howls of protests from users--some 700,000--the media old and new jumped to cover the backlash.

But Facebook emerged stronger than ever. According to comScore Media Metrix, which tracks Web activity, it is now the sixth most-trafficked site in the United States -- 1% of all Internet time is spent on Facebook. ComScore also rates it the number-one photo-sharing site on the Web, with 6 million pictures uploaded daily.

And it is starting to compete with Google and other tech titans as a destination for top young engineering talent in Silicon Valley. Debra Aho Williamson, a senior analyst at eMarketer, says it is on track to bring in $100 million in revenue this year--serious money indeed.

Yet there is an undercurrent of controversy about whether Mark Zuckerberg is making the right decisions about the juggernaut he has created.

Late last year, a blog called TechCrunch posted documents said to be a part of an internal valuation of Facebook by Yahoo. The documents projected that Facebook would generate $969 million in revenue, with 48 million users, by 2010. The New York Times and others reported that Yahoo had made a $1 billion offer to buy Facebook -- and Zuckerberg and his partners had turned it down.

This followed an earlier rumor of a $750 million offer from Viacom. Yahoo, Viacom, and Facebook would not comment on the deal talk (and they still won't). But Silicon Valley has been abuzz ever since.

"It's all been very interesting," deadpans Zuckerberg, sitting in a conference room in Facebook's Palo Alto headquarters. He looks every bit the geek in his zippered brown sweatshirt, baggy khakis, and Adidas sandals. He came into the room eating breakfast cereal from a paper bowl with a plastic spoon.

He still lives in a rented apartment, with a mattress on the floor and only two chairs and a table for furniture. ("I cooked dinner for a girlfriend once," he admits at one point. "It didn't work well.") He walks or bikes to the office every day.

Zuckerberg's college-kid style reinforces the doubts of those who see the decision to keep Facebook independent as a lapse in judgment. In less than two years, the two reigning Web 2.0 titans have sold out to major corporations: MySpace accepted $580 million to join News Corp., and YouTube took $1.5 billion from Google. Surely any smart entrepreneur would jump at a chance to piggyback on those deals.

Looming over the Facebook talk is the specter of Friendster, the first significant social-networking site. It reportedly turned down a chance to sell out to Google in 2002 for $30 million, which if paid in stock, would be worth about $1 billion today.

Now Friendster is struggling in the Web-o-sphere, having been swiftly eclipsed by the next generation of sites. The same thing could happen to Facebook. New social-networking sites are popping up every day.

Cisco bought Five Across, which sells a software platform for social networking to corporate clients. Microsoft is beta-testing a site named Wallop. Even Reuters is planning to launch its own online face book, targeting fund managers and traders.

So is Zuckerberg being greedy--holding out for a bigger money buyout? If so, will that come back to haunt him? If not, what exactly is his game plan?

Zuckerberg's answer is that he's playing a different kind of game. "I'm here to build something for the long term," he says. "Anything else is a distraction." He and his compatriots at the helm of the company--cofounder and VP of engineering Dustin Moskovitz, 22, his roommate at Harvard, and chief technology officer Adam D'Angelo, 23, whom he met in prep school--are true believers. Their faith: that the openness, collaboration, and sharing of information epitomized by social networking can make the world work better.

You might think they were naive, except that they're so damn smart and have succeeded in a way most people never do. From a ragtag operation run out of sublet crash pads in Palo Alto, they now have two buildings (soon to be three) of cool gray offices and employ 200 people who enjoy competitive salaries and grown-up benefit packages--not to mention three catered meals a day with free laundry and dry cleaning thrown in. And they continue to crank out improvements to a Web site that is in every meaningful way a technological marvel.

Right now, the folks who fronted Zuckerberg that $12.7 million back in the spring of 2005 and the other venture investors whose money and connections have helped juice Facebook's growth describe themselves as content.

After all, since news of the Yahoo deal surfaced, the user base has continued to boom, arguably increasing Facebook's value. But when those money guys start agitating to realize a gain on their investment, can a sale--or more likely an IPO--be far behind?

"What most people think when they hear the word 'hacker' is breaking into things."

Zuckerberg admits to being a hacker--but only if he's sure you understand that the word means something different to him. To him, hacker culture is about using shared effort and knowledge to make something bigger, better, and faster than an individual can do alone.

"There's an intense focus on openness, sharing information, as both an ideal and a practical strategy to get things done," he explains. He has even instituted what he calls "hackathons" at Facebook--what others might call brainstorming sessions for engineers.

But it was old-fashioned breaking-and-entering hacking that spawned Facebook--and Zuckerberg was the culprit. Zuckerberg grew up in the well-to-do New York suburb of Dobbs Ferry, the second of four kids and the only son of a dentist (he has no cavities) and a psychiatrist (insert your own mental-health joke here).

He began messing around with computers early on, teaching himself how to program. As a high school senior, at Phillips Exeter Academy, he and D'Angelo built a plug-in for the MP3 player Winamp that would learn your music listening habits, then create a playlist to meet your taste.

They posted it as a free download and major companies, including AOL and Microsoft, came calling. "It was basically, like, 'You can come work for us, and, oh, we'll also take this thing that you made,'" Zuckerberg recalls. The two decided to go to college instead, D'Angelo to Caltech and Zuckerberg to Harvard.

That's where the hacking episode occurred. Harvard didn't offer a student directory with photos and basic information, known at most schools as a face book. Zuckerberg wanted to build an online version for Harvard, but the school "kept on saying that there were all these reasons why they couldn't aggregate this information," he says.

"I just wanted to show that it could be done." So one night early in his sophomore year, he hacked into Harvard's student records. He then threw up a basic site called Facemash, which randomly paired photos of undergraduates and invited visitors to determine which one was "hotter" (not unlike the Web site Hot or Not). Four hours, 450 visitors, and 22,000 photo views later, Harvard yanked Zuckerberg's Internet connection.

After a dressing-down from the administration and an uproar on campus chronicled by The Harvard Crimson, Zuckerberg politely apologized to his fellow students. But he remained convinced he'd done the right thing: "I thought that the information should be available." (Harvard declined to comment on the episode.)

Ultimately, Zuckerberg did an end run around the administration. He set up the Facebook template and let students fill in their own information. The new project consumed so much of his time that by the end of the first semester, with just two days to go before his art-history final, he was in a serious jam: He needed to be able to discuss 500 images from the Augustan period.

"This isn't the kind of thing where you can just go in and figure out how to do it, like calculus or math," he says, without a trace of irony. "You actually have to learn these things ahead of time." So he pulled a Tom Sawyer: He built a Web site with one image per page and a place for comments. Then he emailed members of his class and invited them to share their notes, like a study group on cybersteroids. "Within two hours, all the images were populated with notes," he says. "I did very well in that class. We all did."

Thefacebook.com, as it was originally called, launched on February 4, 2004. Within two weeks, half the Harvard student body had signed up. Before long, it was up to two-thirds.

Zuckerberg's roommates, Moskovitz and Chris Hughes, joined in, helping to add features and run the site using a shared hosting service that cost $85 a month. Students from other colleges began approaching them, asking for online face books of their own.

So the trio carved out new areas on the site for places like Stanford and Yale. By May, 30 schools were included, and banner- type ads for student events and college-oriented businesses had brought in a few thousand dollars.

"We just wanted to go to California for the summer."

That's how Zuckerberg describes his decision, at the end of sophomore year, to head out to Palo Alto with Moskovitz and Hughes. They sublet a house not far from the Stanford campus. And then fortune intervened.

Out on the street one evening, Zuckerberg bumped into Sean Parker, a cofounder of the file-sharing program Napster. The two had met briefly back East. It turned out Parker was moving to Palo Alto but didn't yet have an apartment. "Basically we just let him crash with us," Zuckerberg says.

Parker moved in, bringing with him an irrepressible spirit, lots of ideas, a killer Rolodex--and a car. Parker was also a walking, talking cautionary tale for what can happen to young entrepreneurs.

After Napster was derailed by legal challenges from the music and movie industries, Parker had helped launch Plaxo, a site that updates contacts. But he told everyone he'd been pushed out by venture heavyweight Michael Moritz of Sequoia Capital, an early backer of Yahoo, Google, and YouTube. (Sequoia declined to comment.) Zuckerberg took it all in.

Within a few weeks, Parker introduced Zuckerberg to his first major investor, Peter Thiel, cofounder of PayPal, president of hedge fund Clarium Capital, and managing partner of the Founders Fund. After Zuckerberg's 15-minute pitch on Facebook, Thiel was clearly interested.

"Peter is a fast-talking, sort of intimidating guy," says Matt Cohler, then a colleague of Thiel's who was in the room. "But Mark stayed calm and got the information he needed." By the end of the talk, he also got a commitment for $500,000 in seed money and an entr�e into the exclusive social network of Silicon Valley.

Zuckerberg and his friends had caught the entrepreneurial bug. With the end of summer approaching, Zuckerberg thought back to a presentation he'd heard at Harvard from a well-known dropout. While taking a computer-science class, he recalls, "Bill Gates came and talked."

Gates encouraged the students to leave and go make something, since Harvard lets students take as much time off as they want. "If Microsoft ever falls through, I'm going back to Harvard," he joked. With Thiel's money to sustain them, Zuckerberg and Moskovitz decided to follow Gates's advice.

Zuckerberg and a growing cadre of engineers managed the Facebook site from a series of sublets around Palo Alto, coding together in endless sessions on rickety furniture. "We never had any money," he recalls with a laugh. "We actually bought a car on Craigslist. You didn't need a key. You just had to turn the ignition." In November 2004, Facebook passed the 1 million--users mark. Six months later, with the help of Thiel, Zuckerberg signed the papers for that $12.7 million in financing from Accel Partners. He hired a new fleet of engineers (including Steve Chen, who would leave a few months later to cofound YouTube). And he moved the company into real office space, on Palo Alto's University Avenue. By the fall of 2005, there were 5 million active users, those who visit the site at least once a month.

Ask anyone who works there what Facebook is, and you will get pretty much the same answer: a social utility that lets people share information with the people in their world quickly and efficiently. Unlike MySpace, where anyone can trawl the site or take on a different persona, Facebook is based on real-world networks of people who share the same email domain and actually want to know more about one another.

What you share--vacation photos, contact information, favorite movies, current whereabouts, upcoming events, whatever--is entirely up to you. This all made perfect sense for the college crowd, who show up at school hungry to meet the people around them. But Web 2.0 watchers wondered how Facebook could grow into something that would work for the rest of us. And it needed to do that, if for no other reason than that the original audience was growing up and getting jobs.

In September of 2005, Facebook was opened up to high school students, many of whom had older siblings already on the site. The following month, the site added a photo feature, and technical demands skyrocketed.

"We're one of the largest MySQL Web sites in production," says chief operating officer Owen Van Natta, 37. MySQL, a popular open-source software, "has been a revolution for young entrepreneurs," Van Natta explains, partly because it frees them from paying the licensing fees of, say, an Oracle. But with sophistication comes heat. Literally.

"In computing, as things get smaller, they run hotter," Van Natta says. When he first joined the company in late 2005, he recalls, it was growing so rapidly there was almost a meltdown. "We were trying to predict how many new users we'd get, how they would use the site, and what we'd need to serve that," he says.

There weren't enough people to do all the analysis. "We were just trying to keep the wheels on the wagon." When he went to check the data center, he was horrified. "There were little fans like this big"--holding up his hands to indicate the size of a grapefruit--"tucked between the servers. It was over 110 degrees in some aisles."

And the data-center guys were plugging in more servers and screwing them into racks, trying to keep up with the rapidly scaling site. The Plexiglas sides of the server racks were warping from the heat. "I was, like, Mayday!" he recalls. "We need to get on top of this!"

Growth continued. In June 2006, the site was opened to work networks. There are more than 20,000 networks of employees, from the Central Intelligence Agency and the Internal Revenue Service to Macy's, McDonald's, Time Inc., and the U.S. Marine Corps. Even MySpace, considered by many to be a Facebook rival, has a corporate network of 22 employees.

Then in September, Facebook announced what it called "open registration": Anyone with a valid email address could join a regional network. It was an auspicious moment--until the Facebook community rose up and almost destroyed its creator. The problem was a new option called News Feed, which creates regular reports about the activity within a network or group of friends.

It may have seemed like a good idea at the time, but it set off a revolt in the Facebook community. Users felt that their personal information was being broadcast all over the Web without their permission. Never mind that they had posted it all publicly themselves. Or that it went only to people who were friends or already in their networks.

Facebook is a fast-moving, throw-it-up-and-see-if-it-works sort of place that typically adds a feature, watches how people use it, and, based on feedback, adds things such as extra privacy controls. But this time, Zuckerberg and his crew had made a mistake by not putting privacy features in place first.

Taking advantage of another new feature, which allowed individuals to start their own issue-oriented "global groups," disgruntled users set up a group they called Students Against Facebook News Feed (Official Petition to Facebook).

Ironically, the News Feed service itself then spread the campaign ("Your friend has just joined this group!"). In less than 48 hours, 700,000 people had joined the protest, and the blogosphere declared it the end of Facebook. News crews camped outside the Facebook offices, as if a bald Britney Spears were being held captive inside. "There was a hilarious email thread as we discussed what to do," says Zuckerberg, who was stuck in New York fending off his own onslaught from the media.

"Someone writes, 'Okay, it's like midnight, and we want to leave. But we can't even look through the blinds because they're videotaping us. I'll pay someone $50 to go streaking.'"

From his New York hotel, Zuckerberg posted an open letter to users via the blog on the site. "We really messed this one up," he wrote.

"When we launched News Feed and Mini-Feed we were trying to provide you with a stream of information about your social world. Instead, we did a bad job of explaining what the new features were and an even worse job of giving you control of them." His engineers worked around the clock for three days to add better privacy features.

The storm eventually passed, and Zuckerberg now claims News Feed has actually been a hit. "Once people had the controls and knew how to use them, they loved News Feed," he says, launching into some uncharacteristic hyperbole.

"We're actually producing more news in a single day for our 19 million users than every other media outlet has in their entire existence." (Facebook has also been snared in a more lingering dispute: When the site first launched, four other Harvard students sued, claiming that Zuckerberg stole their idea. The Facebook defendants filed a countersuit. At press time, litigation is continuing.)

"We're private, and we just don't talk publicly about these types of things."

We're in the Facebook conference room at the end of the day, and Zuckerberg is politely ducking questions about the company's financials. Last spring, Facebook received another infusion of VC funding--$25 million led by Greylock Partners and Meritech Capital; Accel and Thiel also reinvested.

But conversations with the executive team make it clear that Facebook isn't living on VC cash, at least not anymore. When I met with Cohler, who joined Facebook as the vice president of strategy and business operations, I asked bluntly whether a report in The New York Times that said the company was profitable was correct. At first, he hemmed and hawed. "It depends on how you look at GAAP accounting." But then he allowed: "We're growing very fast, and we're funding the growth of the company through revenue and the operations of the business as opposed to financing."

And the scale of those operations is significant. Beyond the 200 staffers and prime Valley office space, explains cofounder and chief of engineering Moskovitz, Facebook has multiple server facilities. The company is also about to invest what COO Van Natta says is "many millions of dollars" on more infrastructure.

So how does Facebook make its money? Advertising and sponsorships, mostly. Apple was an early backer, sponsoring a site for iTunes enthusiasts. JPMorgan Chase and Southwest, among others, pay for similar programs.

"Flyers," the online version of the paper ads that students use to publicize events, also provide a very modest source of revenue. And there is a nascent-but-growing local advertising business. The big money, though, comes from an ad-placement alliance with Microsoft in which the software giant will place banner ads on the site through 2011.

It mirrors a deal MySpace inked with Google last year. (MySpace reportedly got $900 million over three years. Facebook hasn't released the value of its program, and neither party will comment on the terms.) Facebook also just inked a deal with Comcast to create and Webcast an episodic show based on user-generated video content.

Called "Facebook Diaries," the series will be shown on both Facebook and Ziddio.com, Comcast's video-uploading site, as well as through Comcast's video-on-demand service.

"Okay," Zuckerberg says, "you have a Viacom, News Corp., and Yahoo. So you compare and think, This is social, but we're a technology company. What's in it for us? How will it work?"As everyone remembers from the heady sock-puppet days of Web 1.0, you hatch an idea, build it into a company, and concoct an exit strategy--that's the key to taking the business to the next level and rewarding early-stage investors for their money and employees for their hard work.

And there are two basic formulas: Sell to a bigger company, or file an initial public offering. With all the talk about valuations and acquisitions, not to mention the pressure of investors and employees with stock options, exit has to be on Zuckerberg's mind, right?

"The word--it applies a certain frame to thinking about things," he says, decompressing after a long day of meetings. "If you sell your company, that is the exit. That's just not how we think about it."

He pauses, then says with a sigh, "Okay, you have a Viacom, News Corp., and Yahoo. So you compare and think, This [site] is social, sure, but we're a technology company. What's in it for us? How will this work?" The companywide focus is on innovation and engineering, and the commitment to optimizing the user experience, he says.

The goal is not to create a media company. It is not about selling movies. "There are ways that you could do it, but right now, we're focused on building this. And if you look at the stats we have, it's been a good decision so far." But eventually? "At some point, it probably makes sense to do something. But we're in no rush."

One clue to the company's future plans comes from early investor Thiel, who has mentored Zuckerberg through the last year's swirl of acquisition talks and rumors. Bottom line, Thiel asserts, "it's much more valuable than anybody on the outside thinks." He points to the growing user base and page views as evidence. "The people who understand the power are the users. The people who wanted the company don't understand the power and don't want to pay enough for it. So we're not going to sell."

He adds, "I think the MySpace sale was a giant mistake. The Flickr sale to Yahoo--a giant mistake." A better idea, he believes, is to focus on the technology, which he says is the Facebook team's great strength, and continue to grow the company. He points to a laundry list of benchmarks that they'd all like to see. "Can we get to 35 million users this year?" Dominating another sector beyond the college crowd would be key. "If we were to see that in the high school space, that would be very significant."

But Thiel is aware of a ticking clock of sorts, determined by a Securities and Exchange Commission rule. "Once we get to 500 shareholders, we'll be forced into a situation where you have to give full financial disclosure," he says. (Facebook employees have shares as part of their compensation packages.) Most companies go public at that point. "But our current bias is not to do it any sooner."

What seems most likely is some version of a publicly traded Facebook, one that might emulate the quirky Dutch-auction IPO that Google filed in 2004. It seems like a natural fit; Facebook admires the minimalist sensibilities of Google's design, its focus on engineering, and the "do no evil" philosophy that, theoretically, at least, informs its business. Best of all, if handled properly, an IPO keeps the founders firmly at the helm, just like Sergey Brin and Larry Page at Google.

And an IPO would seem to be a good fit for Meritech Capital Partners, which participated in the last round of financing for Facebook a year ago. "Certainly most of our companies go through liquidity in the public markets," says Meritech founder Paul Madera. "Public markets seem to want to pay more than acquirers these days."

If Facebook got a very large offer, they'd have to consider it, he says. "But today, any offer around a billion would be way low."

But Zuckerberg maintains that nothing is happening quickly. "It's a really big change if you go public--all the regulations and stuff, so it's not something that you do lightly."

For now, the company is on track to double its engineering team of 50 this year (check out the first step in the application process at facebook.com/jobs_puzzles) as well as its 50-person customer-service group, headed by Tom LeNoble, who ran global service operations for Palm and customer service for walmart.com and MCI. His reps are mostly from top-shelf universities. (By my estimate, there's $5 million worth of tuition handling customer service at Facebook.)

New users keep flooding on board--100,000 signed on in a single day this past February. The college markets in Canada and the UK have been growing almost 30% a month (Prince Harry and his girlfriend are Facebook users, according to breathless reports in the British tabloids), and nearly 28% of all users are now outside the United States.

And slowly but surely, the site is adding older folks: 3 million users are age 25 to 34, 380,000 are 35 to 44, and a pioneering 100,000 users are currently eligible for Medicare. With stats like that, you can certainly see public-market investors getting excited.

Thirty-six months ago, Zuckerberg was a college sophomore cruising out to California on summer break. Now he approves everything from new hires to the activities of every advertising partner and runs the board meetings of a very-much-established company.

Zuckerberg was even invited to speak at Davos this year. How did it go? "It was great," he says, leaning forward conspiratorially. "I wore shoes."