Sify's Alliance With Microsoft Provides A Good Exit Point

Kaufman Bros. has kept Sify’s (SIFY) rating and price target of $8 unchanged. The Microsoft (MSFT) alliance news did provide some nice gains but I think this is an opportunity for some people to get out. Longs will probably get a better entry point in the future. The stock kind of ran out of gas after early gains and closed the day with a gain of only 1%. Let’s see what happens tomorrow.

On the other hand Rediff’s (REDF) latest news seems to be more material. But once again has the price run up a little too much? Rediff could have some legal issues down the road with the copyrighted content uploaded to Rediff iShare.

Following is an excerpt from the note Sameet Sinha, Senior Equity Research Analyst, at Kaufman Bros., sent to clients:

Sify Announces Alliance With Microsoft For Education And ISP Services

• Sify’s cyber cafes to offer Microsoft education programs. Sify’s iWay cyber cafes is expected to promote and host certification programs for Microsoft products, starting with MS Office. The coursework will be offered online and hence has little incremental associated costs. We believe that Sify will primarily benefit from the browsing fees associated with online education and the company was not able to confirm if there is a revenue share arrangement for the course fee as well.

• Sify’s ISP services to be bundled with Microsoft’s IQ PC. Earlier this year, Microsoft launched its ambitious Unlimited Potential campaign to increase penetration of computer awareness and ownership in less developed countries. As part of this initiative it also introduced a $500 PC (called IQ PC), which ships with a suite of Microsoft’s productivity tools and some education programs as well. The marketing is being tested this month in some cities and will be extended to the entire country by year-end. Sify’s ISP services will be bundled with this PC, offering consumers 100 free hours of online access, with the option of signing up to a paid service at the end. We are not sure if this bundling will be in the form of a set-up disc in the box or an icon on the desktop, or if this is an exclusive relationship. While this deal has much higher revenue generating potential than the education business, it is totally dependent on Microsoft’s initiatives, which are untested at this point. For example, we believe the $500 price point for PCs is still expensive for the average household in India and will not lead to a sudden increase in PC penetration in the country.

• This is part of a larger game plan for Microsoft. SIFY is now a part of Microsoft’s larger game plan of bridging the digital divide in countries like India. The growth of IT penetration in India is slow and a number of initiatives are in place to speed this up. We feel investors need to understand that this will be a slow path and not to expect dramatic changes in Sify’s fortunes, due to this announcement.

• SIFY has had its own issues. We like Sify as a play on the enterprise services, outsourcing and Internet penetration trends in India. However, the company has had its own set of problems over the last year. The new management team under Chairman and CEO Raju Vegesna is working to clean up the operation and financial structure at the firm, which we anticipate will affect top-line growth for at least another quarter. Once the systems are in place, we believe that management will be aggressive in marketing its various businesses and we could start seeing the benefits toward the end of the year.

• Our price target remains $8. This utilizes a 10-year forecast of the company’s estimated unlevered free cash flow discounted at the cost of equity of 13.4%, down from 13.6%, due to a lower risk-free rate (10-year note) in our CAPM model.

• Bottom line. We would caution investors against increasing expectations for SIFY, due to this partnership. We like the SIFY story long term, due to its exposure to the enterprise services and Internet market in India, but near-term issues at the company keep us on the sidelines for now.

SIFY 1-yr chart:

Disclosure: no position in SIFY, REDF or MSFT