Zen Technologies – Practice Makes Perfect

“PRACTICE MAKES PERFECT”

This is a quotation that almost everyone will agree with.  When you are defending the country, the importance of this is almost unchallengeable.

Zen Technologies makes SIMULATORS, for the Armed Forces, Air Force as well as the Police.

They started of with simple driving simulators and today make a huge range of simulators from AK47’s to Grenade and Missile Launchers to Tanks and now the recent Helicopter simulators along with Rockwell.

Look up the balance sheet data, and you will notice that the gross margins of companies in the defence business is over 45%. However, the reason companies in this segment have been pretty unpopular investors are

1. High levels of R&D costs

2. Uncertainty of orders

This is sort of a mixed curse as it has financially destroyed a lot of players in the market, but at the same time, most people who have remained in the industry are ones who are passionate about this business.

Narration	Mar-10	Mar-11	Mar-12	Mar-13	Mar-14
Sales	52.23	17.41	101.84	37.14	46.35
Expenses	34.02	25.35	64.75	32.58	45.74
Operating Profit	18.21	-7.94	37.09	4.56	0.61
Other Income	2.71	1.92	5.35	4.71	3.56
EBIDT	20.92	-6.02	42.44	9.27	4.17
Depreciation	0.60	1.04	1.16	1.89	1.61
EBIT	20.32	-7.06	41.28	7.38	2.56
Interest	0.40	1.26	1.91	1.84	2.48
Profit before tax	19.60	-8.66	39.37	5.53	0.09
Tax	3.40	-1.85	7.80	0.85	0.02
Net profit	16.86	-2.10	31.57	4.68	0.07

One of the most important causes for the pathetic state of defence suppliers in India is that the previous governments defence budgets envisages a 20:80 expense with 20% to Capex and 80% to Revenue expenditure. This made our armed forces deeply outdated as well as never let the domestic industry develop as most of the Capex was spent abroad.

The Modi government wants to change this to 80:20 in the inverted order i.e 80% Capex and 20% revenue, with the additional focus of “MAKE IN INDIA”.

Zen has been more or less the only player in the simulator space and has gained trust and made major inroads into almost all the possible sectors in the defence and homeland security. While this was the case till yesterday there will be new competition entering the market. However, foreign competition is sort of irrelevant due to the Make in India and the Defence Offset Policy and existing domestic players are not ones that have simulators as a core concentration.

Zen has an addressable market size of 6,000 cr ,and if the defence segment performs in line with what the government is proclaiming, Zen should be able to execute 2,000-3,000 cr of sales in the next 7-8years.

Zen does not need CapEx as it own the intelligence and outsources a lot of the production, thus making consistent orders with timely payments its only bottlenecks.

Other things in favour of Zen :

1. Zen is a Small Scale Industry and any purchases from this company will qualify 1.5x for the Defence Offset Policy.
2. While Rockwell is bringing its helicopter technology to India, it is likely to push Zen’s Armed Forces equipment worldwide due to significantly lower costs.
3. Zen should be able to have a 60-80 cr AMC revenue in the near future adding about 25-30cr PAT consistently after 3-4 years.
4. Promoters shares have all been pledged to the Technology Development Board.
5. The company has no plans to raise capital, but is looking at a term loan of 50-60 cr to tide to ramp up production currently.

Zen is a small business in an area of great potential, relatively undiscovered, not within the Mutual Fund radar as of now and it makes training our defence faster, cheaper and better. It looks like the company is in for a long run in the future.

At 57 Rs a share the M.Cap is a shade under 450 cr. In all likeliness the company should execute orders of atleast 200 cr two years from now with a 25-30-% PAT, bringing up the M.Cap to 900-1200 cr at 15x. Just enough for the Funds to start biting.

In the words of Monish Pabrai, “ Heads you win, tails you don’t loose too much.”

And oh, btw, Pabrai is buddies with the Management !

http://www.zentechnologies.com/investors.html