Kale Consultants , On its way to become great !

Investment Highlights

• One of the leading providers of revenue recovery and audit services to airlines globally
• Kale's audit platform is endorsed by IATA (The only one endorsed by IATA) and is the preferred audit provider to the Star Alliance group of airlines
• Has more than 100 clients across 5 continents, including 12 of the top 20 airlines
• It is estimated that over 300 airlines will use the SIS initiative by IATA when it goes live in 2010. SIS (Simplified Interline Settlement) is being developed by Kale.
• The hosted service model offered by Kale helps airlines to streamline its noncore processes with minimum upfront investment
• The recent study conducted by Kale for technology adoption in Indian logistics industry pointed out that only 0.26 % is spent on IT by the Logistics ecosystem as against the global standard of 2-3%. This shows a huge untapped market waiting to explode.
• Less than 1% of the logistics industry in India is organized and there is lack of industry-wide standards, processes, and established technology solutions that creates an opportunity to establish the benefits of technology.
• Also it is estimated that the demand for technology solutions in logistics industry in India is set to cross Rs. 1000 crore by 2013.
• At CMP of 90 Rs this market leader is trading at a valuation of just 120cr.
• Company is at the verge of an inflation point with a reasonable valuation
• The company has been growing consistently for last 5 years even during global downturn.
  [Source: Some of the figures mentioned above are sourced from the study conducted by Kale Consultants. For more details refer the company’s web site http://www.kaleconsultants.com/]
  

Introduction

I always think that why the book "Good to Great" by the celebrated writer Jim Collins always have a great influence when it comes to my investment decisions. In that book Mr Collins has systematically analyzed many companies and who have transformed from a good company to a great company. Some of the concepts that he described like the flywheel effect, hedgehogs are worth mentioning.
Kale Consultants to my mind is one such company which is slowly exhibiting those behaviors and is on the way to become great.
For the benefit of the readers who are new to the book "Good to Great" I will just explain the concepts. This is just an introduction and I would suggest that you read that book.
Refer to: http://www.jimcollins.com/

First Concept: The flywheel effect
After analyzing many successful companies that became good to great as per the parameters described in the book Collins found that there is no dramatic incident / change in any of these companies which overnight transformed them in to great companies. Most of these companies were simply mediocre companies who slowly mastered their business and became best in their business over a period of time.

The whole process of transformation is described as rotating a giant flywheel.

You take great effort to push the flywheel for the first time. With each rotation things are getting better for you and there reaches one stage where your every push has a multiplier effect on the flywheel. Now you really cannot tell which push caused the flywheel to rotate that fast (was it the first push or the last push?..No every push is important).

And more important is the focus and the direction of the effort. You are not reversing the flywheel push every time. And with every push you figure out the best way to push the flywheel , so that you are more comfortable and which gives maximum benifit.By doing the same task every time you are mastering the art of pushing the flywheel and also you are setting new targets every time with every push.

Apply this to the companies you know and you may spot a good to great company which can give you dramatic returns over a period of time.

Second Concept: The hedgehog advantage

A hedgehog is the boring animal that you ever see. It moves slowly, it’s ugly and full of thorns. All these things make the life of a hedgehog very challenging. On the other hand fox is a very cunning animal, very fast and intelligent. But every time the fox tries to catch a hedgehog the poor hedgehog knows only one thing to do

It just bends its body to form a circle or like a ball with all its thorns pointing outwards. The fox tries all sorts of techniques that he knows to catch the hedgehog, every time coming up with an intelligent and innovative idea to catch the hedgehog. But at the last moment the hedgehog does what it knows best to safeguard itself. Only one thing which he is best at doing.

Apply this to the great companies that you see around. Every one of them has a similar hedgehog concept which it can do best. They usually do not try too many things or diversify in to unrelated areas. It keeps on improving its core competency every time improving its efficiency.

Normally it takes years of effort, time and dedication to know and understand your hedgehog concept. Once you identify it work on it, improve it and be the best in it. This is exactly the same thing successful companies across the world are doing. The fox over here is the competitors and the environment in which they operate in.[Source: Good to Great by Jim Collins]

About the company

The company that we see here today is a small cap company: Kale Consultants, a leading solutions provider to the global Airline, Logistics and Travel (ALT) industry. Let me first of all make things clear this is not a software company, it is a solutions provider for airlines, travel and transportation industry who provide solutions in partnership with the industry bodies and customers

The company has been in this business for over 10 years now and now slowly moving up the value chain by providing solutions for the travel and transportation industry. The company over a period of time has acquired great domain knowledge in the travel and transportation industry mainly airlines (which is their hedgehog) and is now slowly moving towards the logistics industry leveraging the business knowledge it has acquired over the years.

This deep business knowledge has helped Kale to work closely with the main Industry body for air travel IATA. In partnership with IATA, Kale is developing many standards based solutions for the airline business. And in majority of the cases Kale is the sole vendor or preferred vendor for IATA. Naturally all major airlines which are part of IATA, looks for any process improvements / efficiency naturally select Kale’s solutions.

Performance Snapshot

If you look at the 5 years starting from 2004-05 to 2008-09 it is more of a steady growth for Kale. That time can be considered as the base setting times were Kale was trying to identify and grow its hedgehog concept. Like other software companies at that time Kale also was there in to every aspect of software services business. It operated an enterprise division which created products and solutions to the Banking and Airline industry. Later they found out that their core strength is in the airline business and not in the banking division. So they sold the banking division to Onward technologies in 2003. From then onwards they were continuously working on their core competency and created a niche in that. The company progressed from a mediocre software service provider for the airline industry to a full fledged solutions provider for the airline, transport and travel industry.

The performance of the company during this phase of growth is given below (Remember the initial push of the giant flywheel).

[Source: Company annual report 2008-09]
Now to me it has come to a phase where the company has entered in to the next level of growth. The estimated figure for the year 2009-2010 is given below
Consolidated revenue: 160Cr*
Consolidated Net Profit: 30Cr
EPS: 22Rs*
* These are my estimations and is subjected to my knowledge levelThis is what I referred to as the explosive growth going forward. The flywheel has reached that stage where your efforts are having a multiplier effect on the movement.

Business Prospects

Globally airline business is going through a very rough patch. Very few airlines in this world are profitable with majority of them have a bleeding balance sheet. This case is almost the same with the logistics industry due to the global economic slowdown.
Most of the airlines are trimming down and trying to cut down unnecessary expenditure to stay afloat in business. Same is the case with non core activities of airlines like Revenue accounting, Revenue recovery and Audit services.

An industry estimate states that about 2-5% of revenue is lost every year due to inefficiency in the system and with channel partners. Also when it comes to airline business it is very common that most of the airlines work through their channel partners and inefficiency at the partner level means a direct revenue loss to your business. These include revenue losses due to ticketing, under-collection of fares and incorrect application of fare rules on tickets issued by the travel agents, inaccurate settlement between other airline partners, either intentionally or erroneously. About 0.7 - 1% of this is directly attributable to ticket sales related errors.

Another area of concern is the process related inefficiencies in the airline business. Kale is working with many airline bodies to remove these inefficiencies in the system itself which can save lot of money for the airlines. For example kale is working with IATA for developing its industry-wide interline settlement platform Simplified Interline Settlement (SIS).At its steady state 3 years from today, SIS will handle over 1 million invoices per year, be used by over 300 airlines, support over 3,000 users around the globe and facilitate settlement of approximately USD 50 bn per year for the industry. And more importantly this will save USD 500 mn annually for airlines.

Most of kale's solutions for the airline industry is derived from its deep knowledge of the industry practices and knowledge of pain points that globally airlines face. This has resulted in better solutions for the airlines resulting in process improvements.

Hosted Business Model

One of the USP (Unique selling proposition) for Kale's solutions is its hosted model. Airlines that wish to improve any of its processes do not have to buy or invest in systems to get this solution. Instead they can subscribe to Kale's hosted solutions and pay based on the transactions they do. This will takes out lot of risk from a system implementation perspective and make airlines in a comfortable position. There are no huge upfront costs they just have to pay as they use it.

Also it is now more aligned to their business conditions. When they make less money they have to spend less for their IT budget as most of the Kale's solutions are on a pay / per transactions model.

They can also outsource their entire backend process through kale’s MPS (Managed Process Service) where Kale take the responsibility of entire business process including People, Operating process & methodology & Underlying software & technology. Here also the airlines save huge upfront costs.

Now for Kale this assures revenue visibility over a long term. Such customers typically have long term contracts, with every possibility of renewing their contracts with Kale. Why the reason is simple – They don’t have a choice :)

Initially an airline looks to save the costs while selecting such solutions and later they realize the benefits of process outsourcing and will outsource more of their backend services. And at some point of time they realize that they themselves do not have expertise in these noncore processes and have no choice but to outsource it to the industry leader Kale.

Any Customers till now?

Very valid question. All these become invalid if the airlines do not see any value in their offerings

Kale's audit platform (Zero Octa’s audit) is endorsed by IATA and is the preferred audit provider to the Star Alliance group of airlines. Have more than 100 clients across 5 continents, including 12 of the top 20 airlines.

Recently Jet Airways has selected Zero Octa to audit its passenger accounting results. Jet Airways, JetLite and Jet Airways Konnect, its all-economy, no-frills service, have a combined fleet strength of 111 aircraft and operate over 410 flights daily.

Cathay Pacific Airways, world’s third largest cargo carrier also choose AMBER, the revenue accounting package from Kale.

J. M. Baxi India’s leading logistics provider selects Kale’s Freight Management System.

What I quoted here are only recent customer wins and there are many more.

Valuation

No analysis is complete without a discussion on the valuations. This year (Year ending March 2010) Kale is expected to post around 160Cr in revenues and around 30cr in profits. This will give an EPS of around 22Rs by March 2010. The market cap is around 120 cr and the stock price is around 95Rs

Last year during March 2009 crash the stock has given an excellent opportunity when it crashed to below 20Rs. From there it has been almost a 5 bagger.

[In fact I would have written about it if this blog would have been up :-). However I was fortunate enough to buy this at that time (Disclaimer)]

There is still very much scope for appreciation even from the current levels as this is still trading at 4 time of its 2010 March earnings which is quite reasonable. The real benefit will come if the flywheel effect which i mentioned at the start of the report kicks in. These kinds of stocks will give maximum benefits when the stock goes from an initial stage to a market discovered stock stage. Given the kind of business Kale is in I would not be surprised if it trades at 10-15 times forward earnings in another 2-3 years time.

Now it’s up to you to see how much is that. For me it’s a buy at 95 levels with a time frame of 2-3 years.