However, all is not rosy with this first public issue from a software company in recent times. Sonata Software is offering each equity share at a premium of Rs 80. Since the premium looks a bit on the higher side, one should see the earnings potential, promoters' exposure to the field of software and track record of the company, before betting on this issue. And on all these fronts, the company does not stand on a sound wicket.

A number of factors like high growth prospects, higher return on networth and high net profit margins (NPM) havemade software stocks darlings of the market. However, it is an open question whether an investor who is buying the scrip at Rs 90 will get any return on his investment.

What makes one software company different from other is its composition of sales. The companies which have strong hold in areas of high growth and high margin enjoy better valuations than others who mainly engaged in low margin operations. In the case of Sonata, product marketing and international operations, 55 and 40 per cent respectively, constitute major part of sales. The company has strategic business alliances with global software majors like Microsoft, Oracle, Lotus and Oracle WGS. It markets products of these companies in India. However, this is low margin business and this segment is likely to grow at only 25 per cent per annum compared to others like ERP solution which is expected to grow at 60 per cent per annum for next couple of years. But these form only four per cent of sales of Sonata. This division contributed only Rs 2.5crore to total sales of Rs 88 crore in 1997-98.

As for international operations, the company provides both on-site as well as offshore services to its clients. Currently, of its 800 employees, 600 work on overseas contracts. For 1997-98, Sonata earned Rs 34 crore as service revenues from 300 employees.

As Sonata's main business comes from product marketing, its NPM is low. The company reported a net profit of Rs 5.58 crore for fiscal 1998 on an income of Rs 88.23 crore. The NPM is just five per cent which is much lower compared to other software companies. Generally, software companies have NPM in the range 15-25 per cent. For 1998-99, the company has forecast a NPM of 6 per cent. Software companies which have NPM lower than 10 per cent do not enjoy valuations more than of 10 times.

The company reported an EPS of Rs 17.17 for 1997-98. On the enhanced equity, the projected PAT of Rs 8.6 crore converts into an EPS of Rs 10.78. Therefore, even if the company is valued at 10 times, the price will be aroundthe offer price. Due to lower equity, the company reported a return on net worth of 36.91 per cent for 1997-98. Even on a current book value of Rs 25.18, the offer price to book value ratio works out to 3.57 times which is on the higher side. The company for the first half of current fiscal has reported a net profit of Rs 4.4 crore against Rs 5.58 crore in fiscal 1997-98. For the complete fiscal, the company expects to earn sales income of Rs 128 crore and a net profit of over 8.6 crore. Interestingly, the company has not said anything about the projects in hand. Professionally run companies enjoy much higher valuations in the case of software companies.

Unlike other software companies, most of the directors are not software professionals. Post issue, a substantial part of the equity, 64 per cent, will be held by promoters who do not have rich experience in the field.As per the prospectus, the company plans to use the proceeds for expansion of the software development centre at Bangalore and augment itslong term resources. However, according to Sonata president and managing director B Ramaswamy, ``The purpose of the issue is to get the shares listed and thus to provide employees the real value of their shares.'' Currently, the majority of the employee stock option is held through an employee trust. Post-issue, the employees of the company will have 21 per cent stake in the company, down from the pre-issue level of 28 per cent.

Sonata was initially set up as a division of Indian Organic Chemicals Limited(IOCL), but was later hived off as an independent company in order to retain the employees by providing stock option. IOCL later sold its equity holding to present promoters.

Post-issue Rajan Raheja and Bhupati Investments & Finance Ltd (investment company of S B Giha, chairman and managing director of Indian Organic Chemicals) will hold 23 per cent stake respectively. It remains to be seen whether the company will catch up with the Jones or not. The best policy would be wait and watch.