The signs are all positive for the Chennai-based Rs 389 crore turnover Pentamedia Graphics Ltd. Nevertheless one question continues bother anlaysts, "when will the scrip price go up?"

Not so long ago the scrip was at dizzy heights, with the price ruling at Rs. 2,344. From these dizzying heights the scrip has gone through a great fall to Rs. 316. After languishing at Rs.347-band for sometime, it is now changing hands at around Rs. 350.

Ranked third in the $25 billion global animation business, the company is growing at a scorching pace of 35 per cent per annum. It is engaged in three main spheres of activity viz. 2D and 3D animation, special effects (big, small and personal screen) and multimedia activities that includes New Millennium TV (Num TV)-the web casting division-and CD-ROM duplication.

For the first half of this fiscal Pentamedia reported a turn over of Rs.249.49 crore, up by 45 per cent as compared to the previous year's corresponding period. The net profit too went up to by 42 per cent to Rs. 66.63 crore. The company hopes to close this fiscal with a turnover of around Rs.500 crore. For an entertainment company's scrip with a P/E of just 8 times should be a steal. But the market doesn't think so.

Its recent achievements have not enthused the investors. The company recently acquired a 51 per cent stake in the Nasdaq-listed Film Roman Inc for $ 15 million cash thereby enhancing its opportunities and capabilities for larger animation orders. (see Focussing on profitable partnerships) It has been ranked as world number three in the animation industry by US-based Pixel-The Computer Animation Directory. It has also hived off Num TV into a separate subsidiary, thereby freeing Pentamedia from the risks of a new medium.

So what is that bugging mutual funds and industry analysts to keep away from Pentamedia's counter?

"Lack of transparent accounting," is the crisp answer one gets from a south-based mutual fund official.

To support their stance analysts cite the company's Rs. 194 crore multimedia software development expenses last year while Rs. 26 crore was accounted under the head 'salaries'. This gives an impression that the company is partly accounting salaries as development expenses - a case of non-transparent accounting practice.

At these figures, for staff strength of 1,500 the average annual salary works out to Rs. 1 lakh plus when software professionals generally command much higher pay packets.

For the half year-ended 30 September 2000 the company accounted just Rs. 5.9 crore under the head salaries, allowances and incentives (staff strength 1,732) where as the multimedia/software development expenses is shown as Rs.123 crore.

Reacting to the charge, Dr. V Chandrasekaran, chairman and chief executive of the company states, "Oranges and apples can't be compared. We should not be compared with other software companies". In the same vein he says that there is no other company in the world having a similar business model against which Pentamedia's performance could be benchmarked.

"Even Lucas Digital/Industrial Light Magic and Disney Studios -- ranked first and second in the world by Pixel -- have different business model. We are purely turnkey contractors," he adds.

While the analysts might be right in their stance, Mr. K. Srinivasan, director and chief operating officer (COO) also has a point when he says, "PriceWaterhouseCoopers, our auditors, did not raise any objection to our accounting practice." Even leading software companies do account part of their staff cost under development expenditure head, he cites.

Reacting to the complaint that the company does not disclose its order values under the veil of non-disclosure agreements, Mr. Srinivasan says, "A 90-minute animation film would require a labour of 1.2 lakh man hours. Payments are made on the basis of milestones. The order value for Sinbad-Beyond the Veil of Mists was $22 million."

Adds Mr.S. Ramasamy, general manager, corporate finance, "As against our cost of $20 (off shore) and $80 (on site) we charge $45 and $200 per man hour respectively." While onsite work contributes 30 to 35 per cent of the animation division's turnover the remaining is earned from offshore work.

According to him the short turn around time offered is what that attracts overseas film production companies to Pentamedia.

The company has animation/special effects orders worth more than $100 million for execution over the next 18 months. The big screen projects include Pandavas - The Five Warriors, Alibaba and the Forty Thieves, Five and a Half Hours to Dawn, Story of the Buddha etc. Small screen projects include Mr.Doonz and Miaao. The latter, a 2D animation, is similar to Tom and Jerry cartoon.

The other worrying aspect about Pentamedia is its sliding operating margins since the second half of last year. For the first six months of this fiscal the operating profit margin was down to 41 per cent as against 45 per cent logged during the corresponding period last year.

Explains Mr. Ramasamy, "Reduction in the operating margin is mainly due to the initial cost incurred for new projects towards pre-production and start-up expenses relating to Num TV operations abroad. The overseas revenue relating to the above will flow during the subsequent 12 months. Operating profit margin will be on the higher side during the periods to come."

According to Mr. Srinivasan, the decision to hive off Num TV operations into a separate outfit augurs well for Pentamedia, as it would free the company from making additional investments in an entirely new operation. Further the Rs. 20 crore provision made last year towards internet related risks might be written back after the hive off. (See Num TV hive off - A surprise move)

Be that as it may, the recent developments like reporting its annual results as per US GAAP and the plans to issue $250 million ADR/GDR should address the question of transparency in Pentamedia's accounts.

Theme parks
Meanwhile, buoyed by takeovers and alliances Dr. Chandrasekaran nurtures big ambitions of investing around $10 million annually towards acquisitions, apart from the additions to gross block.

During the first half of the current year gross block went up by Rs.17.36 crore and is expected to be at Rs. 30 to Rs. 35 crore in the second half year.

Part of the investments will be for setting up animation theme parks - the first of its kind in the country - near Chennai, to utilise its animation/graphics/special effects expertise.

Elaborates Mr. Srinivasan, "We plan to put up nine domes each at a cost of Rs 5 crore. Each dome will occupy around 2 acres and will offer different themes like sports, movies, aquarium etc. The company has tied up with Silicon Graphics, USA for the purpose and the first dome is to be commissioned in a year."

Broad basing its risk
While branching off into theme parks will enable it to utilise its existing animation/special effects strength, bulk of Pentamedia's revenues will continue to be earned from computer animation.

Currently the US is a major market accounting for 48.5 per cent of the global market, followed by Europe and Asia Pacific accounting for 21.9 and 29.6 per cent respectively. Interestingly the Asian market is growing at a faster clip than the US market.

With major part of its animation revenues coming from the US, Pentamedia has decided spread its geographical presence by entering lucrative markets like Japan, Hong Kong and France.

One such move is its recent tie-up with Nasdaq-listed Japanese company Creek and River Company Ltd. As nearly 50 per cent of the Asian market is in Japan, the tie-up is expected to provide a ready access to a lucrative market. Unlike other countries animated TV programmes has a big market in Japan.

For example computer games in one big segment in Japan where Dr. Chandrasekaran sees great opportunity partnering with Creek & River.

According to Mr. Yukihiro Ikawa, president and chief executive, Creek & River, the Japanese company currently operates in five major domains - visual creation (TV shows, news broadcasting, entertainment, TV commercials), multimedia (music, sound effects, graphics and video), video games, advertising and publishing and crossover. The company is planning to use Pentamedia's infrastructure to get its work done.

It is also interested in marketing the Chennai company's digital assets - previously created images - in Japan. Pentamedia has around 9.2 terra bytes of digital assets - animation - the valuation of which is being done by PricewaterhouseCoopers.

More acquisitions on the anvil
Not content with the Film Roman and Animasia acquisitions, Dr. Chandrasekaran is thirsting for more. This time around he is on the look out for companies in the field of pre/post production and distribution. And unlike Film Roman – an all cash deal - the future acquisitions will be a combination of cash and stock.

In respect of the CD-ROM duplication business, Pentamedia is performing fairly well. The company does work for Internet service providers apart from duplicating educational materials.

Finally when one looks at the company it certainly seems that it has joined the global league. But the company cannot rest on its laurels and get complacent. Competition from ex-employees of the company is setting in and is sure to put Pentamedia under pressure (see Competition puts Pentamedia Graphics on notice) However in order to avoid any doubts about its capability Pentamedia should morph itself to be more open and transparent organisation.

Such a change has to come from within as no amount of computer graphics and special effects could showcase that. If that doesn't happen then Pentamedia will be the only entertainment industry scrip that will be available for P/E of 8/9 times or even lesser.