Bhavin Shah of JP Morgan believes that the larger impact of MAT will be on smaller, off-shore oriented companies. In his view, MAT tax credit would mean that the EPS impact may not be much.
According to him, nothing has changed in the long term fundamentals. He further adds that FBT on ESOPs is negative. He adds that the market has already factored in the negatives in the IT sector.
Excerpts of CNBC-TV18's exclusive interview with Bhavin Shah:
If anything, what does this imply for the life cycle of 10A and 10B? Some people have been drawing inferences about whether 10A, 10B will be extended, proponed, not extended after what happened yesterday.
In a way what the government is saying is that IT companies have become large enough, they are making very good margins, so they can afford to pay tax. So the logic for extending those Section 10 benefits after imposing MAT doesn't make sense, but we will have to see and I wouldn't read in too much into the minds of the Finance Minister.
But at least the message being given here is that if you are doing so well might as well pay some tax in India. I don't see the logic for extending section 10 after that.
Have you worked out exactly how this tax will be put forth and which companies stand to get hit the most than the rest?
Clearly some of the smaller companies that predominantly may have offshore operations, or BPO companies that have most of their profits in India would be hit higher. Obviously, the lower your margin, the percentage impact is higher. So if a company is earning a 15 per cent margin, percentage impact is going to be large - greater than a company earning 25 per cent margin.
So it's likely that we will see a bigger impact on a smaller and midsize companies than more offshore geared companies and that's why you are seeing some of those smaller stocks hit a little bit harder.
Although we are surprised that a couple of stocks didn't get hit at all, the larger caps like Infosys and so on have come out and clearly explained already what the impact is. They are in a best position to do the calculations and we agree with those calculations of some evidence of 6-7 per cent in terms of cash impact.
But they have that tax credit, deferred tax credit that they can take on MAT, which means that the EPS impact in the near term may not be there at all. But the cash impact would be there. The other thing is that in our models, we have been assuming slow increase in local taxation from 2010 onwards.
So when you look at the longer term valuation perspective, the impact of discounted cash flow valuation is very small - significantly less than one per cent, because it is only the next 2 years, which are getting impacted incrementally. We had already factored the impact beyond 2010.
What about FBT on ESOPs? Some large companies have discontinued ESOPs but many of the midcap companies have very aggressive ESOPs programmes. How badly could that scar earnings?
Recently, when we published a report on semi conductor policy, which was clearly not in agreement with government giving out incentives, which will only benefit foreign capital equipment providers but nobody else in India, we said that tax treatment of ESOP is one unique thing about India that should continue, basically to give incentive to employees who are contributing greatly to fast growing companies.
So this fringe benefit is a bit of a surprise. When they exercise whether the stock option or RSU (restricted stock units), if they are making gain on top of the exercise price, they are subject to taxation already.
At least to me it seems like double taxation of the same thing and I guess companies could do variety of things, one of the things that you might see them doing is shift more towards restricted stock rather than options. But also if this particular incentive becomes less valuable to the employees maybe then you are thinking about competition from overseas companies which might be compensating more in cash.
There is very small maybe marginal pressure on cash salaries but it is hard to quantify that, it's a thing that you cannot quantify but you know its not good.
Any specific midcap companies which have rather hefty soft programmes?
I wouldn't exactly call it a midcap but HCL Tech does have a larger exposure to this issue in our estimates.
As an analyst though, given what has happened both in terms of MAT and FBT including ESOPs has anything changed significantly in the universe of tax stocks that you track?
The market is efficient; the market has already taken into account this one-off event or it's an ongoing impact. But it happens once and then it continues. The market has, by and large, factored this in, maybe a little bit more for some of the smallcap.
But by and large, market has factored this impact in. Now when we look at the earnings growth, whatever we have been seeing over the last couple of months or what the companies have been seeing in terms of the growth opportunities and earnings growth.
Over the next couple of years, we continue to see an opportunity to invest in this sector and we will certainly see this dip as an opportunity for those who are feeling that valuations was a little bit stretched, maybe get some additional opportunity to enter the stock. So we are not seeing anything fundamentally in terms of a long term story.