ADRs in General and Indian Software Services Firms

[doreeg]

Here is something I submitted to Phil's Blog on his recent SAY thread but wanted to share on this site as well:

There are 2 topics I want to comment on: ADRs in general and the Indian Software Services Companies.

ADRs (American Depository Receipts
When you trade these you are trading shares in a company that trades in a non-US market. There are 2 transactions involved every time you buy or sell an ADR. When you buy an ADR, you first buy the native currency of the country where the company’s stock trades in exchange for US dollars (USD) and then with that foreign currency (FX) you buy shares of the company. When you sell, the reverse happens – you sell the stock and then use the FX proceeds to buy USD.

These currency transactions are done at the spot price on the day of the transaction. This means that if the FX fluctuates vs. the USD between the time you buy and the time you sell the ADR you may make or lose money on the currency part of the transaction in addition to making or losing money on the stock part of the transaction.

Therefore when you buy and sell an ADR it is important to understand the currency part of the transaction as well as the company whose shares you are buying.

Ideally, one wants to buy foreign assets when the USD is strong (you get a lot of the FX for your USD) and sell them when the USD is weak (you get a lot of USD back in exchange for your FX).

I looked on Yahoo and found that in the last 5 years there has been very little fluctuation in the USD and Indian Rupee relationship. The high has been 50 and the low 43. (The New Zealand dollar vs.the USD, on the other hand has varied from .40 to .75 in the last 5 years). It appears from this, that the currency risk affiliated with purchasing shares in an Indian company is relatively low. But it is still a risk that should be factored in.

The Indian Software Services Firms
The better known Indian Software Services Firms are INFY, SAY, Tata Consultancy Services, Wipro and Patni. I know some of them have good Big 5 numbers. But they all seem pretty inter-changeable to me. This gives me concerns about their Moat.

Although I put CTSH in this group, I think CTSH is unlike the rest and does have a Moat. Also, CTSH is a US based company and you buy the actual shares in USD and not an ADR.

I also believe from my research that CTSH has a very different and value-added selling proposition. CTSH is able to sell at the highest levels of major corporations. In this regard and others, I think it also competes effectively with Accenture, IBM and EDS. However, CTSH, using the Indian labor market, has a much better value proposition than the other 2. So I really like it a lot.

That said, the pure Indian firms are adding the vertical US based services to their offerings and the big US firms like EDS are starting to use offshore services to fulfill their contracts. So it seems to me that the whole market is converging on the successful model of CTSH.
Doree

[Justin]

Doree I'm not quite sure how this post got past me but thank you for adding some wonderful insight to ADR's and trading foreign markets. I was always sure that there had to be some extra level of risk involved at least on some level. I don't think I'm ready to start concerning myself with currency exchange in addition to stock exchange!!

Anyway, great post.