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Satyam: Forex blues hit bottomline

Jan 20, 2005

Introduction to results
Satyam has announced mixed results for the third quarter and nine-month period ending December 2004. While the topline has witnessed a marginal growth on a sequential basis, profits are down due to a sharp decline in other income. While margins are almost flat for the quarter, they are down by 200 basis points for the nine-month period.

Financial performance (Consolidated): A snapshot…
(Rs m) 2QFY05 3QFY05 Change 9mFY04 9mFY05 Change
Sales 8,621 9,074 5.3% 18,370 25,493 38.8%
Expenditure 6,493 6,844 5.4% 13,458 19,194 42.6%
Operating profit (EBDIT) 2,128 2,230 4.8% 4,912 6,299 28.2%
Operating profit margin (%) 24.7% 24.6%   26.7% 24.7%  
Other income 240 22 -90.8% 708 571 -19.4%
Interest 2 2 30.1% 8 7 -18.0%
Depreciation 280 282 0.8% 886 833 -5.9%
Profit before tax 2,086 1,967 -5.7% 4,726 6,030 27.6%
Tax 304 289 -4.8% 780 893 14.5%
Extraordinary items (0) (0)   (29) (23)  
Share of loss in associate companies (13) (29)   (127) (59)  
Profit after tax/(loss) 1,769 1,649 -6.8% 3,791 5,055 33.3%
Net profit margin (%) 20.5% 18.2%   20.6% 19.8%  
No. of shares 317.6 317.6   314.5 317.6  
Diluted earnings per share* (Rs) 22.3 20.8   15.9 21.2  
P/E ratio (x)         17.0  
(* annualised)            

Fourth largest software services exporter
Satyam is one of the leading players in the Indian software services space and its offerings include software development and maintenance (54% of revenues), consulting and enterprise business solutions (35%) and engineering solutions (7%). Apart from these services, Satyam also provides BPO services through its subsidiary, Nipuna. Over the past couple of years, the company has managed to move up the software value chain, as is visible from the rapid growth in the high-end service of package implementation. The contribution of this service has increased from 6% of revenues in FY01 to around 30% in 3QFY05.

What has driven performance in 3QFY05?
Billing rates help topline growth:  Marginal growth in both onsite and offshore rates combined with improvement in volumes helped the sequential topline growth for Satyam in this quarter. Of the 5% sequential growth in the topline in 3QFY05, while volumes and billing rates contributed 9% combined, the 4% appreciation of the rupee vis-à-vis the US dollar has pruned the same. On the basis of segments, the software development and maintenance business (2.5% QoQ) contributed the maximum to Satyam's topline in this quarter, followed by the consulting and enterprise business solutions business (1.7% QoQ). Satyam added 28 customers in 3QFY05 (27 in the previous quarter). Its active client base now stands at 372.

Higher utilisation helps margin stability:  Despite a marginal rise in employee costs (as % of sales), Satyam managed to maintain its margins almost at the 2QFY05 levels. This was mainly on account of an increased contribution to revenues from offshore services and improved utilisation (for both onsite and offshore). The improvement in utilisation levels was, then, a consequence of the slow pace of hiring in this quarter, which saw the company add a net of 793 employees (the lowest in past five quarters). It is important to note that Satyam has traditionally been less aggressive than its peers like Infosys and Wipro in this regard. The company now has 17,665 employees on its rolls. In comparison, Infosys had 35,229 and TCS had 43,681 employees on their rolls at the end of 3QFY05.

Lower other income leads to net profit decline:  A sharp reduction (91% QoQ) on the other income front has led to Satyam's net profit decline sequentially in 3QFY05. The reason seems to be on account of appreciation of the rupee vis-à-vis the US dollar, leading to forex related losses for the company.

Performance in the recent past
  4QFY04 1QFY05 2QFY05 3QFY05
Sales (QoQ growth, %) 8.4 7.8 10.5 5.3
Employee costs (% of sales) 55.0 56.4 57.5 58.1
Operating margins (%) 25.7 24.9 24.7 24.6
Profits (QoQ growth, %) 0.6 21.9 8.0 (6.8)
Employees (Nos.) 14,032 15,631 16,872 17,665

What to expect?
At the current price of Rs 360, the stock is trading at a price to earnings multiple of 17.0 times annualised 9mFY05 earnings. The management has slightly revised its guidance upwards for FY05 for the standalone entity (98% of consolidated revenues). While revenues are expected to grow YoY by 34.9%-35.1%, EPS is likely to be in the range of Rs 22.9 to 23.0 per share.

While we are positive about Satyam's forays into the high-end package implementation business, our concerns lie in the fact that the company has consistently under-performed its peers in the past. Also, there have been certain doubtful investment decisions made by the company in the past that do not enthuse confidence. However, considering the fact that the company is restructuring its businesses and is seemingly doing the right things now, valuations look attractive from a long-term perspective.

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