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Satyam: Conference call extracts - Views on News from Equitymaster
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Satyam: Conference call extracts
May 24, 2005

Satyam Computers (Satyam) recently announced its FY05 results. We had a conference call with the management in order to get a better understanding about the company’s long-term strategy and what steps it is taking in order to achieve the same. Here are the excerpts of the same.

Conference call excerpts
View on the industry: The management remains positive about the prospects of the Indian software industry. It is of the belief that the pace of IT spending will not slacken noticeably during the year and that the offshoring momentum will continue to drive the performance of Indian software companies over the medium term. In line with what other companies’ managements have indicated to us, Satyam’s management is also of the view that billing rates will remain largely stable throughout FY06, without any major change.

Onsite-offshore mix: Satyam’s revenues predominantly consist of onsite revenues (57.5% of consolidated revenues in FY05). One of the major reasons has been the strong growth in the package implementation business, which has a high proportion of onsite work attached to it. Going forward, the company is looking at consciously improving the ratio in favour of offshore, where margins are higher. In fact, part of this shift was visible during FY05, when, during 1QFY05, offshore revenues were 42% of the total, while in 4QFY05, the same was 43.5%.

Capex plan: The management has indicated that the company plans to spend around US$ 40 m to US$ 50 m (Rs 1.8 bn to Rs 2.2 bn) on capex during FY06. They have not indicated as to how much would be spent on increasing the seat capacity at Nipuna, Satyam’s BPO subsidiary. At present, Nipuna has 2,200 seats (1,367 employees) and has the capability of working in two shifts. The company has estimated that the capital cost of setting up a BPO seat in India ranges between US$ 9,000 to US$ 12,000 (Rs 0.4 m to Rs 0.5 m).

The BPO picture: Nipuna, Satyam’s BPO subsidiary, recorded US$ 10 m in revenues during FY05 and incurred a loss of US $ 8.5 m. For FY06, the management expects the company to rake in revenues of US$ 18 to US$ 20 m and to break-even in the second half of the year. Nipuna’s revenue break-up in terms of voice and non-voice activities is 46:54.

Employee costs: Over the last five years in succession, employee costs have been consistently rising as a percentage of revenues. They have increased from 41.5% of revenues in FY01 to 57.5% in FY05. This is much higher than 49.6% of revenues that Infosys spends towards its employees. The main reasons given by the management have been increments given to its employees without any increase in billing rates over the years and a fall in utilisation rates due to a step up in hiring. The company plans to correct this by increasing the utilisation rate, improving the onsite-offshore mix and hiring a greater number of freshers, which would reduce the average employee cost. This would have a beneficial impact on the margins, which fell by 190 basis points in FY05, to 24.7%. We expect Satyam to earn operating margins of 25.5%, 26% and 26.5% in FY06, FY07 and FY08 respectively. The management has indicated that it plans to hire between 4,500 and 5,000 employees during FY06.

SG&A leverage: Over the years, sales, general and administrative (SG&A) and other expenses have gone down quite dramatically. They have fallen from 39.0% of revenues in FY01 to 17.8% of revenues in FY05. This trend is a complete reversal of the trend seen in employee costs. In fact, this has been the main reason as to why margins actually improved from FY01 to FY04. The company has been able to keep its travel and communication costs low, because of which it has managed to rein in SG&A costs. It has also mined its clients more effectively, causing a reduction in G&A costs.

Citisoft acquisition: Satyam acquired a company called Citisoft, a strategic IT and business consulting firm focussed on the investment management industry, for a consideration consisting of a guaranteed payment of US$ 23.2 m payable over a 3-year period and an additional performance based payment of up to US$ 15.5 m, to be paid over a 3-year period. Citisoft has a revenue run rate of US$ 16 m. This acquisition strengthens Satyam’s position in the banking, financial services and insurance (BFSI) space. Citisoft will complement Satyam’s offerings in that Satyam will come in where Citisoft leaves. Citisoft will do the high-end work such as designing a strategy for its clients and Satyam will then perform the downstream activities such as coding, application development and maintenance.

Future growth drivers: The management believes that the BFSI vertical is showing good growth. The acquisition of Citisoft is expected to boost Satyam’s presence in this vertical. Satyam’s ability to identify, nurture and tap diverse business practices is expected to be a key differentiator in the marketplace. The company plans to not only tap diverse verticals, but also offer newer services in its existing verticals. Better relationship management and client mining are expected to be key growth drivers, going forward. Satyam has about 144 global fortune clients and it will continue making efforts to grab a greater share of the client’s wallet. Europe and Asia-Pacific are seen as the key regions where growth has been faster than the overall growth rate recorded by the company.

Our view
At the current market price of Rs 445, Satyam’s stock trades at a price to earnings multiple of 12.8 times our expected FY07 earnings. We expect the company to grow its revenues and profits at a CAGR of 26.4% and 27.1% respectively during FY05 to FY08. Critical factors like the continuous shift towards offshore and leverage on the costs front are likely to give Satyam some leeway on the profitability front. More importantly, we expect the performance to be less volatile in the future. Considering all the initiatives the management is taking and the improvement in certain operational parameters, we are positive on the stock from a 2-3 year perspective.

Company background
Satyam is India’s fourth-largest software services exporter. The company’s service offerings include software development and maintenance (54% of revenues), consulting and enterprise business solutions (35%), extended engineering solutions (7%) and infrastructure management services (4%). 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 been consistently increasing over the past few years and now constitute a major portion of revenues.

We will update our research report on Satyam shortly.

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