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Satyam: Shedding sins of the past?

Jun 8, 2004

The past three years have been the most uncertain for the software industry in the country. While global technology spending slowed down in the first two years leading to a slower growth for Indian software companies, now the sustainability of improvement in spending is under question. However, despite all the pressures, Indian software majors like Infosys and Satyam have managed to outperform the Sensex by a huge margin. In this article, we take a look at Satyam's performance over these years and see where the company is headed going forward.

Over the past few years, Satyam has reaped the benefits of moving up the software value chain. And this the company has done through consistently increasing revenue contribution form the package implementation business. Revenues from this segment increased from 6% in FY01 to 26% in FY04. Going forward, if the company manages to increase this contribution further, not only will it be able to garner higher billing rates but it will also give Satyam an opportunity to work far more closely with the top management of client companies, as a high-end job like package implementation has a high onsite component, at least to start with.

This rise in revenues from high-end services has also helped Satyam in easing some pressure on the billing rates front. Onsite and offshore rates for the company, which had fallen by drastic 6.6% and 5.5% respectively in FY03 (over FY02), witnessed lower declines of 1.9% and 1% in FY04. Satyam has also been able to improve its volume growth levels. While these had grown by 23% YoY in FY03, the growth in FY04 was larger at 34%. While the company has not clearly stated in its annual results as to which segment contributed to the largest chunk of this volume growth, we believe that the package implementation business, due to its fastest rise among all other business segment might have effected this growth in a big way.

Now, despite all factors that have contributed to the growth of Satyam in the past, there are others that have restricted this growth. One such factor has been certain decisions taken by the Satyam's management that have not inspired investor confidence. In the past, Satyam made certain failed investments like Sify, VisionCompass Inc., IndiaWorld Communications (Pvt.) Ltd. and Cricinfo Ltd. that have cost the company heavily. While the company has not announced any major investment in the recent past (FY04), we believe that investors need to view future investments with caution due to the track record of the management.

At the current price of Rs 311, the stock trades at a P/E multiple of 17.6x FY04 earnings and 11.9x our expected FY06 earnings. Satyam has consistently traded at a discount to its peers. The most important reason for this seems to be investors' lack of confidence on the management's ability to steer the company towards higher growth going forward in the wake of increasing competition from domestic and MNC companies. The company's questionable investment decisions of the past also hang like the sword of Damocles on the perception about the management's ability to forecast trends. However, we believe that if the company continues to focus towards organically building up its businesses and consistently moves up the software value chain as it has done in the last 2-3 years, valuations will follow!

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