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Satyam: Best of the lot - Views on News from Equitymaster
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Satyam: Best of the lot
Jul 20, 2007

Performance summary
  • Topline grows by 3% QoQ on back of 9.5% volume growth and improvement in billing rates.
  • Onsite and offshore billing rates increase 1.3% and 1.5% sequentially.
  • Operating margins contract by 0.6% QoQ due to rupee appreciation.
  • Bottomline declines 4% QoQ largely due to higher taxes and lower other income.
  • FY08 revenues seen at just under US$ 2 bn.
  • Management’s EPS guidance for FY08 downgraded from Rs 25.7 to Rs 24.6.

Consolidated financial performance
(Rs m) 4QFY07 1QFY08 Change
Sales 17,791 18,302 2.9%
Expenditure 13,689 14,199 3.7%
Operating profit (EBDIT) 4,102 4,103 0.0%
Operating profit margin (%) 23.1% 22.4%  
Other income 704 632 -10.2%
Interest 74 33 -55.1%
Depreciation 354 387 9.3%
Profit before tax 4,378 4,315 -1.4%
Tax 442 532 20.3%
Profit after tax/(loss) 3,936 3,783 -3.9%
Net profit margin (%) 22.1% 20.7%  
No. of shares (m) 675.2 684.7  
Diluted earnings per share (Rs)*   20.87  
P/E ratio (x)*   23.00  
* On a trailing 12-months basis

What is the company business?
Satyam is India’s fourth-largest software services exporter. The company’s service offerings include application development and maintenance (47% of revenues), consulting and enterprise business solutions (41%), extended engineering solutions (7%) and infrastructure management services (5%). Satyam also provides BPO services through its subsidiary, Nipuna, which had revenues of US$ 38 m in FY07.

What has driven performance in 1QFY08?
Volume and billing rates drives topline: Satyam recorded a topline growth of 3% QoQ (10% QoQ in dollar terms) in 1QFY08. This was largely driven by 9.5% QoQ growth in volumes, 1.3% QoQ growth in onsite billing rates and 1.5% QoQ growth in offshore billing rates. The growth in topline has by far been best amongst its peers. During the quarter, Nipuna, Satyam’s BPO subsidiary, clocked revenues of US$ 12 m and incurred a loss of US$ 2m.

In terms of service offerings, there has been a clear move to high-end services like consulting, extended engineering solutions and infrastructure management services (IMS). In fact, IMS recorded a growth of 27% QoQ in 1QFY08, while consulting and extended engineering solutions recorded a growth of 7% and 6% respectively. Revenues from application development and maintenance declined by 3% QoQ during the quarter.

In terms of business verticals, apart from a small decline in BFSI and manufacturing, there has been good growth in other verticals. Retail and logistics stole the show by recording 11% QoQ growth. While the TIMES and healthcare division recorded QoQ growth of 4% and 3% respectively.

The growth across geographies has more or less been stable with the US, Europe and ROW (rest of world) recording growth of 1%, 4% and 6% respectively. In terms of client acquisition, Satyam added 29 new clients during the quarter and the total number of active clients now stands at 570 (including subsidiaries). The number of clients with annual billing in excess of US$ 10 m and US$ 5 m has gone up by 1 and 8 respectively. As regards employee data, Satyam added a net of 2,795 employees and the total headcount now has crossed 42,000 mark. More importantly the attrition rate have declined to 14.9% (15.7% in 4QFY07) indicating better human resource policies being adopted.

Performance in recent past 3QFY06 4QFY06 1QFY07 2QFY07 3QFY07 4QFY07 1QFY08
Sales (QoQ growth, %) 9.6 3.8 9.8 11.0 3.7 7.1 2.9
Employee costs (% of sales) 58.3 57.1 57.6 61.3 58.2 63.3 62.2
Operating margins (%) 24.9 25.5 24.6 22.6 24.7 23.1 22.4
Profits (QoQ growth, %) 13.7 5.5 24.4 (9.7) 5.4 16.7 (3.9)
Employees (Nos, incl. subsidiaries) 23,432 28,624 29,843 34,908 38,188 39,552 42,347

Rupee appreciation dents margins: The operating margins contracted by 0.6% (60 basis points) largely due to rupee appreciation. The company managed to increase the offshore utilisation rates by 1.5% and reduction in the onsite share (1.5% QoQ) also helped the company to maintain its margins. This small drop in operating margins is also due to the fact that Satyam gives its annual salary hike in second quarter of the financial year. So in the next quarter, the impact of salary hikes (5% hike for onsite and 15% hike for offshore) would be seen on the company’s operating margins (estimated impact on EBITDA margins is 3.5%). The company also expects the EBITDA margins to decline by 1.25% YoY in FY08.

Higher taxes, lower other income impacts bottomline: Satyam recorded a 4% QoQ decline in bottomline largely due higher taxes and lower other income. The effective tax rates went up from 10.1% in 4QFY07 to 12.3% in 1QFY08. Secondly, the company booked a lower other income than its peers despite it following the old methodology of marking to market its forward exchange contracts. This is a negative surprise as its peers Infosys and TCS have booked a 100% QoQ growth in other income by following the same method. The other income is possibly lower because Satyam currently hedges only 50% of its portfolio while peers are now covering an entire year of their receivables mainly to keep pace with the appreciating rupee.The company currently has hedge position of US$ 750 m as on 30th June 2007.

What to expect?
At the current price of Rs 480, the stock is trading at 14.0 times our estimated FY10 earnings. While the company has under performed its rupee guidance owing to the sharp appreciation in rupee against the US dollar, the positive that has come out of this quarter’s performance has been that the company continues to ramp up its presence in the high-end services. Secondly, Satyam has recently won 4 major deals in Singapore, Australia and UAE. We had recently recommended a ‘Hold’ on Satyam. At this juncture, despite the weak performance in 1QFY08, we maintain our positive view on the stock from a long-term perspective.

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