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Satyam: Top up, bottom down! - Views on News from Equitymaster
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Satyam: Top up, bottom down!
Jul 21, 2005

Introduction to results
Satyam has announced results for the first quarter ending June 2005. Topline for 1QFY06 has witnessed a strong sequential growth, driven by an increase in volumes billed. Billing rates, particularly for the offshore services, have been stable, marginally skewed towards the positive. However, the salary revisions have adversely impacted margins, which were lower compared to the previous quarter. The lower margins, along with a reduction in other income, with a considerably higher tax burden led to a sequential decline in the bottomline.

Financial performance (Consolidated): A snapshot…
(Rs m) 4QFY05 1QFY06 Change
Sales 9,715 10,587 9.0%
Expenditure 7,332 8,180 11.6%
Operating profit (EBDIT) 2,383 2,407 1.0%
Operating profit margin (%) 24.5% 22.7%  
Other income 298 234 -21.4%
Interest 2 5 95.2%
Depreciation 300 313 4.4%
Profit before tax 2,378 2,324 -2.3%
Tax 283 392 38.7%
Extraordinary items 2 (0)  
Share of loss in associate companies (35) (31)  
Minority interest - 2  
Profit after tax/(loss) 2,062 1,902 -7.7%
Net profit margin (%) 21.2% 18.0%  
No. of shares 319.3 320.7  
Diluted earnings per share* (Rs) 25.7 23.7  
P/E ratio (x)   21.5  
(* 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 (51% of revenues), consulting and enterprise business solutions (38%), extended engineering solutions and infrastructure management 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 been consistently increasing over the past few years and now constitute a major portion of revenues. During the period FY01 to FY05, Satyam has grown its revenues and profits at compounded rates of 26% and 28% respectively.

What has driven performance in 1QFY06?
Volume-driven topline growth: The major driver for the strong 9% QoQ increase in revenues has been an increase in volumes billed. In particular, the company’s consulting and enterprise business solutions horizontal has shown strong traction. The billing rates for the quarter remained flat with a slight positive bias. Offshore rates, particularly domestic rates, witnessed a 1% rise during the quarter. Given that the rupee appreciated in the region of 4% to 6% against the Euro and the Pound during the quarter, this would have negatively impacted revenues to some extent.

On the basis of horizontals, consulting and enterprise business solutions contributed to as much as 56% of the increase in sequential revenues this quarter. It grew by as much as 14% sequentially. This business has been the main growth driver for Satyam over the past few years and going forward, this is expected to continue to aid the company’s move up the value chain. Satyam added 31 new clients during 1QFY06 (28 in 4QFY05), including 4 global 500 corporations. The company’s active client base now stands at 410, compared to 390 at the end of the previous quarter. Satyam’s BPO subsidiary, Nipuna, recorded revenues of Rs 144.9 m during the quarter, with losses of Rs 109.2 m. Satyam expects Nipuna to break-even this year.

Satyam has entered into a definitive agreement to acquire a company called Knowledge Dynamics Pte. Ltd., a Singapore-based company, specializing in the provision of Data Warehousing and Business Intelligence (DW & BI) solutions, with a focus on the government, financial services and telecom verticals. This acquisition is expected to enable Satyam to increase its presence in the high-end consulting services space in the DW & BI sector and offer vertical-specific solutions in a shorter time frame. The consideration for this all-cash deal is US$ 3.19 m, with US$ 1.74 m being the initial payment and the balance payable over a period of two years. Also, US$ 2.15 m would be paid out as earn out payments, based on the achievement of certain revenue and profit targets over the next three years.

Higher employee costs impact margins: The salary revisions carried out by Satyam during 1QFY06, like for a few of the other software companies, have adversely impacted margins. Margins were lower by 180 basis points during the quarter, compared to 4QFY05. This was entirely due to the increase in salary costs. As a percentage of revenues, these increased to 60.4% in 1QFY06 compared to 58.1% in the previous quarter. Margins would have been impacted even more severely had it not been for lower operating and administration costs, which reduced to 16.9% of revenues from 17.4% during 4QFY05. Satyam increased headcount by 1,341 during the quarter (1,499 in 4QFY05). The relatively slower pace of hiring during the quarter led to an increase in utilisation levels, which were at 74.2% compared to 73.7% in the previous quarter (including trainees). At the end of 1QFY06, Satyam had 20,505 employees on its rolls and 1,612 employees were a part of Nipuna. In comparison, Infosys had 39,806 and TCS had 48,404 employees on their rolls at the end of 1QFY06.

Lower other income, higher taxes lead to lower bottomline: A fall in the company’s other income, coupled with a higher tax rate has led to a sequential fall in bottomline during 1QFY06. Other income was affected by a Rs 48.2 m loss on foreign currency fluctuations. The company’s tax rate increased considerably, to 16.9% during 1QFY06, compared to 11.9% in 4QFY05. As a result, due to a combination of lower margins and the above reasons, bottomline has fallen sequentially by 8%.

Performance in the recent past
2QFY05 3QFY05 4QFY05 1QFY06
Sales (QoQ growth, %) 10.5 5.3 7.1 9.0
Employee costs (% of sales) 57.5 58.1 58.1 60.4
Operating margins (%) 24.7 24.6 24.5 22.7
Profits (QoQ growth, %) 8.0 (6.8) 25.0 -7.7
Employees (Nos.) 16,872 17,665 19,164 20,505

What to expect?
At the current price of Rs 510, Satyam’s stock is trading at a price to earnings multiple of 14.2 times our expected FY07 earnings. The management has raised its revenue and profit guidance upwards for FY06. The expectations are for a 29% to 30% growth in revenues and earnings per share (EPS) is expected to be in the range of Rs 27.2 and Rs 27.4. We, however, estimate a higher EPS for FY06, at Rs 28.2, which implies a 28% growth over FY05.

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. However, the company does appear to have started to show some sort of consistency in its performance over the past few quarters. Given recent traction in order wins and business, particularly in the enterprise solutions space, growth prospects look strong. The management expects margins to improve over the next few quarters, as the impact of the salary revisions has been factored in.

We had recommended a ‘Buy’ on the stock in May 2005 at Rs 457, with a target price of Rs 640 in the long-term. Given recent initiatives taken by the company to grow its business and recent traction witnessed with good order wins, we remain positive on the company. As such, we maintain our recommendation on the stock.

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