Satyam: Blemished pioneers - Views on News from Equitymaster

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Satyam: Blemished pioneers

Sep 15, 2001

In January 1992, when Satyam computers wanted to put up a 64 kbps data link it had to convince all and sundry in the government that it was not working against the country’s security and was not leaking any of the countries secret. This is what the company that pioneered ‘offshore’ development to go through. Today as the software industry, as it faces one of the most challenging times ever, has fallen back on the offshore advantage to give it an edge above global competition. It is these pioneering efforts that led to the 146-fold increase in revenues of the company between 1992 and 2000. Satyam with revenues of Rs 12 bn was India’s fourth largest software exporter in FY01 and is the fifth largest software firm in the country. In the past four years Satyam has grown at a breezy CAGR (compounded annual growth rate) of 61.7%. What differentiates Satyam from others is that it one of the very few companies that has the capabilities to provide ‘end to end’ IT solutions in the Indian software sector. The company’s major service offerings are in the area of client server and open systems (29% of revenues in FY01), maintenance and re-engineering (21%), Internet and e-commerce (26%), open systems and telecommunications (9%), ERP (enterprise resource planning) implementation (9%) and engineering services (6%).

Another thing that sets the company apart from others is its agility. The company has been very quick to change its business mix in the past and in the present. The US economy slowdown forces corporates to cut back on their IT budgets, especially the e-commerce projects. When it saw a decline in revenues from the e-commerce area it has very rapidly taken on additional work in the area of application development and maintenance. Due to this move the company managed to post sequential growth for the last two quarters (1QFY02 and 4QFY01), while many other software companies have not managed this feat.

Fleet footed
(Rs m) 3QFY01 4QFY01 Change 1QFY02 Change
Client server and open systems 1,108 1,221 10.2% 1,302 6.6%
% of total revenues 33.8% 31.6%   31.6%  
Maintenance and re-engineering 605 896 48.0% 1,226 36.9%
% of total revenues 18.5% 23.2%   29.8%  
Internet and e-commerce 1,007 870 -13.6% 811 -6.7%
% of total revenues 30.7% 22.5%   19.7%  
Open systems and telecommunications - 326 - 292 -10.6%
% of total revenues NA 8.4%   7.1%  
ERP (enterprise resource planning)
implementation
223 309 38.8% 292 -5.7%
% of total revenues 6.8% 8%   7.1%  
Engineering services - 270 - 179 -33.7%
% of total revenues NA 6.9%   4.3%  

Satyam has always had a strong focus on the manufacturing sector. In December 1998 it had established a joint venture with GE. In FY99 the company had revenues of Rs 113 m (3% of total revenues) from engineering services. The figure has grown to Rs 784 m in FY01 (6.4% of total revenues). This translates to a CAGR of 163% for the last two years.

Satyam’s offerings in the engineering services include CAD/CAM/CAE solutions. The company has also ventured into promising areas like PDM (product data management) and collaborative commerce. The services include product design, legacy conversion, modeling, drafting, assembly and fabrication drawings and Bill of Material (BOM) generation. The company provides services using CAE applications including Ansys, Nastran, HyperWorks, Elfini, IDEAS-Simulation, Pro/Mechanica, and Moldflow.

The need to work closely with suppliers and customers has given rise to a demand for software that will help commerce or business to be done in a more synchronized or collaborated way. Collaborative product commerce will result in increased efficiency and lower costs for the organisations. Companies are adopting collaborative commerce due to the fact that they work across geographical boundaries. Hence, the need for seamless information flow has become mission critical.

To cash in on this opportunity, Satyam recently announced an enterprise consulting partnership agreement with Parametric Technologies (PTC’s). Satyam will implement PTC’s Windchill software solutions. Windchill solutions span the entire product development cycle, allowing collaboration from design to in-house or contract manufacturing, to service and support. The concept of collaboration product commerce gives rise to another set of interesting opportunities. There is a very vital need for the engineering and manufacturing departments to communicate. Engineering changes get delayed adding time and expense. Therefore, the lack of solutions, which will help the manufacturing departments to view and manipulate drawings on computers, does tend to be a major source of inconvenience.

The company is undoubtedly one of the best in the software sector. However, at a current market price of Rs 135 the stock is trading at a P/E multiple of 8x FY02 estimated earnings. Compared to others in the software sector like Infy this is at a significant discount (at Rs 2,875 the stock is trading P/E multiple of 24x).

The majors concerns about the company are the profitability of its subsidiaries. According to Satyam the two major subsidiaries VisionCompass and Satyam Infoway are expected to break even by the end of this Fiscal 02. Jointly these two subsidiaries contributed significantly to the company’s loss on account of subsidiaries. If this happens then the company’s valuation might improve.

The U turn
(Rs m) FY00 FY01 4QFY01 1QFY02
Net profit as per Indian GAAP 1,393 4,952 1,111 1,204
Deferred stock compensation charges -765 -2,056 -246 -136
Amortization of goodwill -110 -209 -51 -51
Losses of subsidiaries & joint ventures -857 -2,095 -654 -545
Gain from sale of Infoway
stake under Indian GAAP
- -1,743 - -
Other accounting differences 17 -147 -92 -71
Total US GAAP Adjustments -1,715 -6,250 -1,043 -803
Net Income as per US GAAP -323 -1,298 68 400

Another reason for the subsidy in valuation is the company’s management. The management credibility was clouded with the Indiaworld deal in 1999 which the company’s subsidiary, Satyam Infoway, acquired for Rs 5 bn. Not stopping here the company went on to buy another portal cricinfo.com for Rs 1.7 bn in June 2000. For FY01, Satyam Infoway has already written off Rs 1 bn in Indiaworld and Rs 200 m in cricinfo for diminution in investments. Only the management has the insight to understand the valuations that were paid for these stocks.

This is a very good example for retail investors. The company is one of the best in the software sector and has a very strong future. If the subsidiaries break even the company’s valuations may see a significant upside. However, unless the management comes clean with its act, it is always likely to trade at a discount compared to its peers like Infosys.

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