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Satyam: Consistent consistency!
Oct 20, 2005

Introduction to results
Satyam has announced its results for the second quarter and half-year ending September 2005. Topline for 2QFY06 has witnessed a strong sequential growth, driven by an increase in volumes billed. Billing rates, both onsite and offshore, have been stable, marginally skewed towards the positive, as was the case in the previous quarter. Due to savings on costs, particularly salary costs, a strong margin expansion was witnessed. This, aided by higher other income due to forex gains and a lower effective tax rate, resulted in bottomline soaring by as much as 25% QoQ. The performance for the half-year has also been good.

Financial performance (Consolidated): A snapshot…
(Rs m) 1QFY06 2QFY06 Change 1HFY05 1HFY06 Change
Sales 10,587 11,550 9.1% 16,419 22,137 34.8%
Expenditure 8,180 8,786 7.4% 12,351 16,966 37.4%
Operating profit (EBDIT) 2,407 2,764 14.8% 4,069 5,171 27.1%
Operating profit margin (%) 22.7% 23.9%   24.8% 23.4%  
Other income 234 316 34.7% 549 550 0.2%
Interest 5 8 63.7% 4 12 192.9%
Depreciation 313 347 10.8% 551 660 19.9%
Profit before tax 2,324 2,725 17.3% 4,063 5,048 24.3%
Tax 392 333 -15.1% 604 725 20.0%
Extraordinary items (0) (0)   (23) (1)  
Share of loss in associate companies 31 19   30 50  
Minority interest 2 1   - 3  
Profit after tax/(loss) 1,902 2,373 24.8% 3,406 4,275 25.5%
Net profit margin (%) 18.0% 20.5%   20.7% 19.3%  
No. of shares 320.7 330.6   321.3 329.8  
Diluted earnings per share* (Rs) 23.1 28.8   20.7 25.9  
P/E ratio (x)         22.8  
(* 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 (50% of revenues), consulting and enterprise business solutions (39%), 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 2QFY06?
Volumes prove the growth driver again: As was the case in the previous quarter, volume growth has yet again been the major driver of the strong 9.1% sequential growth witnessed this quarter. Overall volumes grew at 7.1% sequentially, while billing rates were up by 0.2% QoQ. This quarter, due to the depreciation of the rupee against the dollar, revenue growth was aided to the extent of 0.7%.

As regards service lines, once again, the start performer for Satyam has been the Consulting and Enterprise Business Solutions (CEBS) space. This business grew by as much as 13.9% sequentially, reflecting the company’s strengths in this high-end business of package implementation. This business accounted for as much as 64.9% of the incremental revenues for Satyam (standalone) this quarter and now contributes to nearly 40% of revenues, the highest ever. Satyam won a significant order in this space from the World Health Organisation (WHO), where it will implement Oracle ERP solutions across 140 countries for the United Nations (UN) body. This shows continued traction in this key business and is expected to continue to be the major growth driver for Satyam going forward. This will aid the company’s steady move up the value chain. In terms of geographies, Europe grew at a double-digit sequential rate of 15.2%, while the US geography also showed strength, growing at 6.5% despite decreasing as a percentage of revenues.

Satyam added 32 new clients during 2QFY06 (31 in 1QFY06). The company’s active client base now stands at 429, compared to 410 at the end of the previous quarter. Satyam’s BPO subsidiary, Nipuna, recorded revenues of Rs 182 m during the quarter, a sequential growth of 25.6%. The company made losses of Rs 106 m. Satyam expects Nipuna to break-even this year. It added two clients during the quarter. Inclusive of Citisoft, Knowledge Dynamics and Nipuna, the total number of active clients stands at 468.

Satyam added as many as 1,977 employees during the quarter (1,341 in 1QFY06), the highest ever in a quarter. This shows good visibility ahead in terms of revenues and pipeline built up. Utilisation rates improved to 74.7% compared to 74.2% in 1QFY06 (including trainees). Nipuna added a net of 61 employees during the quarter. Satyam standalone had 22,482 employees, while Nipuna had 1,673 employees at the end of September 2005. Inclusive of all subsidiaries and joint ventures, Satyam had a net of 24,798 employees as at end-September. This strong hiring is similar to the other top tier IT companies. Infosys and Wipro had also made record hirings in this quarter. TCS also added over 4,200 employees. Thus, this is conclusive proof of the strong visibility that the top-tier software companies have in terms of revenues and has been driven by increasing acceptance of offshoring and better traction in geographies like Europe.

Cost control powers margins: In 1QFY06, Satyam’s margins were adversely impacted due to the salary revisions carried out during the quarter. This quarter, this was factored in and as a percentage of revenues, employee costs reduced from 60.4% last quarter to 58.7% this quarter. This led to a strong 120 basis point expansion in margins.

Higher other income, lower taxes power bottomline: A considerable jump in other income as well as a considerably lower effective tax rate led to the bottomline growth outpacing topline growth and this grew by an impressive 24.8% QoQ. Higher other income was due to a Rs 28 m profit on exchange fluctuations, compared to a loss of Rs 8 m last quarter. The effective tax rate fell from 16.9% in 1QFY06 to just 12.2% this quarter, providing the final kicker to the surge in bottomline.

Performance in the recent past
  3QFY05 4QFY05 1QFY06 2QFY06
Sales (QoQ growth, %) 5.3 7.1 9.0 9.1
Employee costs (% of sales) 58.1 58.1 60.4 58.7
Operating margins (%) 24.6 24.5 22.7 23.9
Profits (QoQ growth, %) (6.8) 25.0 (7.7) 24.8
Employees (Nos.) 17,665 19,164 20,505 22,482

What to expect?
At the current price of Rs 592, Satyam’s stock is trading at a price to earnings multiple of 13.2 times our estimated FY08 earnings. The management has raised its revenue and profit guidance upwards for FY06. This is the second consecutive quarter in which the management has raised its guidance and now expects revenues to grow YoY between 33.5% to 34.0% (compared to 29% to 30% growth in revenues at the end of 1QFY06) and earnings per share (EPS) to be in the range of Rs 29.1 to Rs 29.2, a YoY growth of 30.0% to 30.5% (compared to Rs 27.2 to Rs 27.4 at the end of the previous quarter). This is above our estimates of Rs 28.2 EPS for FY06, which implies a 28% growth over FY05.

Satyam continues to demonstrate improving consistency with every quarter. The performance of the key package implementation business has been highly impressive and this has enthused us. The inconsistency of the past appears to be behind the company and, going forward, the improving performance of its subsidiaries, such as Nipuna is also expected to contribute in a more meaningful manner to the bottomline.

Given recent traction in order wins and business, particularly in the enterprise solutions space, Satyam’s growth prospects look strong. Increasing scalability will help the company to bag a greater number of big deals, going forward. 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 by FY07. 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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