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Patni Computers: Improved performance

Nov 29, 2005

Introduction to results
Patni Computer Systems (PCS) recently announced its results for the third quarter of CY05 (the company's financial year ends in December). During 3QCY05, topline has grown at a good pace, mainly led by volume growth, while billing rates improved marginally. Due to a lower-than-proportionate rise in expenses, margins witnessed an expansion. Coupled with considerably higher other income and lower depreciation charges, net profits saw a strong double-digit sequential growth.

Consolidated Financial Performance (US GAAP): A snapshot
(Rs m) 2QCY05 3QCY05 Change
Sales 4,730 5,197 9.9%
Expenditure 3,900 4,262 9.3%
Operating profit (EBDITA) 830 935 12.7%
Operating profit margin (%) 17.5% 18.0%  
Other income 54 92 71.0%
Depreciation 160 176 9.8%
Profit before tax 724 851 17.7%
Extraordinary items - -  
Tax 102 138 35.0%
Profit after tax/(loss) 621 714 14.8%
Net profit margin (%) 13.1% 13.7%  
No. of shares (m) 125.0 126.7  
Diluted earnings per share* (Rs) 19.9 22.5  
P/E ratio (x)   20.0  
(* annualised)      

What is the company's business?
PCS is India's sixth-largest software services exporter, engaged in providing software solutions and services, domestically and internationally. The company's sphere of offerings includes application development and integration, application maintenance, enterprise application systems, R&D services and business process outsourcing services. PCS has the GE Group as its largest client, with a revenue contribution of 23.5% to consolidated revenues in 3QCY05. Among verticals, PCS has a substantial presence in the financial services, insurance, telecom and manufacturing verticals. The share of revenues from these verticals in 3QCY05 was over 82%.

What has driven performance in 3QCY05?
Strong volumes drive the topline: In 3QCY05, Patni witnessed a strong volume-led topline growth. Billing rates also witnessed an increase for both offshore as well as onsite rates. Net revenues grew at almost 10% sequentially, thus, continuing the trend witnessed by the top-tier software companies this quarter. This confirms the strong demand environment for offshoring and is a clear confirmation that offshoring as a concept is gaining increased acceptance from global corporations. Patni was one of the companies that had won part of the US$ 2.2 bn ABN Amro outsourcing deal, along with Infosys, TCS, IBM and Accenture, although the company has not disclosed the size of the order that was won by it. This was, undoubtedly, one of the highlights of the quarter for the company. The management had guided for a 5% to 6% sequential growth. The topline growth has, thus, exceeded the management's expectations. There was an increased offshore content this quarter (65.0%, compared to 63.8% in 2QCY05) and this is a positive for margins, as they are higher for offshore services.

Client metrics improved for PCS. The company added 18 new clients during the quarter, with the total number of US$ 1 m clients increasing from 50 in 2QCY05 to 60 at the end of this quarter. However, the total number of active clients for PCS remained static at 191, the same as at the end of 2QCY05. As regards GE, its largest customer, revenues constituted 23.5% of total revenues this quarter and grew by 11.5% sequentially. Over the past few quarters, the contribution from GE has declined and this trend is expected to continue, going forward, as other engagements grow in size and the de-risking of revenues takes place.

Lower expenses result in margin expansion: During 3QCY05, due to a lower-than-proportionate rise in operating expenditure, PCS witnessed a 50 basis points margin expansion. Lower SG&A expenses as a percentage of revenues helped the company keep its costs under control, resulting in a good performance on the margins front. This SG&A leverage was the case in the previous quarter as well and this quarter, SG&A expenses as a percentage of revenues reduced from 19.0% in 2QCY05 to 18.6%.

Other income, lower depreciation power the bottomline: Higher other income, due partly to a forex gain recorded this quarter as against a loss in 2QCY05, helped prop up the bottomline, which grew by nearly 15% sequentially, considerably higher than the topline growth. This profit was helped by the depreciation of the rupee against the dollar. Lower depreciation charges also played their part in pushing up the bottomline. This performance was despite considerably higher taxes paid, partly due to prior period taxes.

Performance in the recent past…
  4QCY04 1QCY05 2QCY05 3QCY05
Sales growth (%, QoQ) 6.5 8.1 9.1 9.9
EBIDTA margins 23.0% 22.5% 17.5% 18.0%
Profits growth (%, QoQ) 4.4 5.8 8.9 14.8

What to expect?
At the current market price of Rs 451, the stock is trading at a price to earnings multiple of 20.0 times annualised 3QCY05 earnings. The stock has seen good action on the bourses of late and this performance seems to justify the run-up in the stock price. Of course, at these valuations, the stock still trades at a fair discount to its top rung peers like <>Satyam and <>HCL Technologies and a big discount to the big three software companies - Infosys, TCS and Wipro.

PCS continues to earn a large proportion of its revenues from the US. This was around 84.3% during 3QCY05, which is considerably higher than the extent to which peers like Infosys and Satyam depend on the US markets. As such, the company faces considerable risk to its business and profitability if any adverse development affects the US markets. Although this percentage has reduced over the past few quarters, it is still very high when compared to its peers.

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