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Patni Computers: Underperformer!

Dec 22, 2004

Patni Computers, the sixth largest software services exporter from the country, has been a poor performer in the past few quarters. Despite being one of the older companies in the sector, Patni has not been able to achieve the high level of growth relative to its large younger peers like Infosys and Wipro. Let us analyse the company’s performance in the latest quarter and see where it is likely headed in the future.

Financial performance (Consolidated): A snapshot
(Rs m) 2QCY04 3QCY04 Change
Sales 3,668 3,767 2.7%
Expenditure 2,779 2,826 1.7%
Operating profit (EBDITA) 889 940 5.8%
Operating profit margin (%) 24.2% 25.0%  
Other income (29) (1)  
Depreciation 118 142 20.4%
Profit before tax 742 797 7.4%
Extraordinary items (6) (11)  
Tax 118 93 -21.4%
Profit after tax/(loss) 618 694 12.2%
Net profit margin (%) 16.9% 18.4%  
No. of shares 124.8 124.8  
Diluted earnings per share* (Rs) 19.8 22.2  
P/E ratio (x)   18.3  
(* annualised)      

What is the company’s business?
Patni Computer Systems (PCS) is a mid-size company 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 GE Group as its largest client with revenue contribution of over 31% to consolidated revenues. Among verticals, PCS has a substantial presence in the financial services, insurance and manufacturing verticals. The share of revenues from these verticals in 3QCY04 was around 77%.

What has driven performance?
Lacklustre across all segments: Sedate growth in key segments like application development & maintenance (ADM; 74% of revenues) and enterprise application systems (14%), has led to the lacklustre growth in Patni’s topline in 3QCY04. Notably, while a host of Indian software companies have witnessed strong growth in their bread and butter business of ADM, growth for Patni has remained slow, which is a concern. Other business segments have also performed poorly in the quarter. The company added a net of 569 employees in the quarter. Though this is on of Patni’s highest additions over the past few quarters, it lags behind what Patni’s peers are doing. Slow addition to the manpower base is a probable indication that the company is not anticipating much business going forward. High attrition rates (20%) also indicate that Patni has been incapable to stem the tide of people moving on to join more reputed Indian and MNC technology companies.

Rising offshore contribution aids margins: While the topline growth has been slow, the company has managed to improve its operating margins by 80 basis points. While increase in offshore contribution (from 62.7% to 64.3%) has aided margin expansion, lower utilisation levels seem to have stemmed the same. Marginal declines in cost of revenues and sales and marketing costs have also helped Patni improve its margins in 3QCY04.

Net profits: Sharp reduction in forex losses has helped Patni post a higher net profit growth in relation to growth in the topline. As a matter of fact, from Rs 85 m in 2QCY04, the company more than halved its forex losses to Rs 41 m in the current quarter. Reduced tax liabilities have also aided profit growth. However, in line with sales growth, profit growth has also underperformed peers in the quarter.

Performance in the recent past…
  4QCY03 1QCY04 2QCY04 3QCY04
Sales growth (%, QoQ) 4.2 (2.7) 17.3 2.7
Operating margins (%) 25.4 24.6 24.2 25.0
Profits growth (%, QoQ) 21.5 (11.1) 10.4 12.2

What to expect?
At the current price of Rs 406, the stock is trading at a price to earnings multiple of 18.3 times annualised 3QCY04 EPS. While this is lower than what Patni’s peers are trading at currently, investors should take note that there are a couple of factors playing their part in keeping valuations low for the company. One, the company has been a laggard when it comes to performance parameters (see the table above). And two, the stock, we believe, suffers on account of ‘identity crisis’. This is because investors, in recent times, have concentrated their focus (and money) on large integrated players that have scalable business models and proven execution capabilities. If Patni has to have valuations near or at par its large peers, the management needs to get its act together and strive to take the company towards a higher growth path.


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