Kotak – Buy Satyam Computers

  • Weakness in the US BFSI vertical spreading to other sectors and geographies.
  • Decision-making cycle getting longer. Only selective projects with quick pay-back, being pursued by clients.
  • Some parts of Enterprise Business Solutions and consulting business (~45% of revenues) expected to be further impacted.
  • Average realizations stable, as yet. No major client specific impact, post 2QFY09. Company continues to witness large deals.
  • No change in 2HFY09 guidance in constant currency terms as yet. Cross currency variations may impact US GAAP results.We make marginal changes to our FY09E earnings at Rs.33.7 per share.
  • Stock discounts potential slowdown in earnings, now captured in our DCF analysis.
  • Valuations attractive at 6.7x FY09E PE and 1.6x FY09E BV (RoE of ~27%). Net cash expected to be at Rs.87 per share in FY09E.
  • Stock has corrected significantly in past few sessions. Maintain BUY with a revised price target of Rs.373, albeit with a cautious stance on the sector in the near term.
  • A prolonged recession in major user economies and a sharper-than-expected appreciation in rupee v/s major currencies are the key risks to our call.

We spoke to the company officials to get an update on the latest macro developments and some company-specific issues. The following are the key takeaways :

Macro scenario challenging

  • Satyam maintained that, the macro scenario has remained challenging with the crisis in the US BFSI sector spreading globally and to other verticals.
  • While the spending decisions are getting delayed, the budgeting exercise for CY09 will probably be finalized by 1QCY09 itself.
  • The manufacturing sector has started seeing some impact in terms of delayed decision making. The TIMES (Telecom, Media) vertical is also seeing an impact with clients postponing projects.
  • Clients are going ahead with only those projects which promise immediate returns / benefits with the balance projects being postponed.

Existing revenues and Growth

  • As far as existing revenues are concerned, there are more concerns about the sustainability of these revenues because of the significantly fluid situation globally.
  • However, there have been no major client-specific developments post 2QFY09. In fact, some of the large accounts have scaled up during 3QFY09 and are expected to contribute in 4QFY09 also.
  • Revenues from "impacted" clients like Merrill Lynch have remained steady. The company has also started receiving additional projects from clients like Barclays, negating the impact of Lehman’s revenues.
  • We believe that, in the near-to-medium term, client specific issues may gain prominence and may lead to differentiated growth rates for Indian IT services vendors over this period.
  • In terms of growth (new revenues), the outlook remains unclear because of the

volatile economic situation. Billing rates, stable as yet but may be impacted in 2HFY09

  • We believe that, the smaller competitors have started under-cutting on prices with a view to secure volumes.
  • This is expected to aggravate and may put pressure on Satyam’s realizations in the future.
  • While on an overall basis, Satyam’s average realisations are expected to be stable in 2HFY09 the company has already started seeing some impact in segments of the BFS sector.
  • This may lead to lower realisations in some sub-segments in 4QFY09.

Enterprise Business Solutions (EBS) and Consulting

  • Satyam has a significant share of revenues (~45% in 2QFY09) coming from the Enterprise Business Solutions and Consulting business.
  • SAP has indicated a moderation in the license sales, recently and this is expected to have a rub-off impact on service providers like Satyam.
  • We expect Satyam’s revenues to be impacted by the slowdown over the next couple of quarters. The impact is expected to be on the implementation revenues as clients defer these initiatives.
  • However, the impact may be moderated by the growth in the annuity and maintenance services. Also, the company’s focus on Asia Pacific markets is expected to cushion the fall as this geography has been relatively less impacted.
  • The Business Intelligence and Data-warehousing revenues have not seen any major impact and should help set-off some impact in the EBS and Consulting business.

Employee addition target holds

  • The company had scaled down the guidance for gross employee additions for the fiscal from 14000 – 15000 to about 8000 – 10000.
  • The company has maintained this target of gross additions. However, it will be flexible on this front depending on the evolving macro situation. Assuming normal attrition, we expect minimum employee addition in 2HFY09.
  • Satyam has indicated that, it will look at increasing the utilization factor to 79% as against the existing 76%.
  • While this is attributed to the margin protection initiatives of the company, we believe that, this is also likely indicative of the demand visibility for the company.
  • We will closely watch this matrix in the future quarters.

Hedging position maintained

  • Satyam has maintained its hedging position at about 2 quarters’ net receivables (after deducting for expenses, capex, etc).
  • Thus, the total hedges are at about $650mn ($615mn as at 2QFY09 end).
  • Satyam had additional debt of Rs.2.35bn during 2QFY09. The management had attributed this to the promissory note which it has issued for the acquisition of Caterpillar’s Market Research and Customer Analytics (MR&CA) operations.
  • We expect this to be repaid in the current quarter.
  • We have made marginal changes to our earnings estimates.
  • We expect revenues in FY09 to rise by 32% (33% earlier). EBIDTA margins are expected to be higher due to the rupee depreciation and other cost control initiatives.
  • Consequently, PAT is expected to rise by 34% to Rs.22.6bn, leading to an EPS of Rs.33.7.

Valuations

  • We have adopted the DCF method of valuation to account for the potential impact arising from the challenging macro environment.
  • After incorporating lower growth in the foreseeable future, we arrive at a fair value of Rs.373 for Satyam. At this price, our FY09E earnings will be discounted 11x.
  • Current valuations are attractive at 6.7x FY09 PE. The stock is available at 1.6x FY09 BV with a RoE of ~27%.
  • The company is expected to have net cash of Rs.58.5bn as at FY09 end, translating into Rs.87 per share.
  • We maintain BUY on Satyam.

Concerns

  • A prolonged recession in major user economies may impact our projections.
  • Appreciation of the rupee v/s the USD above our assumed levels will impact our projected financials negatively.

Kotak Securities :- We recommend BUY on Satyam Computer Systems with a price target of Rs.373

, , ,