From THE HINDU group of publications
Sunday, July 01, 2001


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Satyam Computer Services: Buy (high risk)

Recommendation: Buy (high risk)

Krishnan Thiagarajan

AT Rs 170, Satyam Computer Services is trading at a price earnings multiple of 15 times its 2000-01 per share earnings of Rs 11.24.

Given the strong financial performance for 2000-01, good client base (especially, given the US slowdown), likely debt-free financial profile after the US American Depository Share offering in May 2001 and aggressive attempts to forge strategic alliances/joint ventures to gain technological and vertical domain expertise.

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At the same time, high client concentration levels, adverse financial position of the company's subsidiaries, particularly Satyam Infoway, and the relatively poor corporate governance record continue to remain the risk factors.

Suitability: With the economy in a slowdown, and most Old Economy stocks out of favour, investors with a high-risk profile, aiming to diversify their portfolio, can consider investing in Satyam Computers at current price levels.

Though the frontline software stocks are being swayed by Nasdaq's fluctuations, Satyam seems to be a good investment candidate for investors with a one-year time horizon or recovery of the US economy, whichever happens earlier.

Investment prospects: As the US slowdown intensifies and the flurry of revenue/profit warnings from major telecom and IT companies spill into the second quarter, it is obvious that chances of a near-term recovery (say, by the third quarter of 2001) are remote.

Most frontline Indian IT companies which initially thought the strong Indian offshore software delivery model would help them recover, have begun to recognise the ground realities, and started to revise downwards their revenue/profit forecast -- Infosys, being the first to set the trend.

Among these frontline companies, Satyam Computers appears relatively better-placed on the valuation and risk-return yardstick than the rest of its peers now.

Strong financial performance: On the financial front, Satyam's performance -- with an 85 per cent rise in revenues to Rs 384 crore, and 164.5 per cent growth in post-tax earnings to Rs 111.34 crore in the fourth quarter ended March 31 -- was better than the first two, and marginally so over the third quarter.

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In the three quarters, Satyam had recorded a revenue growth of 74.8 per cent, 73.8 per cent and 84 per cent respectively, with sustainable post-tax earnings growth of 94.9 per cent, 117.7 per cent and 142 per cent.

For the year ended March 31, 2001, Satyam recorded an 83 per cent growth in revenues to Rs 1,241.67 crore and a 134.43 per cent jump in sustainable post-tax earnings (before extraordinary items) to Rs 316.16 crore.

In the third and fourth quarters, Satyam managed to maintain its operating profit margins at 37.7 per cent and 37.3 per cent vis-a-vis a decline in the first two quarters of 2000-01. The improved OPM indicates that Satyam has obtained better price realisations from its clients.

Improvement in quality of earnings: The

contribution of offshore revenues at 57.65 per cent of the total -- with 42.35 per cent contributed by onsite and offsite business for this year -- continues to inspire confidence. This percentage is marginally higher than some of Satyam's frontline peers.

Second, the proportion of contracts undertaken by Satyam on a fixed price at 20.3 per cent for the nine months ended December 31, 2000 (down from 26.1 per cent for 1999-2000) is fairly high and comparable to some of its frontline peers. Though a higher proportion of fixed price contracts exposes Satyam to additional risks vis-a-vis time and material contracts, the improvement in project management and execution skills makes the company worth the risk.

Finally, the 21.11 per cent contribution of software maintenance and re-engineering to revenues helps maintain predictability in their revenue streams in these uncertain times.

Near debt-free status: The ADS offering completed by Satyam in May will help it attain a near debt-free status, probably, by 2001 first quarter. According to the ADS offer document, Satyam had allocated approximately $26 million (around Rs 120 crore) to repay the existing debt.

Satyam's balance-sheet reveals that out of a total loan portfolio of Rs 171.98 crore for the year ended March 31, rupee-denominated loans amounted to Rs 114 crore. Even before the ADS offering, Satyam started taking steps to reduce its debt burden. In the 2000-01 first quarter, Satyam had realised Rs 170.12 crore, net of transaction and tax through the sale of a 1.5 per cent equity stake in its subsidiary, Satyam Infoway to the Government of Singapore Investment Corporation Pte. Ltd. A part of the proceeds from this sale was used by Satyam to repay its debt burden.

Risk factor: High client concentration According to the ADS offer document, Satyam's biggest client, General Electric, accounted for 15.5 per cent of its total revenues for the nine months ended December 31, 2000 and 14.2 per cent for 1999-2000. During the same period, its second biggest client, State Farm Mutual Automotive Insurance Company, accounted for 8.6 per cent and 11.9 per cent of its total revenues. In addition, the top five clients of Satyam accounted for 39 per cent and 42.4 per cent of its total revenues. The contribution of the top two clients and five clients are significantly higher than what it is for frontline peers. This means higher risks for Satyam. At the same time, vis-a-vis the existing client profile, Satyam is perhaps better placed than any of its peers.

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