Stock Review: Mahindra Satyam

 

 

Satyam looks well poised for growth with the new leadership in place. Investors having a 2-yr horizon may accumulate the stock at every dip

 

   FOLLOWING the restatement of its results for the past two years, Mahindra Satyam is back on track under the new management. The erstwhile Satyam Computer Services had to suspend accounts in January 2008 after its previous owner confessed to a financial fraud. After the clean-up of its financial reports, Satyam looks well poised for growth with the new leadership team in place. The company has started winning new projects across various IT services domains in the multi-year category, which reflects that it is successful in winning back clients' confidence. Going ahead, the new management is expected to merge its operations with Tech Mahindra, which offers solutions to telecom vertical. This would help in creating a stronger IT solutions company with global footprint across major verticals. Satyam's stock has gradually fallen by nearly 20% since the restatement of its accounts in late September. Investors having a two-year horizon may accumulate the stock at every dip given its future potential.

FINANCIALS:

The balance sheet size of Mahindra Satyam has shrunk by one-fifth to 5,927 crore as on March 31, 2010 from the reported numbers in FY08. In that, fixed assets have been revalued down to 986.5 crore from 1,279 crore in FY08. The declaration eliminates uncertainty over the assets of Satyam and also over the claims to those assets, if any, from banks and other lending agencies.

   Another factor that offers relief is the presence of current assets on Satyam's books. The company has reported cash and bank balance of 2,176.8 crore and investments of 626.8 crore. The new management has also brought down the proportion of sundry debtors, or outstanding revenue that is yet to be collected, to 23% of the total current assets from 31% previously. This would reduce the working capital requirement and improve operating cash flows. Further, prior period accounting errors of 6,242.8 crore are written off. This should lead to cleaner financial statements in the subsequent quarters. After taking into account the exceptional items worth 416.9 crore, the net loss came out to be 124.6 crore for FY10. These items include expenses related to forensic investigations and restructuring and erosion in assets. Given their one-time nature, the losses appear to be a temporary phenomenon. The new management has also streamlined Satyam's operations. The company's operating and administrative costs more than halved to 1,043 crore in FY10.

GROWTH PROSPECTS:

Satyam's current operations are generating cash flows. The company has over 350 active clients and 27,400 employees. Though these numbers are much lower than 617 clients and 46,000 employees reported by the previous management, they reflect that the company is still able to retain a major chunk of its operations despite the accounting fiasco. The new management has reiterated that business is growing across verticals in major geographies, including the US, Europe and emerging markets. It added 44 clients in the March 2010 quarter. This is higher than the quarterly client additions of 30-40 for the top tier IT players. Of late, the company has seen higher additions in the banking and finance vertical.

   In the long-term, the new promoters are likely to combine operations of Satyam with Tech Mahindra. The latter is a single vertical IT solutions provider with a focus on the telecom vertical. It grossed 4,625 crore in revenue during FY10. Together with Satyam, the combined entity would be 10,000 crore-strong IT player with capabilities in all the major verticals. Moreover, Tech Mahindra operates at a healthy margin of over 24%. This is likely to boost the margin of the combined entity as well.

   Satyam had faced pricing pressure in the past due to the exodus of clients during the past six quarters. With stability setting in gradually, the billing rates are likely to be aligned with the broader market trend. This should provide some support to its profitability.

VALUATIONS:

Satyam closed FY10 with an operating margin of 8.3%, much higher than the Street's anticipation of 4-5% margin. This is expected to further go up to 10-12% in the next foursix quarters. Considering this and a conservative sales growth estimate of 10-12%, Satyam's stock trades at FY12 estimated P/E of around 12 at a price level of 81. Investors, who can stay invested for at least twothree years, may find it lucrative to buy Satyam's scrip at the current levels and at dips in future. The company looks on a firm ground with sound management and operations. The global demand for global IT is reviving fast and this may also help speed up full recovery in Satyam's operations.