The Hindu Business Line : Satyam Computers: Buy on weakness

We are comfortable recommending the stock in the Rs 450 range, as this entry point has the potential for offering good scope for capital appreciation for investors with a one-year horizon.

Shareholders can remain invested and consider stepping up exposure on declines. On a consolidated basis, the Satyam stock trades at a price-earnings multiple of 21 times its FY-05 earnings.

Satyam Computers has improved its operations on multiple fronts over the past couple of years that reinforces our positive view on the stock.

The variables range from predictable volume expansion in the core offerings; enhanced breadth of service offerings with the inclusion of engineering and infrastructure management services, a lesser degree of reliance on top clients and a wider domain and geographic base.

The recent acquisition of Citisoft, a consulting firm focussing on the investment management industry, is expected to strengthen its presence in the financial services space.

On the flip side, however, any slowdown in the enterprise solutions business, sustained lower-than-expected growth in the top five clients and integration risks associated with acquisitions could throw up surprises on the financial front and upset the management guidance provided for 2005-06.

For Satyam Computers, 2004-05 has proved to be a decisive year on several fronts that has helped improve the financials and lower the risks.

Satyam's technology centre at Hyderabad ... Changes in client profiles are encouraging.

Lower reliance on top clients: The contribution of the top client, top five and top ten clients as a proportion of revenues has come down steadily in the last three years.

The contribution of its top client, GE, has come down from 17.5 per cent in 2002-03 to 10.9 per cent in 2004-05.

Even as this client's year-on-year growth slackened from 6.2 per cent to 3.6 per cent, the overall revenues staged a consistent increase over this period. Similarly, the dependence on the top five and top ten clients have dropped by 10 percentage points over these three years. Revenues from clients outside of the top five recorded a growth about 50 per cent.

This trend has helped Satyam Computer derisk its revenue profile and exploit the potential of clients outside of its tip five.

Improving client metrics: The client relationship patterns have changed significantly over the past three years, evident from the nature of contracts struck by the company.

By end-2004-05, out of 390 active clients, 144 were Global or Fortune 500 companies, accounting for a chunk of revenues.

In addition, it has 130 customers with annualised billing exceeding $1 million.

The growth in additional clients in the $1 million bracket has been faster than any of its frontline peers and this has set the base for greater revenue potential in the future.

Broad-based service offerings: To become an end-to-end service provider, Satyam has consciously broad-based its portfolio of service offerings to include extended engineering services and infrastructure management services.

These two offerings accounted for 11 per cent of revenues, up by 3 percentage points over the previous year and are expected to be the focus areas.

Besides, these have also extended the range of offerings beyond software development/maintenance and enterprise solutions.

Newer verticals and geographies: Apart from broad-basing the offerings, Satyam has also entered into newer verticals of healthcare, transportation and retail, which together account for about 12 per cent of revenues in 2004-05.

This is likely to reduce overall risks and widen the opportunity landscape beyond its core verticals of BFSI (Banking, Financial Services and Insurance), manufacturing and telecom.

In addition to this, the contribution from European and Asia Pacific geography has been quite healthy.

Improved financials: As billing rates have remained quite stable and new clients have been coming in at higher-than-average rates, the company feels that there will only be a marginal decline in operating margins that are hovering at about 25 per cent.

The full impact of a salary hike will be felt in the first quarter of 2005-06, with a 9 per cent sequential decline in per share earnings.

But for the full year, the company expects to be able to mitigate the overall margin impact through higher offshore contribution and lower percentage of selling and administrative expenses.

Risks and challenges

Satyam, however, will remain exposed to some risks on the operational front:

Slowdown of enterprise solutions: Any slowdown in growth in enterprise solutions, which accounted for over one-third of revenues, is likely to affect overall revenue growth.

Though signs only point towards acceleration of revenues from this offering, Satyam's higher exposure relative to its frontline peers leaves it much more vulnerable.

Abrupt changes in client composition: Any changes in client composition dictated by either a slowdown in the US or over-exposure to a particular vertical, say, manufacturing or lower-than-expected growth in its top two/three clients, may lead to slower growth in revenues.

Integration: As Citisoft is a specialised consulting acquisition, the integration and client retention risks for Satyam are high and will have to be monitored closely over the next six-nine months.

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