The Hindu Business Line : Patni Computer Systems: Book profits

Investors can lock into recent gains given the decline in revenue contribution from key services, high attrition rates and uncertainty surrounding promoter stake sale.

MR NARENDRA K. PATNI, Chairman & CEO

The Patni Computer stock has registered sharp appreciation in recent times, moving to the Rs 560 levels, before cooling to around Rs 510. The stock now trades at a valuation of about 28 times its CY-06 earnings and is at a premium to its peers in the sub-$1-billion club. The recent run-up in the stock price is attributed mainly to reports of a possible stake sale by the company's co-promoters to a PE (private equity) firm.

However, subsequent events suggest that a transfer of stake between promoters also remains a possibility. As this will not trigger an open offer requirement, the stock price may cool in the near term.

Given that the outcome of these developments is uncertain, investors can book profits on part of their holdings to lock into current gains.

Business Overview

Patni's services portfolio broadly spans across insurance, financial services, manufacturing, telecom and media, and the product engineering industry verticals. Application maintenance and development is the biggest revenue earner, while some revenues are also derived from enterprise application systems and embedded technology services.

Patni has also made forays into Infrastructure Management Services (IMS) and Business Process Outsourcing, thus establishing itself as a player involved across the entire IT services value chain, much like big-league software service providers. However, certain trends in the company's financials for the latest quarter are of concern.

Business developments

On a sequential basis, Patni's revenues have grown at a modest 1.1 per cent. Adjusting for currency changes, the revenue realisation in rupee terms was actually Rs 8 crore lower than the preceding quarter. Operating and net profit margins have remained more or less flat.

There has been a significant decline in the revenue contribution from the telecom vertical, from 19.4 to 14.7 percent quarter-on-quarter, attributed to a vendor rationalisation process undertaken by a key telecom client. The manufacturing and financial services verticals have also seen a marginal decline in contribution to revenues.

On the services side, Application Development and Management (ADM) has declined significantly in terms of revenue contribution — from 70.1 per cent to 65.6 per cent on an sequential basis.

ADM is the biggest revenue contributor for most IT services companies, in general, and Patni, in particular. Part of this decline can be attributed to the loss of the telecom client. But if this trend continues, non-ADM services may have to show higher growth rates to compensate. Third, though 26 clients have been added this quarter, there are no million-dollar clients in the list. This indicates a relatively higher number of smaller value clients, which may pose challenges in terms of scattered resource allocation and increased costs.

Another significant risk factor arises from Patni's high attrition levels, which stood at 27.9 per cent for the latest quarter; high compared to industry standards (sub-20 per cent levels). The company has increased its offshore salaries by 15-20 per cent and by about 4 per cent for its onsite employees. While the company expects that this move will control attrition to a certain extent, the increased wage bill may dent near-term margins. Wage inflation will also be influenced by the company's plans for a fresher to the lateral recruitment ratio of 60:40 (industry standard is about 75:25).

The company's billing pattern has also tilted further towards time and material billing, and away from fixed contracts, which suggests greater dependency of billing rates on utilisation levels. Significantly, utilisation percentage has fallen 90 basis points over the last quarter.

The positives

The positives to Patni's current operations arise from the increasing contribution of the product engineering vertical to revenues, reduced dependence on GE as a client and the fact that it has hedged part of its revenues against sharp rupee appreciation.

The change in business mix, in terms of a 18.6 growth in product engineering services practice on a sequential basis (overall revenue contributions stands at 16.8 per cent) during the quarter augurs well. This being a service that is higher in the value chain, with better billing, is likely to help overall revenue growth. The revenue contribution from Patni's top client — GE — has reduced from 13.5 per cent to 11.1 per cent on a sequential basis, lowering client concentration.

The last quarter has also seen an increase in revenue contribution from the US. However, currency related risks are partly mitigated by the company's hedging policy. The company has hedged around $200 million worth of its CY-07 contracts at an exchange rate of Rs 43.86-46.85 a dollar. Patni also plans to ramp up its operations in Chennai and Noida and in Germany and the Netherlands. These investments may help expand the scale of operation and take it a step closer towards becoming a player with a global delivery model.

Reports suggest that two of the company's three promoters are planning to sell their stake (about 29 per cent) to interested buyers. An acquisition of this stake by private equity or other software majors may lead to further upside in stock (depending on the pricing of the deal), as this may trigger open offer requirements.

On the other hand, with reports suggesting that the key promoter Mr.Narendra Patni has the first right of refusal on the stake sale, suggest that the deal could also evolve as an inter-se transfer stake between promoters, in which case, there will not be any open offer requirements.

In light of these events, investors may lock into some gains now. Any future restructuring moves relating to management or business, may be triggers to re-enter the stock.

More Stories on : Stocks | Recommendation | Software

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page