JP Morgan: Mahindra Satyam: Restated financials restores normalcy, but progress likely to be slow

• Financials at last: Mahindra Satyam (Satyam) restated its FY09/FY10
financials (Indian GAAP) after a gap of 20 months since the accounting issue
arose out in Jan. 2009. This represents a significant step in the company’s
journey towards normalcy and restores confidence among customers who have
been constrained from dealing with the company due to its lack of financials.
• Revenues for FY10 at Rs54.8B (~US$1.15B) were in line with our estimate
outlined earlier in our September 23 note. The EBITDA margin of 8.3% (before
extraordinary) is likely to move up as operating leverage kicks in with revenue
growth. Satyam’s people costs constituted about 72% of revenues in FY10,
which should normalize to 65% with revenue growth.
• The company’s restated financials point to a loss of Rs1.24B in FY10, but that
is less of a concern to us view given exceptional expenses of Rs4.2B. Investors
are likely to move beyond the past and focus on the future.
• Not too many alarms in the balance sheet per se, but contingencies
significant: The erstwhile chairman (Mr. Ramalinga Raju) has made claims
totaling Rs12.3B through various companies for alleged prior advances made to
the company. This is under investigation. Provision to the tune of Rs15.4B
disclosed in the restated financials amounting to 25% of the balance sheet
embeds some conservatism, in our view.
• On the negative side, Satyam indicated an employee count of 27,470 as of
March 2010, more than 10% below our estimate: This has declined from
45,000 as of Mar-09, indicating the severe ramp-down mode that the company
was in through FY10. We now estimate the current quarterly revenue run-rate to
be about US$250-270MM, in line with the employee count disclosures, and
expect that the company will end FY11 flat relative to FY10 on revenues as it
picks up momentum lost through FY10.
• Still some unknowns: These will have a bearing on the stock and include: (a)
the most recent quarterly financials that gives a snapshot of the company today
after what it went through in FY10; this is expected in 45 days’ time; and (b) the
merger ratio when Satyam merges into Tech Mahindra.
• Despite building in an optimistic FY12 scenario, we still see some downside
potential; downgrade to Neutral: We also remove the stock from the Long
side of our AP Tech Portfolio. Our revised FY12 EPS estimate of Rs7.9 builds
in (a) over 20% revenue growth in FY12, and (b) EBIT margin of just over 15%
– both strong assumptions, in our view. Our revised Mar-11 price target of Rs90
is based on 11.5x FY12E earnings, in line with Indian IT mid-cap valuations.