ICICI Securities: Mahindra Satyam HOLD Maintained; Pain is still not behind; Target Rs85

Despite Mahindra Satyam’s stock underperforming >20% (vs Sensex) post our reinitiating
coverage report, “Running a tight ship” dated March 31, ‘10, we still
believe pain relating to operations is likely to continue in FY11 (despite estimating
1.8% revenue decline in FY11, which is still not conservative with downside risk
persisting) and EBITDA margin is unlikely to improve beyond 20% even post
FY12. We continue to believe the management’s efforts on restructuring and
business growth in FY11 would start yielding results from FY12 only. Hence, we
re-iterate our HOLD rating on Mahindra Satyam with a revised price target of Rs85
and re-state that risk-reward is still not favourable at current FY12 valuations. We
continue to believe that EV/E is a better multiple to value the company given the
lower predictability on items below EBITDA. Even Q1FY11 & Q2FY11 results
(expected in mid November ’10) are unlikely to provide any major positive
surprise on margin (versus FY10) & revenue fronts, as increased participation in
large deals (post re-stated financials) would start yielding results from FY12 only.
􀁦 Downgrade target price to Rs85 based on target EV/E of ~8x, which is ~15%
discount to our fair multiple for HCL Technologies (HCL Tech) and 40-50% discount
to other large caps. We downgrade our FY11-12 EBITDA by 28-42% considering
lower-than-expected revenues for FY10 (despite in-line employee size), the resulting
higher impact on EBITDA, high wage inflation especially for Mahindra Satyam in
FY11/FY12 and rupee appreciation.
􀁦 Revenue and margin challenges to last till FY11. While FY10 revenues are at
~US$1.158bn, FY11 revenue growth would depend upon run rate of Q4FY10 vis-àvis
overall FY10. Even to achieve our estimate of 1.8% dollar revenue decline in
FY11, new business signings of ~$385-645mn would be required, which is not a
conservative estimate. Further, despite near-completion of employee rationalisation,
having a right talent mix for targeting demand growth would be the next big challenge
for Mahindra Satyam versus peers starting FY11, given: i) higher attrition, ii) likely
deterioration in training infrastructure; and iii) increasing lateral attrition in industry.
Hence, we expect Mahindra Satyam’s revenue growth rates to grossly underperform
in FY11. Re-stated accounts would result in higher eligibility in new-deal RFPs,
hence we expect higher growth in FY12. On margin front, FY11 personnel cost per
employee will increase significantly due to high wage inflation and lower FY10
employee cost per average headcount due to cut in variable pay for part FY10.
􀁦 Significant cleaning up of the balance sheet with only major issues remaining:
i) the US class action law suit related liability; ii) income tax disputed liabilities; and
iii) alleged advances from Ramalinga Raju’s family entities – already provided in the
balance sheet. Mahindra Satyam’s FY10 net worth is Rs18,809mn with net cash of
Rs24,340mn (post Upaid settlement).