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Mahindra Satyam – Result Update
Angel Broking recommends switch from Mahindra Satyam to Tech Mahindra.
Mahindra Satyam reported its 1QFY2011 and 2QFY2011 numbers, which were
below the market’s expectations. The company reported a 0.4% qoq decline in
revenue to `1,242cr in 2QFY2011 from `1,248cr in 1QFY2011. EBITDA margin
declined by 381bp qoq to 5.9% in 2QFY2011 from 9.7% in 1QFY2011 on the
back of wage hike in 2QFY2011, which led to a `50cr increase in employee cost.
The company has hiked wages by 3% for onsite employees and 15% for offshore
employees, as it tries to retain/recruit talent in a tightening supply environment.
During the quarter, Mahindra Satyam added 346 employees, taking the total
headcount to 28,068. Further, the company plans to hire 5,000 entry-level
graduates in the next year. Utilisation during the quarter stood at 71%, as
compared to peers that reported utilisation excluding trainees above 80%, as still
majority of Mahindra Satyam’s middle-level employees are underutilised. Going
forward, this could be an important lever to pull up operating margins as
business from existing clients ramps up. Net profit came in at `23.3cr in
2QFY2011 as against `97.5cr in 1QFY2011, due to weak operational
performance and forex loss of `9.1cr in 2QFY2011 against `33.6cr profit in
1QFY2011. On the merger of Satyam with Tech Mahindra, management has
indicated that it has started initial discussions with board members for both the
companies; however, the process will take time (approximately 12 months).
Operating metric highlights: Mahindra Satyam is witnessing good traction in
service industries, such as manufacturing, telecom, media and entertainment. The
financial services segment has just started picking up, while the healthcare and
life sciences segment remains weak. Among service lines, enterprise solutions,
engineering services and infrastructure management services have shown good
strength. Geography wise, US currently contributes 59% to the company’s
revenue, while Europe contributes 26% (UK–10%). In 2QFY2011, the company
reported good revenue growth in India and the APAC region, while it witnessed a
strong deal pipeline in the Middle East. During the quarter, the attrition rate stood
at 25% on an annualised basis on account of the overall buoyancy in the job
market. The top 100 clients furnished 91% of the company’s total revenue. Total
active client base stood at 217 (active clients are clients who contribute more than
US $250,000 per year to revenue). Further, Mahindra Satyam is looking for
inorganic expansion in its BPO space, which currently has 2,500 employees.
Margin recovery on the cards: Mahindra Satyam is currently focusing on
improving its revenue and strengthening its business, which would eventually lead
to improvement in margins. The company is currently focusing on adding new
logos and has one-third of its sales force dedicated towards it. The company
witnessed a 381bp decline in its EBITDA margin to 5.9% in 2QFY2011 from 9.7%
in 1QFY2011 on the back of wage hike during the quarter. Going forward, the
margins levers for the company can be a) increasing utilisation levels (currently at
71%) with more business from existing clients and addition of new clients and
b) benefitting from SG&A synergies by reducing SG&A costs (currently 21% of
sales) and rental expenses by shifting employees to company-owned facilities.
Switch to Tech Mahindra: The operational performance of Mahindra Satyam came
in below the market’s expectations, which will taper-off the full-year operational
performance expected in FY2011. Mahindra Satyam is currently trading at 1.6x
EV/Sales, which is on a higher side as compared to Tech Mahindra, which is
trading at just 1.15x EV/Sales on a standalone basis. Also, when we value Tech
Mahindra on a standalone basis at 12x FY2012E EPS of `55.1 and add the value
of its stake in Satyam with holding discount of 15% to its market cap,
Tech Mahindra still looks attractive on risk-reward basis as it gives a target price of
`952, providing a 31% upside from current levels. Hence, we recommend a switch
from Mahindra Satyam to Tech Mahindra.
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