Mahindra Satyam - SELL A disappointment:: IIFL

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Mahindra Satyam - SELL
A disappointment


Satyam’s exit revenues (2QFY11: US$m 267; -2.2% QoQ) and
EBITDA margins (2QFY11: 5.9%; -380bps QoQ) were much below
our estimate. This highlights the severity of the task ahead for its
management. Moreover, visibility on revenue growth is poor and
the company faces an uphill task in winning large deals. Even
utilisation and pyramid efficiencies that were highlighted as the
key margin levers depend on revenue growth and a consequent
pickup in hiring. As such, there remains a risk of EBITDA margins
falling further before they start improving. We maintain our
negative stance and are revising down our FY11 and FY12 revenue
estimates by ~10% and EPS estimates by ~35-50%.


Structural issues with revenue growth: Given the robust revenue
growth at larger vendors during 2QFY11 (6-12% QoQ), a revenue decline
at Satyam increases our concern on a revenue recovery. While disclosure
of financials has lifted a ban on participation in many RFPs, the client loss,
employee attrition and diminished capabilities make winning large deals a
difficult task. As such, we expect Satyam’s revenue growth rate to
languish (FY12ii CQGR of 3.5%) over the medium term.

EBITDA margins have not bottomed? Wage increases, attrition, loss of
key contracts and deterioration of age pyramid have left Satyam with a
poor EBITDA margin of 5.5% (2QFY11). Going forward, restructuring the
pyramid and operating leverage remain the key hope for a margin
recovery. However, with a poor visibility of revenue growth over the
medium term, we remain sceptical of a robust margin improvement and
don’t rule out the possibility of them falling further.

No comfort in cash: On the back of lower-than-expected exit revenue
and significantly worse margins, we are revising down our FY11 and FY12
revenue estimates by ~10% and EPS estimates by 35-50%. Also, cash
balance of ~Rs25 (per share) fails to provide us comfort, due to the
overhang of legal liabilities and even probable risks in the event of a
reverse merger with Tech Mahindra. We maintain our negative stance and
see a fair value at ~Rs60.