Tech Mahindra - Satyam results: Weak as expected: BofA ML

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Tech Mahindra Ltd.
Satyam results: Weak as expected

􀂄 Satyam results disappoints, as flagged by us
As flagged by us in our 20th Oct note, Satyam 42% subsidiary of Tech Mahindra
(TML) disappointed on 2Q margins due to cost pressure from wage hikes, SG&A
and flat QoQ revenue growth. 2Q margins at 6% were lower than our 7% estimate
and much lower than Street est of ~11-13%. We cut FY12 and FY13 earnings
expectations for Satyam by 12% and 4% to factor margin miss in 2Q and our view
that margin recovery from here on likely to be gradual. Consequently our revised
expected EPS (incl proportionate share of Satyam) for FY12 and FY13 on which
we value TML now stands reduced to Rs58 (Rs61) and Rs72 (73). Cut PO to
Rs705 and retain Underperform rating.


2Q margins fall; flat QoQ revenue growth
While 1Q margins were ahead of our est, 2Q margins declined 400bp QoQ on
wage hike and sluggish revenue growth. Hiring during the quarter was muted with
net adds of ~350 and attrition stood at 25% on quarterly annualized basis.

Margin recovery likely to be gradual
Satyam operates at gross margins of ~28% given higher onsite revs (60%) and
likely competitive rates. SG&A at 21% is also much higher than peers given low
scale. With high attrition levels of 25% and utilization levels at ~71% we believe
there is limited scope to drive margins through employee rationalization programs.
Margin expansion in our view likely to be driven by top-line growth and SG&A
optimization, and likely to be gradual given Satyam needs to rebuild credibility and
close deals in a tough competitive environment.

Healthy balance sheet; legal suit remains a concern
Satyam’s balance sheet remains healthy with cash balances of Rs~28.5bn
(Rs24/share). However, this excludes potential liability of Rs12bn towards alleged
advances provided by group companies of ex chairman & founder (Ramalinga
Raju) and liability from US Class Action suits.