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Patni Computers
Remains an Attractive
Investment Opportunity
Quick Comment: We remain buyers of Patni at current
levels. We believe Patni could emerge as one of the
best-performing stocks in the group in 2011. iGATE
management has stated a goal of using the Patni
acquisition for growth and has said it plans to deliver
value quickly. iGATE’s open offer for Patni is expected
to end by March, after which the new management
would take over reins of the company. The open offer
price is 8% higher than current levels. Given the
potential for re-rating and earnings revisions for the
company, we would recommend not tendering shares in
the open offer.
What's new: iGATE’s results offer a glimpse of what
new management could deliver at Patni. iGATE’s
revenue was up 56% YoY in 4Q and it ended 2010 with
revenue of US$281mn (+46% YoY). Non-GAAP net
margins (excluding stock expenses, amortization and
acquisition-related expenses) are now at 25% for the
company. iGATe now has cash of US$140mn.
Concerns may be overdone; expect a turnaround:
We believe signs of revenue growth for Patni should
emerge by October/December quarter. Patni
management discussed the deal with 30 of its large
clients and reported a positive feedback on the deal. We
believe most large clients including GE have expressed
a desire that their core delivery teams should not be
changed due to restructuring post the deal/change in
ownership at Patni. We also believe that iGATE
management is unlikely to use Patni cash for paying off
its debt anytime in the near-medium term.
Valuations: We note that iGATE was trading at 17x
one-year forward consensus earnings prior to the Patni
deal. Patni currently trades at 10-11x one-year forward
earnings. We believe the stock could emerge as a
rerating candidate as revenue growth picks up in C2H11.
Patni’s billing rates are at a premium to iGATE’s, and
hence margin improvement would lead to earnings
upgrades as well, in our view.
IGATE Conference Call takeaways:
1) iGATE indicated that client budgets are expected to be up
modestly for 2011. It expects QoQ revenue growth in 1Q11 to
be healthy but lower than the double-digit growth rates seen
last year due to a lack of pent-up demand.
2) To us it appeared that management downplayed concerns
about integration with Patni on the call. This, in our view, is the
first sign of management comfort in integrating the companies
as so far CEO Phaneesh Murthy and team have referred to the
integration as a big challenge.
3) In the first phase of integration, 300 sales people at Patni
and 100 sales people at iGATE are likely to be integrated to a
joint go-to-market strategy and share best practices, which is
critical for the success of the combined entity, in our view.
Price target: We derive our price target for Patni by using
probability weighted average of our risk-reward scenarios. [PT
Rs700 = 25%*Rs950 + 65%*Rs650 +10%*Rs400]. Our price
target of Rs700 implies a P/E of 17x 20011e EPS and 14x
2012e EPS. We have arrived at our risk-reward scenario
values using the discounted cash flow (DCF) methodology.
Our DCF assumptions are as follows: risk-free rate 6%, equity
risk premium 8%, beta 0.93, cost of equity 13.4%, terminal
growth rate 3%.
Valuations: Patni has traded at varying premiums to the
market. More recently, however, it has traded at a discount to
Sensex multiples. Our base case estimate implies a P/E of 15x,
which is within Patni’s average trading range of 4x to 18x in the
last three years and in line with recent trading patterns.
Key risks: 1) Integration-related risks and challenges, 2)
currency volatility impacting margins, and 3) macro economic
concerns in US/ Europe leading to slower-than-expected
revenue growth for Patni.
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