Patni Computer Systems BUY - Improving visibility :: ICICI Sec

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Patni Computer Systems BUY
Maintained
Improving visibility 
Reason for report: Q3CY10 results review & earnings revision



Despite Patni Computer Systems’ (Patni) Q3CY10 in-line revenue performance (up
6.7% QoQ) and low growth guidance for Q4CY10 (0.7-1.2% growth), we believe
growth is likely to be higher in CY11 considering improving large deal win ratio
(won three deals each having TCV of +US$30mn in Q3CY10) as well as continuing
pipeline of large deals. Attrition continues to remain a challenge (LTM IT Services’
attrition was up QoQ to 25.9% vs 21.5%) though management is confident of
bringing it down going forward on the back of continuing high recruitment
(9MCY10 addition constituting 18% of CY09 base despite CY10 revenue growth
likely to be muted ~7%) and high retention ratio among high performers. We
reiterate BUY as current valuations are not expensive on EV/E (factoring in lower
growth versus peers). We continue to believe that high cash on books with
improving cashflow generation will support valuations and expect re-rating with
improvement in growth from CY11 onwards. Key risks to our call are: i) Inefficient
use of cash or EPS-dilutive inorganic initiatives and ii) Further increase in attrition.
􀁦 Revise target price to Rs540 based on ~11x core business EPS + idle cash per
share, both at the end of four quarters ending Sept ‘12, which discounts EBITDA (of
four quarters ending Sept ‘12) by 6.4x. Our target EV/E is at ~55% discount to
Infosys. Please note that our earlier target price was based on CY11 EPS & EBITDA
and included special dividend of Rs63 announced and distributed in Q3CY10.
􀁦 Outperformance of low growth guidance for Q4CY10 can not be negated, as the
management has taken conservative approach to milestone achievement of new
business won in Q2CY10 considering higher holidays. Even insurance deal win post
acquisition of CHCS Services in Q2CY10 would likely achieve full ramp-up in
Q4CY10 (running at ~65-70% capacity), which would further provide revenue delta in
Q4CY10. Hence, outperformance of revenue guidance as well as resulting
outperformance on PAT can not be negated in Q4CY10 despite headwind of rupee
appreciation. Patni has guided for 0.7-1.2% QoQ revenue growth for Q4CY10 with
PAT (ex-forex) guidance of $22.5-23mn versus $23.7mn (ex-forex) in Q3CY10.
􀁦 Good cashflow performance in Q3CY10 with cashflow from operation (CFO) at
$45.1mn, constituting 25% of revenues & 157% of PAT, due to improving working
capital QoQ (debtors days including unbilled reduced to 79 days from 84 days QoQ
as well as QoQ increase of ~$9mn current liability relating to “billings in excess of
costs and estimated earnings on uncompleted contracts”) and free cashflow
generation of $43.6mn. Increase in cash equivalents QoQ (excluding the payout of
special dividend and tax thereon worth $208mn) was as high as $59.2mn in Q3CY10.
􀁦 Increasing focus on employee addition to control attrition with net addition of
1,663 in Q3CY10 (934 in Q2CY10) & guidance of further net adds of >500-1,000 per
quarter in coming quarters