Mahindra Satyam- ‘Growth+ cost’ pangs= Margin pressures:: Emkay

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Mahindra Satyam

‘Growth+ cost’ pangs= Margin pressures

REDUCE

CMP: Rs 85                                       Target Price: Rs 70

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n     Mahindra Satyam’s result continue to indicate the ‘Hard toil’ faced by the company as Sep’10 qtr revenues decline by ~2% QoQ, margins falling by ~380 bps QoQ to 5.9%

n     Result vindicate our negative stance on the company as it faces stiff challenges from both weaker competitive positioning in erstwhile areas of strength

n     Cut our FY11E/12E/13E margins to 8.4%/14%/14.7% (V//s 15.2%/17.1%/17% earlier) driving a 48%/24%/19% to Rs 2.7/4.9/6(V/s Rs 5.1/6.4/7.5 earlier)

n     Maintain REDUCE rating with a revised March’12 DCF based TP of Rs 70(V/s Rs 81 earlier, implying ~12.5x 1 yr forward P/E)

H1FY11 results continue to indicate the ongoing challenges faced by

Mahindra Satyam

Mahindra Satyam (MS)’s indicate the ongoing struggles being faced by the company as

it tries to resurrect itself. We note that the company faces significant pressure on

operating margins , given growth continues to elude in a more favorable macro

environment.( Tier 1’s seeing sequential revenue growth in high single digits during the

Sep’10 quarter with a number of mid tier peers also benefitting from the strong macro

environment during the quarter).

Although Mahindra Satyam’s H1FY11 revenue performance at US$ 541 mn( US$ 268

mn, -2% QoQ on the back of revenues of US$ 273 mn in June’10 qtr) was marginally

better than expectations, the sequential decline in revenues during Sep’10 quarter

indicates that the company might still have seen some client ramp downs during the

quarter. Further co’s EBITDA margins at 5.9% in Sep’10 quarter were down by ~380

bps sequentially on a/c of lower revenues and wage increments implemented during the

quarter as company tries to retain/recruit talent in a tightening supply environment. Co

has reported H1FY11 EPS at Rs 1.

Cutting FY11/12/13E earnings by ~48%/24%/19% respectively to Rs

2.7/4.9/6, Retain REDUCE with a revised TP of Rs 70

Although we still continue to build in a strong revenue recovery for MS at ~20% CAGR (

over FY11E-13E after building a 4.3% YoY decline for FY11, we tweak our earnings

model primarily for (1) lower margins at 8.4%/14.1%/14.7% for FY11/12/13E (V/s

15.3%/17.1%/17% earlier on a/c of higher supply side pressures and a reset in US$/INR

to Rs 45/44/44 for H2FY11/ 12/13),and (2) increase in FY11/12/13E tax rate to

24.5%/25%/25%(V/s 15%/24%/24% earlier) driving in ~48%/24%/19% cut in our

FY11/12/13E earnings to Rs 2.7/4.9/6.0 (V/s Rs 5.1/6.4/7.5 earlier). We retain

REDUCE on Mahindra Satyam with a revised DCF based March’12 TP of Rs 70(V/s Rs

81 earlier). Key risks to our call emanates from the potential merger ratio between Tech

M and Mahindra Satyam being in favor of MS.