Mahindra Satyam-Recovery likely to be more prolonged: UBS

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UBS Investment Research
Mahindra Satyam
Recovery likely to be more prolonged
􀂄 H1 FY11 revenue shows stability, but margins disappoint
Mahindra Satyam (Satyam) reported consolidated revenue of Rs12.5bn and Rs12.4bn
in Q1 and Q2 FY11, respectively, indicating some stabilisation in the revenue run rate.
EBITDA margins, however, declined from 9.7% in Q1 FY11 to 5.9% in Q2 FY11 (vs.
8.3% in FY10). Net profit dropped to Rs233m in Q2 FY11 from Rs975m in Q1 FY11
due to the margin decline and high taxes (52.9% of PBT).


􀂄 Margin recovery likely to be delayed, and more muted than expected
A wage cost increase in Q2 due to salary hikes of 3% onsite and 15% offshore was the
primary reason for the margin decline in Q2 FY11. We are also disappointed by the
lack of improvement in SG&A (Rs5.1bn in H1 FY11 vs. Rs10.4bn in FY10) in H1
FY11. We now expect margin recovery to be lower than our earlier estimates.

􀂄 Lower EPS estimates by 54/31% in FY11/12
While we expect revenue to be in line with our earlier estimates, we expect margin
performance to be significantly lower. We now forecast EBITDA margins of 8.8/11.0%
in FY11/12 versus 18.9/18.7% earlier. We lower our EPS estimates for FY11/12 from
Rs4.86/5.35 to Rs2.54/3.68 to reflect the slower margin recovery. We also lower our
price target from Rs85 to Rs65.

􀂄 Valuation: prefer Tech Mahindra to Satyam
We continue to prefer Tech Mahindra to Satyam as we believe the upside from the
impending merger of the two companies could be better captured by the owners of the
holding company (Tech Mahindra). We expect the merger ratio to favour Tech
Mahindra, and view a more favourable merger ratio as an upside risk for Satyam. We
derive our price target from a DCF-based methodology and explicitly forecast longterm
valuation drivers using UBS’s VCAM tool. We assume a WACC of 12.5% and a
terminal growth rate of 3%.