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Patni Computer Systems Ltd.-------------------------------------------- Maintain OUTPERFORM
Better than it appears
● Patni’s Jun-11 result was expected to be weak. It was further
subdued due to higher-than-expected one-offs and changes in
accounting policy. For instance, this quarter included ~US$17 mn
(20% of FY11E PAT before one-offs) relating to severance costs.
● Management commentary on topline growth was subdued. On the
other hand, management reiterated its margin guidance of 25%
EBITDA by the second half of 2013 (2Q11 (adj): 12%, iGate
2010A: 22%, Patni 2013E: 22%).
● Management reported that integration was proceeding smoothly
and we were pleasantly surprised by an improvement in employee
attrition rates and client metrics.
● We reduce our EPS (as reported) estimates for FY11 and FY12
by 30% and 12%, respectively. Our target price changes to Rs400
(earlier: Rs410). Given low float, an offer for buyback seems likely
and thus, management’s incentives may not be aligned to
improving stock prices near term. This presents a key risk to our
OUTPERFORM rating.
Results impacted by one-offs, accounting policy changes
Patni reported decline in revenue of 3.4% QoQ vs CS est of 1% drop
driven by (1) volume decline of 1.1% and (2) one-off revenues in
March 2011 quarter and revenue not recognised due to change in
accounting standards: 2.4%. Adjusted for one-offs, EBIT margin
declined by 840 bp QoQ vs CS est of 400 bp drop. This was driven by
(1) impact of wage hike: 350 bp, (2) increased depreciation, SG&A
expenses, decline in revenue and others: 490 bp. Depreciation was
higher due to revaluation of assets due to push-down accounting.
SG&A expenses increased due to higher travel expenses, fees for
consultants, etc relating to the integration process. Adjusted PAT was
38% below CS estimates.
Unexciting demand outlook, positive margin commentary
Management indicated it was observing some volatility in the demand
environment and that decision cycles were lengthening. On the other
hand, management reiterated its margin guidance of 25% EBITDA by
the second half of 2013 (2Q11 (adj): 12%, iGate 2010A: 22%, Patni
2013E: 22%).
Management expects subdued topline growth in the ‘protect and
stabilise’ phase of 2011 and growth to reaccelerate only in 2012.
However, it expects margins to steadily improve starting next quarter.
We remain confident of management’s ability to improve margins at
Patni since it had successfully used the same margin levers at iGate.
Integration on track. Client, employee metrics positive
Management reported integration was proceeding as per plan.
Employee attrition dropped 170 bp QoQ. Client metrics were positive
with number of US$1 mn and US$5 mn clients increasing QoQ.
Low float could be a risk
iGate owns 83% of the outstanding stock of Patni. Based on current
regulations, it is required to either reduce its shareholding to 75% or
increase it to 100% (delist) by May ’12.
For dilution to occur, stock must be 26% above our TP (iGate’s
purchase price for its current stake), which we find difficult to justify. In
this scenario, a buyback seems more likely. Thus, management’s
incentives may not be aligned to improving stock prices near-term
though the announcement of stock buyback could lead to volatility.
Maintain OUTPERFORM
We reduce our revenue growth estimates for FY11/FY12 by 3-4%, in
line with subdued management commentary. We also reduce our
margin estimates by 400 bp/ 200 bp largely due to the impact of
higher than earlier anticipated depreciation and amortisation expenses.
This leads to ~12% change in EPS pre-extraordinary items
for FY11/ FY12. Including impact of severance costs in Q2, EPS
changes by 30% and 12% for FY11 and FY12, respectively. We
exclude the impact of higher depreciation & amortisation expenses
(non-cash costs) and severance costs (one-off) while calculating our
target price of Rs400 (earlier TP: Rs410). At a 24% upside potential to
CMP, we still rate the stock an OUTPERFORM.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Patni Computer Systems Ltd.-------------------------------------------- Maintain OUTPERFORM
Better than it appears
● Patni’s Jun-11 result was expected to be weak. It was further
subdued due to higher-than-expected one-offs and changes in
accounting policy. For instance, this quarter included ~US$17 mn
(20% of FY11E PAT before one-offs) relating to severance costs.
● Management commentary on topline growth was subdued. On the
other hand, management reiterated its margin guidance of 25%
EBITDA by the second half of 2013 (2Q11 (adj): 12%, iGate
2010A: 22%, Patni 2013E: 22%).
● Management reported that integration was proceeding smoothly
and we were pleasantly surprised by an improvement in employee
attrition rates and client metrics.
● We reduce our EPS (as reported) estimates for FY11 and FY12
by 30% and 12%, respectively. Our target price changes to Rs400
(earlier: Rs410). Given low float, an offer for buyback seems likely
and thus, management’s incentives may not be aligned to
improving stock prices near term. This presents a key risk to our
OUTPERFORM rating.
Results impacted by one-offs, accounting policy changes
Patni reported decline in revenue of 3.4% QoQ vs CS est of 1% drop
driven by (1) volume decline of 1.1% and (2) one-off revenues in
March 2011 quarter and revenue not recognised due to change in
accounting standards: 2.4%. Adjusted for one-offs, EBIT margin
declined by 840 bp QoQ vs CS est of 400 bp drop. This was driven by
(1) impact of wage hike: 350 bp, (2) increased depreciation, SG&A
expenses, decline in revenue and others: 490 bp. Depreciation was
higher due to revaluation of assets due to push-down accounting.
SG&A expenses increased due to higher travel expenses, fees for
consultants, etc relating to the integration process. Adjusted PAT was
38% below CS estimates.
Unexciting demand outlook, positive margin commentary
Management indicated it was observing some volatility in the demand
environment and that decision cycles were lengthening. On the other
hand, management reiterated its margin guidance of 25% EBITDA by
the second half of 2013 (2Q11 (adj): 12%, iGate 2010A: 22%, Patni
2013E: 22%).
Management expects subdued topline growth in the ‘protect and
stabilise’ phase of 2011 and growth to reaccelerate only in 2012.
However, it expects margins to steadily improve starting next quarter.
We remain confident of management’s ability to improve margins at
Patni since it had successfully used the same margin levers at iGate.
Integration on track. Client, employee metrics positive
Management reported integration was proceeding as per plan.
Employee attrition dropped 170 bp QoQ. Client metrics were positive
with number of US$1 mn and US$5 mn clients increasing QoQ.
Low float could be a risk
iGate owns 83% of the outstanding stock of Patni. Based on current
regulations, it is required to either reduce its shareholding to 75% or
increase it to 100% (delist) by May ’12.
For dilution to occur, stock must be 26% above our TP (iGate’s
purchase price for its current stake), which we find difficult to justify. In
this scenario, a buyback seems more likely. Thus, management’s
incentives may not be aligned to improving stock prices near-term
though the announcement of stock buyback could lead to volatility.
Maintain OUTPERFORM
We reduce our revenue growth estimates for FY11/FY12 by 3-4%, in
line with subdued management commentary. We also reduce our
margin estimates by 400 bp/ 200 bp largely due to the impact of
higher than earlier anticipated depreciation and amortisation expenses.
This leads to ~12% change in EPS pre-extraordinary items
for FY11/ FY12. Including impact of severance costs in Q2, EPS
changes by 30% and 12% for FY11 and FY12, respectively. We
exclude the impact of higher depreciation & amortisation expenses
(non-cash costs) and severance costs (one-off) while calculating our
target price of Rs400 (earlier TP: Rs410). At a 24% upside potential to
CMP, we still rate the stock an OUTPERFORM.
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