Satyam Computer: Off infoway?

Recommendation

Risk averse : Book profits

Risk bearing: Hold - Medium term

Krishnan Thiagarajan

Given the challenging external environment, post-September 11, and the revised management guidance for 2001-02, investors with a low-risk appetite can consider booking profits in Satyam Computer Services at current price levels.

In line with the steep rise in the Nasdaq Composite Index, the stock has run up sharply over the past couple of weeks. Risk-averse investors can capitalise on this uptrend, by cutting exposures in a phased manner and consider re-entry at declines. However, risk-bearing investors, with a medium-term perspective, can hold onto the stock for reasonable capital appreciation.

Following the turbulent chain of events, post-September 11, Satyam was forced to revise its financial projections downwards for 2001-02 (in the second quarter of the year *vis-a-vis the projections made during the 2001-02 first quarter). The revised projections are:

* Income from software services to grow at 30-33 per cent in dollar terms in 2001-02.

* The operating profit margins revised to 32-33 per cent from 34-35 per cent.

* The per share earnings revised downwards to Rs 13.75-14.25 from Rs 14.75-15.25.

On the revenue front, the revised projections seem to indicate that average billing rates may continue to remain under pressure, though Satyam clocks the lowest billing rates among frontline peers.

In the second quarter ended September 30, the contribution of software maintenance revenues went up to 32.15 per cent from 29.76 per cent in the first quarter. Since software maintenance is likely to be the battleground for secure and steady revenues, the fierce competition is likely to push down billing rates in the near term.

With the contribution of onsite revenues growing to 45.11 per cent in the 2001-02 second quarter from 41.38 per cent in the first quarter, Satyam's operating profit margins (OPM) have come under pressure.

If this trend continues, the OPM is bound to decline further in 2001-02 second half. The lower projected revenues and the OPM seem to have contributed to a downward revision in the per share earnings for 2001-02. At a projected Rs 13.75-14.25 level, the per share earnings are expected to record a 22.2-26.67 per cent growth in 2001-02 over the previous year.

Going forward, Satyam faces three key challenges. The first relates to bringing down the client concentration levels, acquiring bolster new clients, and create greater geographic diversification.

In the 2001-02 second quarter, the contribution of the top 10 customers to the company's revenues increased to 52.03 per cent from 48.38 per cent in the first quarter. On a sequential basis (second quarter vis-a-vis the first 2001-02 quarter), the new customer addition slowed down to 24 clients from 27.

Similarly, over this period, the concentration of revenues from the US has actually gone up marginally to 77.96 per cent from 76.92 per cent.

Second, Satyam Computer, which holds a 52.5 per cent equity stake in Satyam Infoway (Sify), has categorically stated that it proposes to divest its equity stake, either in whole or in part.

Since Sify's net losses have been mounting, the crucial test for Satyam Computer will be its ability to implement this divestment as early as possible. It will go a long way in instilling greater investor confidence in the Satyam Computer stock.

Finally, the biggest challenge for Satyam Computer will be the deployment of the huge cash flows secured through the ADS offer (of almost Rs 640 crore) and regular cash from operations towards either acquisitions or additional capital expenditure in a lucrative IT space that will yield attractive returns in future.