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Suresh Krishnamurthy

Mr Ramalinga Raju, CMD, Satyam Computers.

SATYAM Computer Services shareholders can reduce their exposure to the stock. Given the current valuation of the stock and the considerably watered down growth prospects, there may be a further downside of 10-15 per cent.

Importantly, the impact could be even more if Satyam's earnings decline in the next two quarters. The company expects profits to rise in the following quarter.

However, it has reported two consecutive quarters of earnings decline and the operating environment continues to be challenging.

The perception of value will, however, change if Satyam unveils acquisitions.

With liquid cash of around Rs 1,500 crore (accounting for 71 per cent of the company's net worth), Satyam appears poised to make acquisitions. Review of the investment decision will then be needed.

Buckling under

The operating profit margin of Satyam Computer declined by 1 percentage point in the March quarter compared to the December quarter.

This is despite only a 0.18 per cent decline in billing rates attributed to a jump in personnel expenses. Overall, sustainable profits (that is, before including profit on sale of stake in a joint venture) declined 16 per cent over the quarter ended December.

For the year ended March 2003, profits fell 11 per cent on a sustainable basis. The earnings guidance given by Satyam also does not leave any room for optimism.

Earnings are expected to grow at a rate that is lower than that of revenues in 2003-04. In other words, a decline in profit margins is expected, which may be due to reduction in billing rates and rising selling costs.

In terms of cash flows, Satyam added Rs 425 crore during 2002-03. However, this was facilitated by significantly low investments in fixed assets during the year, which were one-third of the depreciation costs.

This trend may be unsustainable in the following years. If fresh investments rise, cash flows will come under pressure, affecting the return on net worth and the valuation of the stock.

Things could change if the cash on the balance-sheet is replaced with assets.

The cash earned measly returns of about 3 per cent in 2002-03. Good treasury management can make it earn slightly higher in the years ahead.

The return is still unlikely to rise above 4 per cent. Instead, if it were invested in businesses earning higher returns, the valuation would change.

However, acquisitions come with risk. A big-bang acquisition that turns out awry can affect valuations.

Modestly priced

The Satyam stock trades at a multiple of around 11 times its earnings for the year ended March 2003.

This is roughly half of the multiple of 20 commanded by Infosys in the markets.

However, Satyam expects its earnings to grow at a rate lower than that of Infosys. In 2002-03, Satyam reported a decline in earnings and Infosys a decline in earnings growth.

These factors justify the lower multiple accorded to the Satyam stock. In fact, if cash flows are also considered, Satyam's multiple works out to two-thirds that of Infosys.

Overall, the stock of Satyam is indeed modestly priced. Consistent growth in earnings and cash flows of around 8-10 per cent over the next few years holds the potential to deliver significant capital appreciation for shareholders.

However, will that happen is the question? If the declining trend in earnings growth continues, a further fall in stock price is in store.

The margin of safety for shareholders in such a situation is low. In this backdrop, shareholders can pare their exposures now.

Any rise in stock price over the next week would be the best time to exit.

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