Since declaring Q1FY08 results on July 20, 2007 Satyam Computer Services has returned -7.8% (negative 7.8%), underperforming the BSE-IT index slightly (-6%), the Sensex (flat) and Infosys (-4.8%). We felt that some amount of correction was due given the run-up prior to the results which we believe has happened. Satyam derives a relatively smaller proportion of its revenues from the BFSI segment relative to its peers such as Infosys and TCS, which is about 24% of overall revenues. Thus, should it not be better placed relative to peers in the current environment? We spoke to Mr. V Srinivas, CFO to understand if Satyam senses any incipient impact of the ongoing weakness in the sub-prime mortgage segment in the US. We also wanted to understand whether the company is doing anything differently to deal with this situation. We asked Satyam 10 questions on the above-mentioned subject, to which, the company responded in the following manner:
Questions and Answers
1. How do you see the environment in the US affecting Satyam?
A. We have just concluded our routine monthly review meeting with the top-40 business unit heads and senior managers. As part of this exercise, we dissect the progress of each client account, review the behavior of all practices and see how these data points emanating from such a granular level feed into shaping our outlook. This is commonly a 3-day exercise. Our August-end review suggests to us that it's business as usual. We are not seeing any impact as of now on account of the difficulties in the US.
2. Satyam's application development and maintenance exposure (ADM) has grown over the last four quarters at just over 25% on a y-o-y basis. Hasn't Satyam's growth in the recent past accrued from "discretionary" spend? What is the relative ADM exposure in Satyam's BFSI segment?
A. The ADM market is generally a slower-growth market than the rest of IT-Services such as package implementation, infrastructure management, independent testing and system integration. So, our growth has been very much in line with this trend. We have a higher-than-company average concentration of the ADM type of work in our BFSI segment. To this extent, our exposure to the BFSI segment is relatively defensive.
3. Are you concerned by the increasing concentration of your revenues in enterprise solutions which contributed over 44% of your revenues in Q1FY08?
A. We must deconstruct the composition of this segment that we at Satyam characterize as enterprise solutions. The classical ERP type of applications account for only a part of this (about 30% of overall revenues) with the rest coming from business intelligence, data warehousing, analytics, supply chain management and CRM solutions. Further, only about 50% of the pure-ERP portion (i.e. about 15% of the overall revenues) accrues from new implementations as the balance comes from support (mainly done offshore) which tends to be relatively stable. In essence, therefore, ERP work that one might classify as "discretionary" accounts for about 15% of our overall revenues or about a third of our overall exposure to enterprise solutions. Moreover, a good part of our exposure in enterprise solutions derives from the manufacturing and TIME vertical, outside the BFSI segment.
4. Are there any segments of your BFSI exposure (especially BFS), that you are worried about? Exposure to investment banking clients or any others?
A. Our direct exposure to sub-prime mortgage lenders is negligible, and to the mortgage segment as a whole, is less than 1% of our revenues. Only about 24% of our FY07 revenues came from the BFSI segment, most of the work is done for large, diversified financial institutions. The BFS accounts for about 17% of this while insurance, which is stable, contributes the balance 7%. Our 17% BFS exposure is split roughly equally across the three line viz. commercial/retail banking, financial services and investment banking (or capital markets). Thus, our capital market exposure is about 6% of revenues and though we haven't seen any indications of any fallout yet in this subsegment, we believe that if there were to be some hiccups in this area broadly speaking, our modest exposure to this places us in a favorable position to manage them.
5. Are you seeing any impact on business that can be termed as "discretionary spending'?
A. High-growth services such as business intelligence, analytics, CRM, SCM and consulting are relatively more discretionary. At the moment they continue to show traction and we so far not seeing a slow-down in such higher-margin discretionary services, but are keeping a watch. We believe that businesses increasingly regard this spend as essential to their competitiveness. More so, we provide such services outside the BFSI segment and largely in the manufacturing and TIMES vertical. Together these verticals contributed about 48% of Q1FY08 revenues).
6. Is it impacting the way you are building order books, building sales pipeline or winning repeat business? New Clients and promised volume growth from existing clients – are they all coming through?
A. There is no change in the near-term outlook for the business. The improvement in pricing is tracking expectations. Our order book is healthy. There are at least 20 large deals up for grabs, each of them of the order of USD 50 million plus and we are in fairly advanced stage negotiations in about 10 of these.
7. Are your hiring plans on track or is there some element of a wait-and-watch policy you are now adopting given this global uncertainty?
A. At this point, hiring is progressing as planned. We have indicated towards hiring about 15,000 – 16,000 people (gross) and that remains.
8. Do you have any mortgage clients in your BPO? If so, what is the impact?
A. Our BPO business has negligible exposure to mortgage clients. We have not seen any impact on our business from the recent events.
9. Are you getting any sense of how CY08 IT budgets of your key clients is shaping up?
A. Clients are yet to firm up their IT-budgets for the forthcoming calendar. We will get a sense from them within a month's time in October. So far, we cannot see the crisis in the US as affecting our clients' CY08 IT budgets. We are carefully monitoring the situation and currently feel comfortable about our clients' engagement levels with us.
10. How will a potential slowdown impact Satyam?
A. A slowdown in the US may set us back by 3-6 months. Today, we are in a better position to manage our order books and if developments in the US unexpectedly slow us down, we can get back on track within a quarter or two. We have flexibility in managing our exposure across clients, practices, geographies. We are seeing traction in infrastructure management and that's relatively immune to a potential slowdown. So, we do not believe that a slowdown should impact our growth rates beyond a quarter or two.
Valuation:
We believe that Satyam will continue to grow in a good macro environment. Satyam's BFSI exposure is relatively lower compared to peers and that puts the company in a relatively good position in the event of weakness in this space. The company is likely to post leading-industry growth in FY08 over FY07 (near-40% in USD terms) but this is already partly factored in at current stock price levels. We will watch out for how Satyam manages its margins in the coming quarters which we believe could be a strong stock driver hereon. In the event of a significantly tougher environment in the US affecting corporate spending on a broad basis, the signs of which we have not yet seen, we would prefer players such as Infosys and TCS by virtue of their relatively higher defensive exposure.
Investors are unlikely to rush into buy front-line technology stocks because they believe that the bottom is sometime away as further concerns continue to be priced in. In our opinion, further declines in stock prices hereon only make the risk-reward balance more favorable for investor. We believe that Satyam's valuations have become fairly reasonable for investors at this point in time. It is at a 20% discount to Infosys on valuations at current levels, which is just about fair and which we believe should not increase. It currently trades at 18.6x FY08E and 14.4x FY09E, and we maintain our 'BUY' rating on the stock.
Questions and Answers
1. How do you see the environment in the US affecting Satyam?
A. We have just concluded our routine monthly review meeting with the top-40 business unit heads and senior managers. As part of this exercise, we dissect the progress of each client account, review the behavior of all practices and see how these data points emanating from such a granular level feed into shaping our outlook. This is commonly a 3-day exercise. Our August-end review suggests to us that it's business as usual. We are not seeing any impact as of now on account of the difficulties in the US.
2. Satyam's application development and maintenance exposure (ADM) has grown over the last four quarters at just over 25% on a y-o-y basis. Hasn't Satyam's growth in the recent past accrued from "discretionary" spend? What is the relative ADM exposure in Satyam's BFSI segment?
A. The ADM market is generally a slower-growth market than the rest of IT-Services such as package implementation, infrastructure management, independent testing and system integration. So, our growth has been very much in line with this trend. We have a higher-than-company average concentration of the ADM type of work in our BFSI segment. To this extent, our exposure to the BFSI segment is relatively defensive.
3. Are you concerned by the increasing concentration of your revenues in enterprise solutions which contributed over 44% of your revenues in Q1FY08?
A. We must deconstruct the composition of this segment that we at Satyam characterize as enterprise solutions. The classical ERP type of applications account for only a part of this (about 30% of overall revenues) with the rest coming from business intelligence, data warehousing, analytics, supply chain management and CRM solutions. Further, only about 50% of the pure-ERP portion (i.e. about 15% of the overall revenues) accrues from new implementations as the balance comes from support (mainly done offshore) which tends to be relatively stable. In essence, therefore, ERP work that one might classify as "discretionary" accounts for about 15% of our overall revenues or about a third of our overall exposure to enterprise solutions. Moreover, a good part of our exposure in enterprise solutions derives from the manufacturing and TIME vertical, outside the BFSI segment.
4. Are there any segments of your BFSI exposure (especially BFS), that you are worried about? Exposure to investment banking clients or any others?
A. Our direct exposure to sub-prime mortgage lenders is negligible, and to the mortgage segment as a whole, is less than 1% of our revenues. Only about 24% of our FY07 revenues came from the BFSI segment, most of the work is done for large, diversified financial institutions. The BFS accounts for about 17% of this while insurance, which is stable, contributes the balance 7%. Our 17% BFS exposure is split roughly equally across the three line viz. commercial/retail banking, financial services and investment banking (or capital markets). Thus, our capital market exposure is about 6% of revenues and though we haven't seen any indications of any fallout yet in this subsegment, we believe that if there were to be some hiccups in this area broadly speaking, our modest exposure to this places us in a favorable position to manage them.
5. Are you seeing any impact on business that can be termed as "discretionary spending'?
A. High-growth services such as business intelligence, analytics, CRM, SCM and consulting are relatively more discretionary. At the moment they continue to show traction and we so far not seeing a slow-down in such higher-margin discretionary services, but are keeping a watch. We believe that businesses increasingly regard this spend as essential to their competitiveness. More so, we provide such services outside the BFSI segment and largely in the manufacturing and TIMES vertical. Together these verticals contributed about 48% of Q1FY08 revenues).
6. Is it impacting the way you are building order books, building sales pipeline or winning repeat business? New Clients and promised volume growth from existing clients – are they all coming through?
A. There is no change in the near-term outlook for the business. The improvement in pricing is tracking expectations. Our order book is healthy. There are at least 20 large deals up for grabs, each of them of the order of USD 50 million plus and we are in fairly advanced stage negotiations in about 10 of these.
7. Are your hiring plans on track or is there some element of a wait-and-watch policy you are now adopting given this global uncertainty?
A. At this point, hiring is progressing as planned. We have indicated towards hiring about 15,000 – 16,000 people (gross) and that remains.
8. Do you have any mortgage clients in your BPO? If so, what is the impact?
A. Our BPO business has negligible exposure to mortgage clients. We have not seen any impact on our business from the recent events.
9. Are you getting any sense of how CY08 IT budgets of your key clients is shaping up?
A. Clients are yet to firm up their IT-budgets for the forthcoming calendar. We will get a sense from them within a month's time in October. So far, we cannot see the crisis in the US as affecting our clients' CY08 IT budgets. We are carefully monitoring the situation and currently feel comfortable about our clients' engagement levels with us.
10. How will a potential slowdown impact Satyam?
A. A slowdown in the US may set us back by 3-6 months. Today, we are in a better position to manage our order books and if developments in the US unexpectedly slow us down, we can get back on track within a quarter or two. We have flexibility in managing our exposure across clients, practices, geographies. We are seeing traction in infrastructure management and that's relatively immune to a potential slowdown. So, we do not believe that a slowdown should impact our growth rates beyond a quarter or two.
Valuation:
We believe that Satyam will continue to grow in a good macro environment. Satyam's BFSI exposure is relatively lower compared to peers and that puts the company in a relatively good position in the event of weakness in this space. The company is likely to post leading-industry growth in FY08 over FY07 (near-40% in USD terms) but this is already partly factored in at current stock price levels. We will watch out for how Satyam manages its margins in the coming quarters which we believe could be a strong stock driver hereon. In the event of a significantly tougher environment in the US affecting corporate spending on a broad basis, the signs of which we have not yet seen, we would prefer players such as Infosys and TCS by virtue of their relatively higher defensive exposure.
Investors are unlikely to rush into buy front-line technology stocks because they believe that the bottom is sometime away as further concerns continue to be priced in. In our opinion, further declines in stock prices hereon only make the risk-reward balance more favorable for investor. We believe that Satyam's valuations have become fairly reasonable for investors at this point in time. It is at a 20% discount to Infosys on valuations at current levels, which is just about fair and which we believe should not increase. It currently trades at 18.6x FY08E and 14.4x FY09E, and we maintain our 'BUY' rating on the stock.
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