Satyam Computer Services: Buy

Investments with a two-year horizon can be considered in the Satyam Computer Services (Satyam) stock, considering its strong growth prospects and reasonable valuation. At the current market price (Rs 418), the stock trades at 19 times its trailing 12-month earnings. This is at a significant discount to its top-tier peers. Satyam appears capable of delivering the earnings growth factored into the valuations.

Concerns about the US sub-prime crisis impacting the company's earnings may be overblown given that non-BFSI verticals contribute about 75 per cent of revenues. Satyam has a relatively high foreign equity holding and has probably experienced greater volatility in phases of profit-booking on the back of global cues. However, the business fundamentals and growth drivers remain strong, providing scope for possible capital appreciation of its stock.

Business Analysis

New engagements hold promise: Satyam's engagements in recent times stand out for the sectors and companies and the associated IT services that have been added to Satyam's portfolio. To cite a few examples, FIFA, the Zurich-based apex football body, has signed up the company to develop a customised event management system and build new intranet and extranet infrastructure. Nestle has extended its contract, estimated to be worth $75 million, with the company for SAP and other customised software implementation. A multi-year contract with a retail major, estimated to be worth $100 million, has been concluded recently.

These engagements augur well for two reasons. One, they help Satyam develop domain expertise in new sectors such as FMCG, event management and retail. Second, these businesses, by their nature, offer relatively secular and non-cyclical growth, thus opening up stable revenue streams for Satyam.

Solid Partnership and leadership in EAS: The company has a leadership position among top-tier players for its Enterprise Application Services capabilities, which has been a key contributor to revenues and is growing at a healthy pace. This stems from the fact that the company has solid partnerships with product software majors such as SAP, Oracle, and Microsoft. This association, over time, has given the company execution capabilities that enable it to customise its solutions to wide ranging client requirements and win new clients of high value.

Strong Global Delivery Model: Satyam delivers its services from 57 countries around the world, spanning six continents, a geographic spread which is more than any other top-tier IT player in India. This allows the company to deliver services through a healthy mix of near-shore, onsite and offshore locations of clientele. The company has about a 50:50 onshore-offsite mix. Although this results in high-cost revenues, this mix seems to have helped the company tap high-value, information-sensitive clientele. That the company has won key IT outsourcing contracts of the US and Singapore governments testifies to this. Through its near-shore presence, Satyam is able to acquire and cater to clients which are hesitant to outsource to offshore locations.

Operating Metrics and Geographical de-risking: High-value services such as engineering and infrastructure management have grown by 52 per cent and 19 per cent respectively over the past year. Improved contribution from these services is expected to aid profit margins. The manufacturing and telecom verticals have also contributed to revenues significantly. Satyam may stand to gain as IT spending by aerospace, manufacturing and telecom businesses is seeing an increasing trend, especially in Europe.

Satyam appears well-placed to tap this market. Europe and the Asia Pacific region now contribute 39 per cent of revenues and are showing an increasing trend over the past year. This reduces its dependence on North America and helps tide over risks associated with rupee appreciation relative to the dollar.

Risks: Though about $750 million of revenues hedged at Rs 42, earnings do face some risks from the recent appreciation in the rupee. The company has no direct exposures to the US sub prime segment. However, any indirect impact from market concerns on other BFSI clients and any slowdown in IT spends by the company's US clientele are potential risks to earnings.