St gives Satyam data the thumbs-down

Celebrations at Satyam Computer Services over a successful completion of restatement of accounts for two financial years — FY09 and FY10 — are proving to be shortlived as analysts take the fizz out of the process.

According to analysts, the restatement has failed to offer clarity on Satyam’s future. In fact, Satyam’s financial health would have a direct bearing on the health of Tech Mahindra, which now has majority ownership in the beleaguered company.

Terming the company’s financial performance, particularly during FY10, as “below expectations,” Nitin Mohta and Atul Soni, analysts with Macquarie Research, said, “key negative surprise for the investors in this result was muted profitability and low headcount base for the company. Since client account ramp-downs for the company took place in 2H FY10, investor expectations for FY11 and FY12 would be revised downwards.”

Though the cash balance of `2,100 crore available with Satyam provides some solace, analysts felt the liabilities have not been fully provided for. “The company has not accounted for liability arising from a class action lawsuit pending in the US. In addition, a `1,200-crore liability claim by different companies owned or associated with the earlier promoter also has not been provided for,” the analysts said.

The restated financials restore normalcy, but progress is likely to slow, JP Morgan analysts Viju K George and Nishit Jasani wrote in their report on September 30. According to them, though there are not too many alarms in the balance sheet per se, the contingencies are significant.

“The erstwhile chairman (Ramalinga Raju) has made claims totalling ` 1,230 crore through various companies for alleged prior advances made to the company. This is under investigation. Provision to the tune of `1,540 crore disclosed in the restated financials amounting to 25% of the balance sheet embeds some conservatism, in our view,” George and Jasani said.

“The employee count has declined from 45,000 as of March 2009 (to 27,470), indicating the severe ramp-down mode that the company was in through FY10. We now estimate the current quarterly revenue run-rate to be about $250-270 million, in line with the employee count disclosures, and expect that the company will end FY11 flat relative to FY10 on revenues as it picks up momentum lost through FY10,” the JP Morgan analysts said.

Slower-than-expected ramp up, higher-than anticipated legal liabilities, rupee appreciation, and protectionism are now being seen as key downside risks.

The proposed merger between Tech Mahindra and Satyam, too, is being seen with a sense of pessimism. Though the company expects the merger to open a new chapter for the activities at Satyam, at least by shedding the name and the negative brand it has been carrying, the JP Morgan analyst said, “We believe that two businesses losing their competitive advantage rarely combine to make a stronger, more robust core”.

“Thus, we believe the merger gives little more than some cost savings on the G&A side. While Tech Mahindra is faced with putting its core business in order, we wonder how can it give productive attention to Satyam, which is also struggling.

Furthermore, Satyam is possibly losing more people in this environment than it is hiring, as the industry is growing faster than Satyam. When employees and management have more options today, we think it is unlikely that they would want to join Satyam. Two weak cores (TechM and Satyam) make a larger core, but not necessarily a strong core, in our view. One can so easily undermine the other as each individually jostles for management attention, resources,” the JP Morgan analyst said.

In a report dated September 30, Bhuvnesh Singh, Sunil Tirumalai and Sagar Rastogi, analysts with Credit Suisse maintained “underperform” rating for Tech Mahindra too. “Tech Mahindra’s 43% stake in Satyam contributes 53% to our target price based on the latest market price of the company. Given a weak core telecoms business and limited visibility on Satyam, we maintain our ‘Underperform’ rating. We also reduce our estimates for Tech Mahindra (standalone) by 9%/16%/17% for FY11/12/13, respectively, as we cut our growth forecasts for the TechM’s core telecoms business and align our currency estimates to the latest CS forecasts,” the three analysts said.

Morgan Stanley analysts Vipin Khare and Gaurav Rateria see some risks in Satyam despite being positive on numbers that were disclosed for FY09 and FY10.

The key risks according to the analysts are —- despite stating FY10 financials, the management has been unable to compile complete details on financial irregularities in prior periods. It did not offer clarity on tax related issues from prior-period issues/ losses either. Besides, the outcome of monetary relief related to class action complaints and SEC proceedings remains uncertain.
Surendra Goyal and Vishal Agarwal of Citi have maintained a negative view on Tech Mahindra. “Our negative view on TechM was premised on (a) Core business of TechM still being sluggish, (b) Low visibility on Satyam’s financials and (c) Tough supply side situation in the sector. More clarity on current margins should emerge when Satyam reports quarterly results on November 15.

However, there are downside risks to Satyam’s margin assumption built in to our report, we believe. Also, clarity over Upaid (the tax liability issue) and class action lawsuits remains. We remain Sellers of TechM,” the Citi analysts said.