Investors with a medium term perspective can consider taking an exposure in the Patni Computer Systems stock. At the current market price, the stock is trading at a price earnings multiple of 23 times its calendar 2006 per share earnings (including additional tax provisions).
Given the competitive intensity in software services among multinational and domestic frontline vendors, investors may have to moderate their return expectations from the stock. Any price weakness linked to the broad markets can be used as an opportunity to step up exposures. Patni Computers is set to benefit from factors such as higher contribution from new client acquisitions, improving operating margins arising from cost optimisation and new service offerings such as product engineering and enhanced revenues from the European geography. Since the demand environment is likely to remain strong, it will play to Patni's strengths in telecom and insurance.
Patni's four key verticals: Manufacturing, insurance, telecommunications and financial services have each grown to a size of $ 80-130 million, with strong anchor clients. This trend is likely to help the company consciously diversify its clientele base beyond the top ten clients. For the fourth quarter ended December 31, 2006, Patni has recorded an improvement in operating profit margins to 17.5 per cent, aided by higher utilisation and lower general and administrative expenses. For the full year, Patni has improved its employee utilisation by 4 percentage points to 71.4 per cent. It is also in the process of broadening the base of its employee pyramid by recruiting more employees at the entry level. From an operational standpoint, the biggest area of concern is attrition, which has risen to 27.4 per cent in the fourth quarter, up from 24.5 per cent the preceding quarter. The contribution of General Electric, its biggest client has been coming down steadily. For the fourth quarter of 2006, it stood at 13.5 per cent of revenues, down from 14.1 per cent on a sequential basis.
Any additional kicker to financials may come from acquisitions in Europe. The last acquisition made by Patni was of Cymbal Corporation in 2004 to foray into the telecom vertical. The key risks to our recommendation are intense competition, anti-outsourcing backlash, managing attrition/wage inflation and appreciation in the rupee.