Satyam Computer - Open Offer

Investors who hold shares of Satyam Computer Services can reject the open offer made by Tech Mahindra. The offer price appears unattractive in the light of Satyam’s future prospects, with the recent financial disclosures showing the company’s financial position to be much better than expected.

The open offer price of Rs 58 is at a discount of 27 per cent over the current market prices of Rs 80 per share. The short-term capital gains tax that investors would incur while tendering their shares (as opposed to open market sales) also makes the offer unattractive.

At the offer price of Rs 58, the stock discounts its likely per share 2008-09 earnings by 8-9 times. This is at a steep discount to all other top tier IT companies (which trade at 14-16 times), which may have been justified if, as Mr Ramalinga Raju had claimed, Satyam were a company with an operating margin of just 3 per cent. But the financials declared for the December 2008 quarter and for January and February, which may not be final given that it is yet to be audited, show a margin of 12 per cent. The revenue size and the fact that the company is profitable at the net level in the December quarter as well as the months of January and February may necessitate a better valuation.
Encouraging financials

The provisional financials disclosed to the exchanges show that, contrary to expectations, Satyam Computer’s revenues for 2008-09, taking its monthly collections run-rate, could be $1.9 billion. That is only slightly less than HCL Technologies’ revenues.

These disclosures show that average monthly collections starting from April 2008 leading up to February 2009 have been Rs 811 crore. After Mr Raju’s confession early in January, the monthly run-rate of receivables has come down to Rs 670 crore levels. Even taking this to be a representative figure, Satyam would still be a $1.3-1.4 billion company.

The operating margin for the December quarter was 12.5 per cent, it dipped in January, but came back to that level in February. The net profit margins too, at around 8 per cent, though below the industry standards of 15-27 per cent, are better than expected. This could be partly ascribed to the fact that there may have been a large number of un-billed employees. To address this problem, Tech Mahindra has initiated a ‘virtual pool’ of employees who are unbilled.

Under this process, 7,000-10,000 employees will not work for the company but will be on its payrolls, with only their basic salaries (plus provident fund and medical insurance) being given for up to six months.

This move has the potential to bring down employee expenses drastically and take the net profit margin to over 11-12 per cent levels over the next year or so. That would make it again comparable to HCL Technologies in terms of its margin profile, especially after its acquisition of Axon. Incidentally, HCL Technologies trades at 15 times its trailing earnings.

Being an off-market transaction, the shares, if tendered, would suffer higher than usual short term capital gains (at 30 per cent), if the shares were held for less than a year or a long-term capital gain if held for over a year.

Over the next couple of years, Satyam investors can also look forward to reaping the synergy benefits from Tech Mahindra and revenue and margin improvements from a restructured organisation. The disclosed financials give a value of Rs 1,085 crore for the entire fixed assets owned by the company as of December 2008. This gives a value of Rs 11 per share for Satyam. The market value though may be much higher (Rs 1,700 crore levels) for the 125 acres of land that Satyam owns, as indicated by one of the Government appointed directors in April. One may have to factor in a loan of Rs 300 crore taken against this, though.

The lawsuits, including that of the Upaid case and claims from several companies (37 of them), together, have the potential to necessitate an outflow for Satyam to the tune of over $1.5 billion.

If this is taken out of Satyam’s cash flows, this may be the key downside for the company. The challenging outlook for the IT sector as a whole also presents a key risk. Given these uncertainties, risk-averse investors not willing to take a long-term view may consider selling the shares in the open market.

via BL