Tech Mahindra catapulted itself into the big league of IT vendors after it won the bid to acquire a controlling stake in Satyam Computer Services. While the deal at the bid price of Rs 58 per share may bring some cheer to Satyam’s shareholders as it brings to end a host of uncertainties, Tech Mahindra has a tough task on its hands, given that Satyam’s revenues and client-base is diminishing slowly.
Positively, Tech Mahindra’s management track record and IT experience provides comfort and should prove handy. Even as the coming together of Satyam and Tech Mahindra is complementary, there are issues of integration besides, how legal liabilities of Satyam will pan out going forward.
Diversification benefits
The acquisition catapults Tech Mahindra to the top-tier of IT companies with combined revenues of $2.5 billion. Notably, as the company caters to the needs of the telecom industry, the acquisition of Satyam also comes with minimal business overlap. More than half of Tech Mahindra’s business comes from British Telecom.
Thus, the acquisition of Satyam, which has exposure to verticals like manufacturing, healthcare, financial services, auto, apart from telecom, will help to diversify its revenue streams. There are benefits of geographical diversification, too (see table). Tech Mahindra will now be able to expand its footprint in other major markets of North America. Experts also opine that the two companies could leverage their respective infrastructure and client base to grow the combined business but, gains would accrue only in the long-term.
However, considering the current IT market conditions, the deal is a tad expensive. Says Anurag Purohit, IT analyst, Religare Hichens Harrison, “Considering Satyam’s annual revenue of $ 1.5 billion and earnings before interest and tax margin of 3–4 per cent, it puts the Rs 58 per share bid at an EV/EBIT of around 23 times as compared to 9-12 times of larger peers like Infosys and TCS.”
Immediate concerns
Even as there are synergies and gains to be made from the deal, what’s equally important in the immediate-term, experts feel, is to retain existing clients. That’s because, Satyam has been gradually losing clients as well as revenues; the run-rate is down from $1.8 billion to $1.5 billion in FY09 and is expected to slip further to $1.3 billion in FY10.
Says an analyst, “Due to BT’s (telecom operator) sizeable stake in Tech Mahindra, it could also give rise to concerns among its competitors, which are currently outsourcing their work to Satyam.” Among other things, the new management will also have to address the issue of integration of operations of the two entities, if it has to extract sizeable gains from the acquisition.
Operationally, too, there is a lot to be done. Tech Mahindra has been able to maintain operating profit margins (OPM) of around 28 per cent, against the industry average of 20 per cent. However, Satyam’s OPM is expected to be around 3 per cent. Apurva Shah, VP & head of equity research, Prabhudas Liladher says, “Satyam’s margins will certainly start improving once Tech Mahindra takes over management control.
But, getting them up to a respectable 15-20 per cent level will take a long time.” The lower OPM of Satyam is on account of subdued utilisation levels, higher bench-strength as well as low billing rates. With cost cutting being the mantra for IT clients, there wouldn’t be any joy on the billing rates front.
Thus, Tech Mahindra may have to take other measures including rationalising Satyam’s work force. Says Nitin Padmanabhan, analyst, Centrum Broking, “A retrenchment of 7,900 employees can increase operating margins to around 13 per cent from the current levels; however, we believe this would be time con uming process as the company is unlikely to be able to initiate a mass layoff.”
Another concern that analysts cite is the expected increase in Tech Mahindra’s debt levels. For a 51 per cent stake, Tech Mahindra has to pool in Rs 2,900 crore. With an estimated cash of Rs 700 crore in its books, the company will have to raise Rs 2,200 crore to fulfil the commitments.
The infusion of debt in Satyam may well take the standalone debt-equity ratio for Tech Mahindra to 1.1, (estimated net worth of around Rs 2,000 crore for FY09). Interest payments for the debt would further drain profitability and would limit the benefits to Tech Mahindra. Tarun Sisodia, head of research of Anand Rathi says, “Tech Mahindra would secure about $1.5 billion in revenue from the acquisition, at 9 per cent EBITDA margin this translates to an incremental EPS of Rs 25. In the event of debt financing, this would be reduced to Rs 8 for 51 per cent of Satyam’s profit when consolidated with Tech Mahindra.”
| PERFECT COMBINATION | |||
| (as %age of revenues) | Tech Mah | Satyam | Combined |
| Vertical-wise | |||
| BFSI | - | 20.5 | 12.1 |
| Manufacturing | - | 23.3 | 13.7 |
| Telecom | 92.0 | 23.6 | 48.0 |
| Health | - | 7.0 | 4.1 |
| Retail, Trans & Logistics | - | 29.4 | 5.5 |
| Others | 8.0 | 16.3 | 16.7 |
| Geography-wise | |||
| North America | 26.0 | 62.0 | 47.3 |
| Europe | 65.0 | 20.6 | 38.8 |
| Rest of the world | 9.0 | 17.4 | 14.0 |
| Prominent clients | BT AT&T | GM, Citi, Cisco, GE, Nestle | |
| Source: Analyst reports | |||
Conclusion
The acquisition will help Tech Mahindra garner incremental revenues from Satyam at a time when its own core business is facing the prospect of declining volumes and pricing pressure from BT (accounts 60 per cent of revenues currently). In the near-term, the prospect of Satyam, which is also experiencing a declining revenue scenario on account of loss of clients, does not look bright and a turnaround by all counts is crucial. However, experts feel that benefits from the Satyam acquisition will filter from FY11.
In the meantime, Anil Advani, head of research, SBICAP Securities says, “for Satyam shareholders, they can tender their shares in the open offer and hold on to the rest for a potential upside in the long-term.” The advice to tender shares in the open offer is not surprising, given the uncertainties pertaining to legal liabilities of Satyam (Upaid and several class action suits).
Although analysts’ current estimates are lower (ranging $100-400 million) as compared to earlier ($1 billion), whenever and if they occur, Tech Mahindra may have to arrange for additional debt, which could put pressure on an already leveraged balance-sheet. Hence, only those investors with patience and some risk appetite, may choose to enter at lower levels with a horizon of two years to benefit from the Satyam acquisition.
