The right steps

POUND WISE

Patni Computer, a laggard in the IT services business, is now trying to get its act together. A report.

Patni Computer Systems (Patni) is not a darling of the bourses. The reason is simple. The company's guidance for the December 2006 quarter is flat and analysts, in general, do not expect the situation to change dramatically for at least another two quarters.

In the September 2006 quarter, Patni posted a q-o-q consolidated revenue growth of 6.3 per cent to Rs 697.1 crore ($151.7 million) and an operating profit increase of 46.7 per cent, adjusting for the extraordinary items in the June quarter.

However, the net profit growth at 33.7 per cent q-o-q to Rs 102.4 crore was slightly muted as compared with the operating profit growth. However, the operating profit margin improved by 456 basis points q-o-q to 16.54 per cent in the September 2006 quarter.

During the September quarter, the company faced a churn in two of its Top 10 clients, lower discretionary spend in one of its BFSI clients, and its telecommunications business which saw a 9 per cent sequential drop.

The management may not be able to wish these issues away in a hurry. It's no wonder then that Patni officials have predicted that the company's net profit will touch $20.4-20.6 million (in the range of Rs 92-94 crore) on revenues of around $152 million (around Rs 692 crore) for the December quarter, marginally below the September quarter revenues.

IT majors are used to posting 10-15 per cent q-o-q growth rates so it's a no-brainer that a 'flat' fourth quarter is bound to disappoint investors. And if one looks at a three-year CAGR (compounded annual growth rate) of the IT majors in this space, Wipro tops with 26.25 per cent, Infosys comes second with 25.64 per cent followed by Satyam with 23 per cent. Patni falls behind with a three-year CAGR of 18.22 per cent.

...but the management is positive
Despite the disappointing outlook for the fourth quarter, chairman and CEO Narendra K Patni hopes that his company will become a $1 billion company in the next two years.

Where does his optimism stem from? "We will stress on existing verticals rather than new verticals. We are also looking for small acquisitions to complement our existing services. Our non-ADM (applications, development and maintenance) services are growing well--from 20 per cent a year to almost 40 per cent a year," he says.

Last year, the company hired 16 senior management people. Of them, 14 were not Indians. The company is currently looking at China to cater to its customers that have Chinese operations.

It plans to set up a global delivery centre in China by 2007 towards this end. It also has Brazil on the radar so that "when India goes to sleep, Brazil wakes up", ensuring that it's a 24x7 global operation for the financial markets.

"Besides, only around 20 per cent of our workforce is in low-cost areas," says Narendra Patni while highlighting the "cost-advantage" the company enjoys.

"We are looking at the European markets (accounting for around 9 per cent of its present revenues). Japan is an interesting market too," corroborates Mrinal Sattawala, Patni's COO, adding "Product engineering accounts for 65 per cent of our business in Japan."

Product engineering accounts for $57-58 million of Patni's total revenue (major competitor is Wipro)--around $75 million if software development revenue is included. In India--not really a focus area with only around $3 million in revenues--the company concentrates on enterprise application integration (EAI), product engineering and niches around the financial and insurance sectors.

Its BPO (business process outsourcing) offering to clients accounts for close to $12 million (around 850 seats). Last fiscal, its revenue was around $5 million. Non-voice business accounted for nearly 70 per cent of the revenues.

During the September quarter, Patni's biggest customer remains General Electric (GE). However, its contribution to the revenue has dropped from a high of 43 per cent to the current 14.1 per cent over the years (14.5 per cent in the second quarter). 
 

IMPROVING NUMBERS
Rs crore	Sep-06	June-06 *	Change (%)
Revenues	697.10	656.10	6.25
Cost of revenues	434.40	427.60	1.59
Operating profit	115.30	78.60	46.69
OPM	16.54	11.98	456 bps
Net profit	102.40	76.60	33.68
* Adjusted for extraordinary items

The GE business grew by a modest 3.3 per cent q-o-q. Revenue concentration of top 10 clients also fell to 51.6 per cent from 54.1 per cent in the previous quarter. The company's total number of active clients stood at 235 (220 in the second quarter) during the end of the quarter. It acquired 27 new clients during the quarter.

The September quarter did have its upsides. Patni got the highest customer satisfaction rating among Indian offshore supply chain solution providers in a Forrester survey that queried 167 supply chain decision makers in North America. 
 

FINANCIAL SNAPSHOT
(consolidated %,  As per US GAAP)	2003	2004	2005
Revenues growth	33.30	30.10	37.90
Operating profit growth	8.00	39.30	15.80
Net profit growth	38.50	25.30	11.30
EPS growth	78.30	13.40	8.90
Operating profit margin	17.40	18.60	15.60
Net profit margin	17.40	16.70	13.50

Sore point
Attrition remains a serious concern for the company. While the attrition rates (excluding BPO) stood at 17.3 per cent in 2005 (high as per industry standards), they zoomed to 24.5 per cent in September 2006.

Milind Jadhav, Patni's senior VP and head-HR, explains that it is employees with 0-3 years (47 per cent) and 1-3 years (29 per cent) of experience that rock Patni's boat.

"We are addressing the issue by hiring people closer to home since there's a tendency for employees from other locations to go back due to home-sickness and other reasons. We hope to reduce the attrition rates by a significant number over the next two-three years," says Jadhav.

Will it pay off?
Offshoring in general has not been affected by the "US slowdown". In fact, IT and ITeS are expected to touch $60 billion by 2010, according to Nasscom. And the billing rates of IT majors has been seeing a positive trend.

What will also work in favour of it, company officials claim, is that most CIOs prefer leveraging multiple vendors for specific project requirements with work competitively distributed. The trickle-down effect is bound to show up in Patni's top line and bottom line.

Second, Patni is a strong player in the product engineering space, which Wipro has a presence in (around 30 per cent of revenues). The company's foray in China, Brazil and Japan too should also pay off in the coming months. Besides, the addition of 16 senior management people should help the company solidify its management strategy.

The Patni stock trades at about 25 times CY06E earnings and 15 times CY07E earnings, which is at a discount to the tier-I IT companies which trade at about 28-30 times FY07 EPS estimates and 22-25 times FY08 estimates.

The discount is not inexplicable""Patni has had a chequered financial performance. Obviously, the company will require time to get this act together. And it appears to be getting there. Whether investors will have the patience to hold on is another matter.