Three years ago when Tech Mahindra Ltd emerged as the highest bidder for Satyam Computer Services, it was seen as an effort to rescue the fraud-hit company. In hindsight, it’s clear that Tech Mahindra needed Satyam as much as Satyam and its stakeholders needed the former.
The merger proposal of the two companies makes clear that the Satyam acquisition has contributed significantly to Tech Mahindra emerging as a large, diversified information technology (IT) services firm. On its own, Tech Mahindra was pretty much on a road to nowhere. Its stand-alone performance in the past three years makes this amply clear.
TechMahindra’s campus in Pune.
Revenue has grown at an annual average rate of 5.8% in the past three years in dollar terms, significantly slower than the 20% growth in industry revenue reported by Nasscom. The trend in profit growth is far worse. Earnings before interest, taxes, depreciation and amortization (Ebitda) have declined at an annual average rate of 10%. In the 2008-09 fiscal year (FY09), Ebitda stood at $266.6 million (Rs 1,340 crore today), after adjusting for a tax write-back. The annualized Ebitda for the first nine months of the current fiscal year stands at $194.4 million. Investors have evidently been disgruntled. Adjusted for the value of its 42.65% stake in Satyam, Tech Mahindra’s market cap has risen by merely 11% between the time of the Satyam acquisition and until news of the merger hit the Street. During the same time, the CNX IT index has risen by 151%.
Satyam’s financial statements aren’t easily comparable over a three-year period because of various one-off costs and write-offs. But the company’s turnaround is evident in this year’s performance. Using the annualized numbers for the first three quarters, revenue is 22.6% higher than in FY11, and Ebitda has more than doubled. Satyam’s Ebitda is now 8% higher than Tech Mahindra’s. Only a year ago, it was less than half the size of its parent company.
Besides, it’s not only the growth numbers that are skewed in favour of Satyam. It is also much better placed with respect to client and industry diversification. Tech Mahindra caters solely to the telecom sector and just one client, BT Group Plc (also a major shareholder), accounted for 38% of revenue in the past year. Satyam’s top client accounts for 10% of revenue and it caters to various industries. It gets around 32% of revenue from the manufacturing industry, and around 20% each from technology, and banking and financial services.
The merger will provide much-needed diversification for Tech Mahindra shareholders. What’s more, BT, which has been a drag on the company’s performance, will now account for only around 17% of revenue. According to an analyst with a foreign brokerage, from a Tech Mahindra shareholder’s perspective, the company’s business risk gets alleviated thanks to the merger with Satyam. The latter’s diversified IT services business is much better placed in relation to the parent company’s telecom focus.
Keeping these factors in mind, another analyst at a domestic institutional brokerage said that the share-swap ratio seems to be a bit unfair to Satyam shareholders. He said a ratio of eight shares of Satyam for every one of Tech Mahindra would have been more appropriate. The two companies have announced a ratio of 8.5:1. At current prices, the value of one Tech Mahindra share (Rs 682.50) amounts to 8.8 Satyam shares (Rs 77.40/share). If the ratio had been 8:1, Satyam shares would have traded 10% higher at Rs 85.
Apart from its superior growth profile and diversified business model, Satyam also brings with it a decent cash pile of around Rs 2,000 crore, unlike Tech Mahindra, which has a net debt of more than Rs 1,000 crore. In addition, the management has chosen to create treasury shares (worth Rs 1,500 crore at current valuations), which can be used for acquisitions.
The merger, therefore, is beneficial to Tech Mahindra shareholders in more ways than one. The combined entity will have revenue of around $2.4 billion, which will increase the scope of the projects it can bid for. It’s little wonder that the combined value of the two firms has risen by 10% since news of the merger hit the Street. This is after adjusting for Tech Mahindra’s stake in Satyam.
The combined entity is now valued at around 11 times estimated earnings for FY13, up from 10 times two days ago. A further re-rating will depend on the company’s ability to demonstrate tangible synergy benefits to investors.
This is a corrected version of an earlier story