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Tech Mahindra irks analysts on accounts

Tech Mahindra irks analysts on accounts
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First Published: Mon, Jan 25 2010. 11 54 PM IST

Restructuring issue: Vice-chairman of Tech Mahindra Vineet Nayyar.
Restructuring issue: Vice-chairman of Tech Mahindra Vineet Nayyar.
Updated: Mon, Jan 25 2010. 11 54 PM IST
Mumbai: Tech Mahindra Ltd, the software company that took control of fraud-hit Satyam Computer Services Ltd in a government-backed rescue, has come under attack from analysts over an accounting decision separate from the acquisition.
Restructuring issue: Vice-chairman of Tech Mahindra Vineet Nayyar.
Their ire was shared by investors as shares plunged 7.38% to Rs1,051.60 each on Monday, having fallen as much as 9.6% during the day. The benchmark equity index, the Bombay Stock Exchange Sensex, was down 0.47%, while the BSE IT index fell 1.31%.
At issue is £126 million (Rs938.7 crore) that the firm received in the third quarter from its largest client BT Group Plc for restructuring a long-term contract that both had entered into in December 2006.
Analysts said the amount should “ideally” have been accounted for in a single quarter as a one-time event. Tech Mahindra’s management maintains that the company is well within permitted accounting practices to recognize the revenue in parts, spread evenly across every quarter across the remaining four years of the contract.
Indian information technology companies have traditionally enjoyed flexibility in recognizing revenue over the several quarters and years that contracts run.
The rules on how the money should be accounted for are clear, said Kanu Doshi, managing partner at Kanu Doshi Associates, a Mumbai-based corporate audit services firm.
“What is critical is whether the payment is a compensation for restructuring the contract or an advance payment for future services to be delivered,” Doshi said. “If it is compensation, then it has to be accounted for in the current fiscal and if it is advance payment, then accounting rules permit amortising the amount over a period of time.”
Tech Mahindra has recognized Rs150 crore of the payment—unveiled on Saturday along with earnings for the three months ended December—in the first three quarters of the current fiscal year. The rest will be accounted for at Rs50 crore each in the coming quarters until the contract ends in 2014.
Analysts said this will inflate revenue and profit margins in a way that is not an accurate representation of?performance.
Tech Mahindra rejected the contention in an emailed response to questions.
“Certain long-term contracts have been restructured and the restructuring fee we have received is for modifying these contracts,” the company said. “Services will continue to be provided over the life of the contract and our auditors, after reviewing the transaction, have advised us that as per accounting standards the appropriate treatment is to amortize the fee over the life of the contract.”
As the payment from BT is a one-time payment of a non-recurring nature, amortizing it over several quarters and including it in the “operating revenue line, which also reflects in the profits” is “a slightly aggressive accounting policy”, Hitesh Shah, an analyst with IDFC-SSKI Securities, said during an earnings call with the company management on Saturday. Shah didn’t want to comment further.
Tech Mahindra executives spent nearly an hour on the call with analysts fielding queries on the issue, offering to discuss the matter “off line”.
“I’m sorry that this BT restructuring issue clouded the entire discussion,” Tech Mahindra vice-chairman Vineet Nayyar said in his concluding remarks. “I do recognize that it has not yet been fully comprehended by some of the analysts. Perhaps we have fallen short in making an explanation.”
All five analysts that Mint spoke with on Sunday, four of whom had second conversations with the management, were still unsatisfied with the explanation. One of them said that such accounting may “inflate revenues and profitability in the coming quarters”.
The analysts requested anonymity because of the sensitivity of the issue.
“When you amortize this amount over the next five years, it comes straight down from the revenue to profits, because you are not incurring any expenses on that,” said an analyst with a Mumbai-based brokerage. “That skews the revenue and margins and may not be an accurate representation of the firm’s operational aspects.”
Analysts also point to two advance payments to BT of about Rs400 crore each in fiscal 2007 and 2008 that were not amortized over several quarters. They were upfront payments towards the savings that Tech Mahindra promised BT.
Tech Mahindra chief executive Sanjay Kalra said the two were separate events.
Analysts Bhavtosh Vajpayee and Nimish Joshi of CLSA Asia Pacific Markets recommended in a 25 January note that investors sell the stock.
“While this payment does ease certain near-term cash flow concerns for Tech Mahindra (Rs450 crore has been used to repay debt), the longer-term implications of this seem adverse,” as the firm “has agreed to severe pricing discounts against this payment and this will likely cloud future finance,” they said.
According to CLSA analysts, if the one-time payment was considered as an exceptional item and not as a revenue item, revenue for the December quarter would have declined 0.4% sequentially as opposed to the reported growth of 4%. Similarly, operating profit margins would have shrunk by 5% sequentially as opposed to the reported 2% decline.
Analysts said they would make their own adjustments on revenue and margins to make growth forecasts and investment recommendations.
“Investors should ideally look at operating cash flow rather than the profit and loss account to evaluate operational performance,” said Saurabh Mukherjea, head of Indian equities at Noble Group Ltd, who was speaking in general and not with specific reference to Tech Mahindra.
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First Published: Mon, Jan 25 2010. 11 54 PM IST