The stock market, in its enthusiasm about Satyam Computer Services Ltd’s financial results, seems to be overlooking one little detail.
The same information was provided to bidders such as Tech Mahindra Ltd, Larsen and Toubro Ltd (L&T), Cognizant Technology Solutions Corp., and billionaire investor Wilbur Ross a little over two months ago. These strategic investors weren’t half as excited about Satyam’s financial condition. Cognizant pulled out of the bidding race; Ross bid Rs20 per share; and L&T bid Rs45.90. Tech Mahindra, of course, won the auction with a bid of Rs58 per share, which a number of analysts and experts felt was expensive.
The markets, meanwhile, are euphoric that the company’s operating margin is much higher than the 3% level B. Ramalinga Raju suggested, and that the annualized revenue run-rate for the January-February period is higher-than-expected at $1.7 billion (Rs8,092 crore today). Satyam shares were locked at the circuit limit of Rs66.80 on the National Stock Exchange. Going by the rise in Tech Mahindra shares (up 25.6%; no circuit breakers apply since derivatives trading is permitted on this stock), it looks like Satyam would at least reach the Rs80 levels. That’s about double the average of the three strategic bids made in April which, to reiterate, were made based after studying the very same data.
It’s also important to note that things had worsened by mid-April, when the acquisition was announced. Tech Mahindra had said then that it had estimated Satyam’s annual revenues at around $1.3 billion. In constant currency terms, that is, adjusted for the depreciation in the dollar, this represents a fall of about 20% from the levels reported for January and February. Also, while Satyam has reported an impressive 17.5% operating margin for the month of February, that needs to be taken with a pinch of salt considering that Tech Mahindra had indicated at the time of the acquisition that margins were in single digits.
Considering that things may have changed drastically since the situation in January and February, these results shouldn’t be given much importance. Still, the data release has allayed the markets’ worst fears, and this is what is reflected in the sharp rise in shares.
On firmer ground? Satyam’s headquarters in Hyderabad. Krishnendu Halder / Reuters
What’s more important is how the company performed during the June quarter, and in particular the months of May and June after the acquisition was completed. A recent report by IIFL Capital, the institutional broking arm of India Infoline Ltd, states that there are signs of stability in Satyam’s client base, after the initial spate of client losses. According to the brokerage, the company’s revenues should settle at $1.3 billion this year. The slide in revenues has abated owing to proactive steps by senior management to reassure clients. As one analyst puts it, “Clients have proven to be more sticky than investors in the case of Satyam.” But as far as profitability goes, IIFL expects an operating margin of just 4% this year, which it expects to increase to 14% in the next fiscal once the cost-cutting measures bear fruit.
But before rushing in to buy Satyam shares, investors must also keep in mind that the firm could end up with huge legal liabilities. Until recently, buying Tech Mahindra shares was a less risky way of buying into the Satyam turnaround story. But with the company’s valuation now having risen to nearly 20 times the current year’s earnings, even an investment in Tech Mahindra would be risky, especially since the worries relating to its top client BT Group Plc. (previously known as British Telecom) remain.
With Satyam now trading at Rs66.80 and set to reach much higher levels, there are likely to be no takers for Tech Mahindra’s open offer to buy a 20% stake from minority shareholders at Rs58. The offer will be open from 12 June till 1 July. This could lower Tech Mahindra’s cash outgo for the acquisition by Rs1,154 crore. The company was estimated to have raised debt of around $425 million to fund the Satyam acquisition and it would be tempting to lower the financing burden.
What’s more, the company can control Satyam even with a 31% stake, and it would be easier to walk away in case legal liabilities end up being much higher than expected.
Of course, the company still has the option of increasing its stake by subscribing to a fresh issue of shares using these funds. But even that may be a comparably better option, considering that the funds would flow into Satyam. Note that until the time of the acquisition, Satyam had been strapped for cash. The initial issue of shares to Tech Mahindra led to an infusion of about $370 million into the company, and if it plans to increase its stake further, there could be inflows of another $245 million.
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