Mahindra Satyam Ltd’s shares are a good example of excessive optimism on the Street. The shares have doubled in the past three months and have risen by 250% in the past six months. At the current share price of Rs122.65, the company trades at a valuation of 14.5 times estimated earnings for the year till March 2011. This represents a valuation discount of about 20% compared to Infosys Technologies Ltd and a premium to HCL Technologies Ltd, which is a much larger firm.
News reports suggest that business didn’t deteriorate as badly as some analysts had estimated. Besides, the company has been winning some large deals lately. In July, the company announced that it had won a five-year multi million dollar deal from GlaxoSmithKline Plc. While these are positive signs, they are insufficient to justify such as sharp rise in valuation.
For one, high-profile exits continue to happen at the company. Recently, Keshab Panda, a senior vice-president at the company with the responsibility of business development and delivery for the Americas region quit the company. According to an analyst with an institutional brokerage, a high number of senior executives have left the company in the past few months and this would hurt the company’s ability to retain clients. So while client attrition reduced considerably after Tech Mahindra Ltd took over the troubled company, it still can’t be said for certain that it has stopped completely. When contracts come up for renewal, some clients may well choose to disassociate with the company, especially in cases where senior account managers have moved on to other firms. Besides, while competitors weren’t aggressively pursuing Satyam’s clients soon after the fraud, they wouldn’t be lenient any more. This could either result in the company losing some clients or having to lower its billing rates.
Graphics: Ahmed Raza Khan / Mint
Mahindra Satyam’s current valuations don’t factor in this risk. On the contrary, current valuations factor in a rather rosy picture. Citigroup Research recently questioned in one of its reports why Mahindra Satyam should trade at a premium to HCL, which is not only a bigger firm, but also has a better mix of service lines. Citi’s analysts noted that their valuation of Satyam was based on aggressive assumptions that the company’s revenue would rise to $1.5 billion in the fiscal year 2011 compared to current levels of $1.3 billion. It also assumed that the company’s operating profit margin would rise to 20%. The possibility of the company under-delivering on both these counts is rather high and so investors are likely to be in for a big disappointment.
Likewise, Tech Mahindra’s shares, which derives a large part of its value from the Satyam investment, may also correct, as and when the latter’s valuation reverts to realistic levels.
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