I will be publishing the analysis in multiple parts.

About
Patni is an IT services company similar to Infosys, WIPRO and other companies in the same industry. The company derieves a major portion of its revenue from the US. The main industry segments in which the company operates are Financial services, insurance, manufacturing and media.

The key feature of the business model is offshoring. Indian IT services company provide a cost advantage to the customer by executing the work in low cost locations such as India.

Financials
The company has been doing fairly well financially for the last couple of years. It has been able to maintain its ROE in excess of 15% over the past 5 years. The calculated ROE is depressed due to high cash on books (running almost 1400 Crs now). The company had a good topline growth till 2005, which slowed down in 2007 and 2008. However it has still been able to pull off a double digit growth for 2008.

The net margins has dropped from around 20% to around 13% levels due to forex losses. The net margins are not as high as the Tier I companies such as infosys, but still at healthy levels.

The net profit growth has been fairly erratic in the last few years due to the forex changes. However the profit has doubled in the last 5 years inspite of the major changes in the market such as recession, flucutations in the Rupee-dollar rates  and increases in the salary etc.

Positives
The company has a fairly healthy cash flow and the same is visible via the strong level of cash on the balance sheet. The company has had a moderate growth in the topline and bottomline numbers.

The company is also growing faster in the non US markets and thus reducing the dependence and contribution of the US markets.

The company recently completed a buyback of almost 10% of its equity at around 210 Rs per share. Thus the company has been able to buyback its shares at a fairly discounted price and thus add value to the exisiting shareholders. This buyback is however partly offset by almost 1 Cr ESOP outstanding for employees which would increase the dilution.

Negatives
The are several negatives with the company. The company performance has been average and has not been of the level of the tier I vendors. As a result the company will not get the valuations of its more successful competitors. The company has had a decent performance, but on a comparitive basis it is poorer than the tier I vendors.

The other negatives is the stock options plan of the company. The earlier stock option plan was almost 5% of the equity. However in 2008, the plan was converted to a RSO (restricted stock options) plan with a strike price of almost Rs 2 / share. The irritating part is that the proposal was approved without the management specifying if the ESOP numbers will roll into the RSO plan. If that happen,I am looking at a reduction of almost 150 Crs (6-7 Rs/ share) in the value of the stock. This may not be huge, but it is irritating to see the company change the plan at the expense of the shareholders.

Risks
The company shares the usual risks faced by the other IT companies such as recession, protectionism in developed markets, cost escalation and competitive pressures from other IT vendors – both indian and foreign.

Next post : competitive analysis, Management quality, valuation and conclusion.

12 Comments

  1. KD says:

    Dear Rohit,
    This other site also looks neat & clean. Only the earier one looks sharper, may be due to familiarity with that. Enjoyed your posts, as usual. Thanks.
    Ketan

  2. Vikas says:

    Hi Rohit,

    This site seems slightly crispier. I like both as they are clutter free.

    thanks for the analysis.

    Vikas

  3. Vikas says:

    I like the name.. rcfunds..:-) Well..that the first step..:-)

    It reminds me of Robertson Stephens Funds, company that I worked for in SF downtown. The year was 1998, RS and Montgomery Securities were the leading Investment Management firms in SF at that time.

    Some sweet memories..:-)

    Vikas

  4. admin says:

    Hi KD
    the earlier look was sharper, due to the darker fonts possibly. i personally have zero programming skills and will probably take professional help to improve my blog

  5. admin says:

    Hi vikas
    thanks for the feedback. i have tried to keep the clutter down consciously.
    rcfunds is proposed name of the funds i wish to start 🙂 so it is a first step in the direction.
    didnot know that you worked with an investment funds. would like to discuss with you about it ..can you send me your email ?

  6. Vikas says:

    Come on Rohit, you have my email aleady..:-) :
    vic_rana@yahoo.com

    I worked in IT, crunching numbers for Fund Managers.:-)

  7. admin says:

    dude ..you keep changing your name 🙂 usually you use vic ..changed it to vikas here.

  8. Vikas says:

    It is either Vic or Vikas..:-) No other change. 🙂

  9. siddharth shukla says:

    Hi rohit,
    Gr8 analysis as always. However i have a generic doubt regarding all your posts. As value investors shouldn’t we be looking at the cash flow rather than GAAP earnings???Why do u use ROE rather than something like CROCE or CROIC. Also even if u do look at GAAP earnings doesn’t looking at ROIC and ROCE make more sense than just looking at ROE. If the numerator in ROE is prey to accounting gimmicks, then how can one rely on these numbers(even cash flow can be facked tough,but it isn’t that common). I would be glad if you could answer my queries.

  10. admin says:

    Hi siddharath
    you are correct. cash flow is more accurate and should be looked at. In the DCF i do on my spreadsheets i do use FCF instead of earnings. however i use earnings as a short cut instead of earnings..in a lot of cases it is close, but in some cases such as capital intensive industries it is not. i however make those adjustments in my head and look at valuations accordingly.

    Also ROIC and ROCE are important too ..however i am looking at low to nil debt companies and hence both these numbers are close.

    in case of patni and several other companies, i have not done detailed DCF as the companies are so undervalued (@ 3-4 time earnings) that a 20-30% error would not matter as long as i get the basic thesis right, there is no accounting fraud and the management doesnt screw up big time.

    in most cases i am looking at low debt companies, with low capex requirement, decent cash flow and decent accounting. these are sort of filters in selecting an investment. as a result a lot of companies with poor cash flow get knocked off.

    however you point is very valid for high capex companies and the DCF should be based on FCF. however in interest of simplicity in my post, i use earnings

  11. admin says:

    Hi vikas/ vic

    now i know ..will watch for it 🙂

  12. […] initiated the analysis of Patni computers in my last post. The rest of the analysis […]

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