Share buyback consideration- an attempt to restore investor confidence
Do not rule out a near term rally in the stock on announcement
Events of the past week can be used by competition against Satyam
‘Low market cap, high cash balance’ could still appeal to strategic/financial
investors
Could more steps to bring back investor faith be in the offing?
Share buyback consideration-attempt to restore investor confidence
Satyam promoters have announced a decision to contemplate a share buyback
program on Dec 29’08 as a measure to try and restore the investor confidence which
has been eroded significantly by the sequence of events surrounding the company
over the past week. Though this move is a right step, we believe that it might be too
little a step and Satyam promoters would need to take several steps that look to
address a more appropriate use of the company’s high cash balance. Our quick
calculations suggest that Satyam could buyback ~7.3% and ~18% of equity at
December 18’08 closing market price of Rs 169.5. (please refer our mail on the
subject Satyam: Damage Control, what could be the quantum of the buyback
issued on December 18’08 for our thoughts as well)
Near term rally possible; competition could use recent events against
Satyam
We expect this announcement to stall a steep fall in the stock price (do not rule out a
near term rally in the stock as well), however believe that the sequence of steps in
the last week might even impact business prospects for the company (co has
received severe flak from investors, media and analysts alike) and could work
against Satyam especially in these troubled business environment where clients
looking to work with fewer vendors. (the proposed and now reversed unrelated
diversification strategy does raise some doubts on the current management’s
commitment to IT services). Given Satyam’s slightly weaker positioning as compared
with peers especially in the financial services vertical, Satyam’s revenues from
financial services could face negative consequences.
Further we believe the sequence of events could even impact employee morale at
Satyam (especially for middle level management) which could lead to a possible
uptick in turnover levels once again (we highlight ‘high turnover levels V/s peers
‘for Satyam as an important investor concern during FY06-07, refer chart in the
section below)
‘Low Market Cap, High cash’: could still appeal to strategic /financial
investors
We note that given Satyam’s current market status of ‘Low Market Cap, High Cash’,
(Cash at it could still be a potential takeover target for both a strategic as well as a
financial investor. As per the Companies Act ‘1956, the acquiring company/investor
needs to raise his stake to 15% before making a formal and a compulsory open offer
for buying another 20% stake in the company. As per SEBI formula, in the case of a
formal open offer, the minimum price is the higher of the two (1) Average of last 26
weeks weekly closing high and low price or (2) Average of daily high’s and lows over
the past 2 weeks as on the day of announcement. Our calculations suggest that as
on December 18’08, the minimum price works out to Rs 326/share.
We do not rule out the possibility of either an existing shareholder’s backed attempt to
replace the current management or an attempt to take over the company from a strategic
investor. In case of whether Satyam could appeal to an existing Tier 1 Indian IT vendor,
we rate the probability low as we believe
(1) there is lack of any significant synergies either in terms of any complementary
service offerings for a Tier 1 vendor except for scale and a greater market share
within some overlapping clients,
(2) Companies would be more focused towards strengthening client
relationships/engagements which would help tide over the current business turmoil
rather than assimilating an inorganic move which would require significant
commitment of management bandwidth towards integration.
Amongst the global peers, in our view Satyam could still make strategic sense for at
least 1 substantial European name given it has lagged peers in offshore penetration.
However the deterrents against coming forward even in this case remain the significant
turmoil in the business environment and the minimum prescribed price as per SEBI
formula ( as on Dec 18’08, it works out to Rs 326/share, at ~92% premium to Dec 18’08
closing market price of Rs 169.50).
Could more steps to restore investor confidence be in the offing?
Although the company will not make any further corporate announcement until the board
meeting on December 29’08, we believe that apart from deciding on the actual quantum
of buyback to be decided at the meeting, issues like payout of special dividends and
more appropriate uses of the company’s cash balances (eg. Increasing the dividend
payout ratio, Satyam has paid a constant dividend of Rs 3.5/share over the past 2
financial years) could be under active consideration.
Force a change in the current board/management
With the current promoters stake in the company at ~8.6% and high institutional share
holding (<70%), and given the sequence of events the existing large shareholders could
try to force changes to the board under Section 169 and Section 284 of the Companies
Act’1956. (however this would require representation from parties holding >10% or
more of equity and could be a slightly long drawn affair in today’s context). Further
we think that such a scenario could be detrimental to the co’s business prospects at
least in the near term (will clients be looking to be involved with a vendors which is
tackling an unfriendly board/management change)
Satyam suffered from high turnover levels during FY06and FY07 which was a
concern for investors. Recent events could impact employee morale, turnover
levels once again.
Cut estimates for cross currency: Do not build in negative impact on
business from event for now
We have reduced our FY10E/FY11E earnings by ~16%/14% respectively as we factor
in (1) cross currency headwinds (similar to the changes exercised for Infosys, build in
~5% cross currency impact from Q3FY09 itself), (2) Reduction in like to like offshore
pricing by ~4% on Q2FY09 reported base and (3) set US$/INR assumptions at Rs 47/$
and Rs 46/$ for FY10/FY11 (V/s Rs 45 and Rs 44 earlier).
We further note that the events of the past week carry high probability of causing loss of
business to Satyam as well as the current management’s commitment to the IT services
business in the longer run could be in slight doubt (despite the fact that the decision has
been reversed) as well as the fact that competition could use this against Satyam in
client discussions (could be detrimental as in today’s business environment, clients
already looking to reduce number of vendors, and the current event reflects
Satyam in poor light).
We point out Financial Services as one special area where Satyam could run chances of
losing business where it already is on a weaker footing as compared to other offshore
Tier 1 vendors.
Cut Ratings, Target price
We preferred Satyam to other Tier 1 IT companies under our coverage (rated
ACCUMULATE V/s HOLD for the rest of the Tier 1 IT services coverage since
sector downgrade in May’08) until now on account of cheap valuations and cash at
~35% of the market cap. However the recent set of proposals (though reversed by now)
in our view has caused irreparable damage to investor’s faith in the company and we
believe it might require several quarters for company to undo the fallout of the current set
of events.
We reduce our rating on the stock from ACCUMULATE to HOLD with a revised target
price of Rs 212 (from Rs 376 earlier). Our new target price implies 5x 1 year rolling
forward P/E multiple on core earnings of Rs 28.4 (from 9x implied earlier) and cash of Rs
70/share.
-a Report by Emkay Research
