June 16, 2009

Analysis – Patni

I will be publishing the analysis in multiple parts.

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.

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.

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.

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.

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

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Anonymous said...

Biggest issue is quality of managemnet and how they treat their employees.No employee will ever like to stay long for thr compnay except those heavy weights at top.

There are many cases(state farm) cases in US for mistreating the employees.

Mastech has a good model than Patni.


Rohit Chauhan said...

Hi kannan
agree with your comment. i am aware of how they treat their employees. unfortunately a lot other companies are the same or worse.
not sure how much one can associate that with the performance of the company.

Mahesh said...

I have worked with Patni for many years and worked with other firms afterwords. I definitely do not 'admire' Patni's management (compare it your admiration for Asian Paints)
The biggest advantage Patni has is its lower cost, which is lower than many other Indian counterparts.
I think employee satisfaction is very important in service industry. Patni has rarely attracted talent that other companies like Infosys and TCS have done consistently. I am sure there are lots of unsatisfied Infosys employees, but I have not seen level of unsatisfaction anywhere else. Regardless, I earned valuable experience at my clients which helped me to go to the next level.

Rohit Chauhan said...

Hi mahesh
you have direct experience working with patni and so you have a first hand knowledge of the work atmosphere.

i dont deny the importance of a good work culture. i have worked with infosys and have friends in other IT companies.

i admire the top managements of infosys for the way they manage the business. however that does not imply i liked the work culture, which incidently was nothing great. but again that is a individuals perspective ..maynot hold for other employees.

i try not look at an investment as an employee in case of infosys. i am an investor and i have tried to view it accordingly without allowing my feelings as an employee to influence it.

in case of patni, i am reading the AR and have found the management is not as good as some other companies. for starters their performance has not been great...and there are other issues which will i write soon.

however the stock is undervalued and as an investor i could get some extra return.

finally companies like patni have not performed as well as the tier I vendors and employee disatisfaction could be reason. the market has accordinly always given a lower valuation to these companies

Anonymous said...

Rohit - I rasied employee is only because patni cannot keep on doing this and they will loose all their advantage. It will be like something that looses its value day by day. All the cash and other selling points may help to give life for next few years.

There is great chance that Patni many screw up client relations at many places.


sumi said...

Hi Rohit adding to the above discussion it makes sense to view a company from an investor's point of view rather than as an employee.Of course management is a crucial point to be considered in the IT industry.Employee woes in this industry are never ending.
Having said that Patni has strong fundamentals to consider it from a value investing point of view, but I am not finding its current price undervalued. Will wait for your next post to discuss further

Rohit Chauhan said...

Hi kannan
i am sure if i agree with you on that point entirely. i agree that employees matter ..especially the key employees at specific position. however all other employees are important but not as critical. dont get me wrong on this - i have been and still am one of those non critical employees.
however if one looks at the big picture, how employees are treated has some impact on the long term value of the company, but i am not sure if we can really quantify it easily.

look at it other way - one of the key indicators of how employees are treated on an average would be attrition rates. i have not seen a major difference between various companies on this ..wipro which i assume treats its employees well, also has fairly high attrition rates.

on patni messing up client relationship - i differ on that too. if the company has been in business for 20+ years and has a repeat business of 90%+, then they must figured that part out inspite of not treating their employees great.


Rohit Chauhan said...

Hi sumi
i dont deny the importance of treating employees well. companies cannot treat them too badly and hope to do well in the long run. but the whole issue of employee satisfaction is grey and fuzzy and it is diffcult to corelate companies which treat employees well with great investment.
in addition, i think the issue is important for non IT companies too.

in terms of valuation, you need strip out the impact of the forex changes as these should average out in the long run.

at current levels of topline and even with a prospective 8% net margin, the company net of cash is selling at 4-5 times PE. This is when the IT market is in a bad shape.

Ninad Kunder said...

Hi Rohit

One overhang that will always exist in Patni is the fact that the promotors want to sell off.

It is a white swan which can happen which adds a lil bit of buffer.

I would suspect if the external environment improves we might see another round of buybacks enabling the promotors to increase stake.



Rajesh Thangamani said...

Hi Rohit - have you ever looked at "R systems international" for investment. The company claims to have about 72 crores in cash. It has made about 28 crores in entire CY08 and about 9.6 crores in Q1 CY09 alone. The market cap is just about 116 crores as of today. I havent studied much about the strength of the business they are in but makes for a compelling investment just on the basis of numbers. As an aside,GE has a stake in this company too

Anonymous said...



Rohit Chauhan said...

Hi ninad
have you seen any specific communication from the promoters on whether they want to reduce their holding ? i have not seen any till date

hi rajesh - i have not checked the company. will let you know my views when i get a chance to look at it


Ninad Kunder said...

Hi Rohit

No Rohit there is no specific comment but it is a open secret that Patni is always in play amongst the investment banking circles.

The challenge always has been to get all the brothers to agree on a price.