Patni Computers : SELL

Twin Challenges of Growth & Integration 

Q1CY11 results of Patni Computers depict the following – Positives: 1) four new wins of USD 25-30 mn total contract value each. Negatives: 1) slow ramp-ups in key accounts; Top 10 clients de-grew ~3% QoQ leading to lower utz. rates excluding trainees at 74.5% (QoQ decline of 150 bps), & 2) near-term challenges indicated by the mgmt. Patni reported revenues of Rs 8.5 bn (3.4% QoQ &  9.4% YoY), EBITDA of Rs 1.7 bn (2.5% QoQ & 11.2% YoY) & Adj. PAT of Rs 1.2 bn (17.4% QoQ &  21.2% YoY) in Q1CY11.  

Key highlights

• Sales:  Constant currency growth in revenues was at ~3.6% largely led by volumes and stable pricing. Telecom vertical grew ~29% QoQ 
• EBITDA:  Impacted by lower utz. (blended utz. excl trainees down 150 bps QoQ). Integration exp. impacted EBITDA margins by ~70 bps.      
• PAT: Higher effective tax rate at 28% (vs.  ~18% in Q4FY10) led to ~17% QoQ decline in PAT.  New deals signings healthy; challenges include key a/c rampups:  Q1CY11 saw decent signings of four deals with multiple service offerings of USD 25-30 mn total contract value each.
• However, concerns persist on: (1) slow ramp-up in key accounts (Top 5/ Top 10 clients de-grew by ~3% QoQ), & (2) integration with iGate which may impact employee additions (Q4 saw net additions of 97) and attrition rates (~25% in Q4 on LTM basis ex. BPO). Additionally, absorption of salary hikes (offshore: 9-10%; onsite: 2-4%) would impact margins in the near-term. Higher tax rates would further lead to lower NPMs.   

Valuation

We forecast ~14% YoY growth in topline for CY11 but 28% tax rates would lead to ~7% YoY decline in PAT. Our target price of Rs 385 (at Core P/E of 9x CY11E EPS + 80% of Cash per share of ~Rs 126) implies a downside of 10% from CMP. Maintain SELL.