Tech Mahindra, Satyam risky bets

20 Apr 2009, ET Bureau

Tech Mahindra is poised to join the top league of Indian IT exporters,offering a wide range of services across verticals, following its successful bid for Satyam Computer Services. But the takeover of the company at the center of India’s biggest corporate fraud to date also means big risk,particularly with the full impact of the scam yet unknown. This week, ET Intelligence Group finds out what the deal means for investors of both the companies and what should be their investment strategy going forward.

The deal offers the much-needed scale and breadth to Tech Mahindra’s existing operations. Currently, the company functions mostly as a single domain IT services company, with nearly two-third of its revenues coming from UK’s largest telecom services provider BT Group, which holds a 31% stake in Tech Mahindra. A specialised domain expertise can attract a premium . However, in the current turbulent times when the global telecom industry in general and BT in particular are passing through a rough patch, the single vertical strategy backfires.

Now, Satyam offers a wide spectrum of IT services and solutions for different verticals. By buying the company, Tech Mahindra gets access to full-services IT business serving clients like Cisco and Nestle. It can also almost triple its workforce by adding close to 48,000 skilled employees, acquiring the scale and size to compete with the likes of TCS and Infosys.

Big benefits, no doubt. But then, the risks and challenges are as big if not bigger. Satyam’s business has been in a mess after its founder and former chairman B Ramalinga Raju confessed to a more than Rs 7,000-crore financial fraud in early January. In the three months since then, the company is feared to have lost more than 15% of its revenues and some key clients and employees.

Winning back the trust of its clients and bagging new accounts may prove to be a big challenge for Tech Mahindra. The deal will also stretch Tech Mahindra’s balance sheet on two counts. The company has announced internal accruals of Rs 700 crore. It has to raise three times more the amount to cover the deal size of Rs 2,889 crore. Also, Satyam is fighting a number lawsuits and litigations from its overseas investors. Though the exact amount is not known, the total tab on this account may reach $1 billion or about Rs 5,000 crore.

Further, there is no clarity over the actual profitability and revenue potential of Satyam. If Satyam’s operating margin were really 3% as stated by its earlier management in its confession statement, the deal would pull down Tech Mahindra’s current profitability significantly.

All these factors make any investment decision in either company tricky. For Satyam, the takeover may reduce the exodus of clients and employees as the uncertainty about the company’s fate is over. If Tech Mahindra can successfully leverage Satyam’s talent pool and depth of its business verticals, this can become another turnaround story of India Inc. Also, the Satyam stock has already taken a lot of plundering in the last four months.

Tech Mahindra is currently trading at an earnings multiple (P/E) of 4.3, which is on the lower side compared to the P/E ratios of top IT companies. But still, there is a lot of risks, particularly with the company yet to restate its financials for the December 2008 and March 2009 quarter.

So, fresh investment in Satyam stock makes sense only for those who love to take risks. For shareholders of Tech Mahindra, the risk appears much higher as the takeover would drag its performance for next few years. It is likely to see a substantial increase in its liabilities and Satyam’s lawsuits would only make it worse.

Therefore, it would be a good strategy for Tech Mahindra shareholders to reduce their exposure to the counter. Fresh investment in the stock is advisable only for those who have a high-risk appetite and an investment horizon of two years or more