Mahindra Satyam

Re-initiating Coverage
Hard toil ahead

October 11, 2010

¾ Reinitiate coverage on Mahindra Satyam(MS) with a REDUCE
rating and a March’12 TP of Rs 81. We see hard toil ahead for
REDUCE the company as it tries to rebuild itself from the ashes.
¾ Mahindra Satyam faces numerous challenges in the form of a
Price Target Price
weaker competitive positioning, loss of vantage position in
Rs 86 Rs 81
core areas of strength (refer section below)
Sensex 20,250
¾ Forecast a strong 21% US$ rev CAGR over FY11E-13E (post a
6% YoY decline in FY11) along with improvement in OPM’s to
Price Performance 17.1% in FY12( V/s 8.3% in FY10 reported recently)
(%) 1M 3M 6M 12M
¾ Reinitiate with a REDUCE rating and a DCF based March’12
Absolute (10) (8) (11) (22)
TP of Rs 81, (implying ~11.5x 1 yr fwd P/E, in line with mid tier
(17) (20) (21) (35)
Rel. to Sensex
peers). Valuations appear rich despite ~15% fall in ~2 weeks
Source: Bloomberg

Recently disclosed financials restore normalcy, hard toil remains

Mahindra Satyam recently disclosed FY09 and FY10 financials which restores normalcy
Stock Details
and sets a base for expectations. However in our view, MS faces a staunch task as it
Sector IT Services
tries to rebuild itself from the ashes driven by (1) weaker competitive positioning (arising
Reuters SATY.BO
from loss of key clients, employees and in some cases in it’s tradional strength areas
Bloomberg SCS@IN like engineering services, enterprise solutions), higher employee attrition (currently an
Equity Capital (Rs mn) 2353 industry wide issue however our channel checks indicate that MS was forced to offer
Face Value(Rs) 2 higher than peer wage increments in Jan’10 at 25-30% in order to retain talent, which
1176
should prevent significant margin improvement as well) . Although co has filled in the
No of shares o/s (mn)
vacant positions through internal promotions and senior appointments from the
52 Week H/L 121/79
parent/Mahindra group; we believe that company faces consolidation before targeting
Market Cap (Rs bn/USD mn) 99/2,227 growth ahead
Daily Avg Volume (No of sh) 17015614
Daily Avg Turnover (US$mn) 36.9 Strong margin recovery difficult in the backdrop of revenue pangs and
increased employee attrition
We build in a strong EBITDA margin performance for Mahindra Satyam as we expect
Shareholding Pattern (%) them to expand to 15.2% and 17.1% in FY11 and FY12 respectively (V/s 8.3% in FY10)
J’10 M’10 D’09 which we believe itself might be a stiff task given the growth pangs that MS faces
Promoters 42.7 42.7 42.7 (expect revenues to decline by ~6% in FY11) as well as margin headwinds emerging
FII/NRI 22.4 21.6 21.0 from wage increments (our channel checks indicate that MS hiked salaries by ~25-30%
across the board in Jan’10 in order to address employee attrition)
Institutions 3.9 4.6 5.0
Private Corp 10.2 10.5 11.2 Reinitiate coverage with REDUCE and a DCF based March’12 TP of Rs 81
Public 20.8 20.6 20.1 We expect MS to also benefit from the demand uptick in the industry and build in ~21%
Source: Capitaline US$ revenue CAGR over FY11-13E (after a 6% drop in revenues in FY11) and expect
margins to improve by ~900 bps over FY10-13E. We estimate earnings of Rs
5.1/6.4/7.5 for FY11/12/13 respectively (based on US$/INR at Rs 45/$ for FY12/13 and
Rs 46/$ for FY11). Our DCF target price of Rs 81 implies ~11.5x 1 yr forward P/E which
is fair in our view given MS’s weaker competitive positioning and the possibility of an
adverse merger ratio (in favor of parent Tech M). Key risks to our call emanate from
better than expected revenue and margin show.

Yr end Mar Net EBITDA EBITDA PAT EPS ROE P/E(x) EV/ P/B
(in Rs mn) Sales % (Rs) % (x) EBITDA (x)
FY10 54,810 4,569 8.3 2,930 2.5 58.5 34.0 17.1 5.3
FY11E 50,144 7,623 15.2 6,053 5.1 27.7 16.4 10.3 4.0
Manik Taneja FY12E 62,026 10,613 17.1 7,579 6.4 26.5 13.1 7.1 3.1
manik.taneja@emkayglobal.com FY13E 72,084 12,277 17.0 8,832 7.5 24.0 11.3 5.7 2.4
+91 22 6612 1253

Emkay Global Financial Services Ltd 1

 Mahindra Satyam Re-initiating Coverage

Recently disclosed financials restore normalcy, hard toil remains

The disclosure of Mahindra Satyam’s FY09 and FY10 restated financials marks a significant
event almost 20 months post the accounting fraud in Jan’09. In our view the new
management at Mahindra Satyam post that takeover by Tech M has done a credible job in
(1) holding the company together and (2) restating the financials which should restore
confidence to customers who might have been constrained from dealing with the company
due to lack of financials.

However we continue to believe that Mahindra Satyam faces a staunch task ahead on
account of a weaker competitive positioning (suffered from both losses of several marquee
Fortune 500 names as well as loss of key talent in areas of tradional strength like
engineering services, Enterprise Solutions). Mahindra Satyam has lost significant top level
talent across verticals/service lines that have moved on to competitors. The loss of key
talent who enjoyed strong client relationships thereby makes it more difficult for Satyam to
regain revenue/market share within these clients. Mahindra Satyam has done well to fill in
the vacancies arising out of these exits through internal promotions as well as outside
hiring, however we believe that in the near to medium term, consolidation of business and
achieving stability within the remaining clients would be the main priority and achieving
revenue growth remains an onerous task.

Some of the key employees to quit Mahindra Satyam since Jan’09

Name Designation Time Details
Anil Kumar Senior VP- US and BFSI Feb'09 n.a
Kevin English Senior Vice-President and Global Head of Satyam’s Feb'09 Amongst the early people to quit, moved in as Partner ,
Media and Entertainment Vertical Business Unit Accenture
Subu , Head, Manufacturing and Automotive Practices Feb'09 Moved in as CEO of Defiance Technologies
Subramanian,
Todd Whaley Head of infrastructure management services at Europe Feb'09 Moved in as SVP, EMEA to CSC Corporation
Anil Chintapalli Finance Feb'09 n.a
Biju Potty Head-financial Services, Continental Europe April'09 Moved in as Principal Business Analyst, Trading &
Capital Markets at Misys
Virender Agarwal Head of Satyam’s Asia-Pacific region, West Asia, Africa April'09 Joined HCL Tech as Head of Emerging Markets
and India business
Deepak Nangia Country Head, Satyam ANZ May'09 Moved in as Managing Director, New Business,
Capgemini, Australia
Naresh Jhangiani Global head (human resources), BPO, May'09 Moved in as Sr. Vice President at VenSat Tech
Services Pvt. Ltd
V Satyanandam head of corporate services, BPO May'09 n.a
Hetzel Folden Head-strategic deals May'09 Vice President Global Business Development at
Computer Sciences Corporation
Kulwinder Singh head of marketing — Asia Pacific, BPO May'09 Joined as Chief Marketing Officer at at VenSat Tech
Services Pvt. Ltd.
T.S.K. Murthy Head, Engg Services June'09 Moved in as Vice President at Wipro Technologies
Ranjan Tayal VP and Head of India business July'09 Ranjan moved in as VP and Head, India business for
Capgemini
Nick Sharma SVP, IMS Aug'09 Took over a CEO of privately held Cybernet-
SlashSupport (CSS)
Ravi Bommakanti Head, TIMES vertical in the US Aug'09 Ravi took over as Head - Technology Development &
Integration, Capgemini
Sriram Papani Head, Enterprise Architecture Sep'09 Joined in as Consulting VP at Oracle post quitting
Satyam
Peter Heij Head of Continental Europe Oct'09 Moved to T Systems International as Strategic Deal
Gajbir Singh Senior VP, Aerospace Division Oct'09 Partner, Global Delivery & Capability Lead, ESO,
Accenture, Bangalore
Mainsh Mehta Head, SAP Practise July'10 Manish took over as EVP & Chief Delivery Officer -
Application Services at Patni Computer Systems
Source: Media Reports, Emkay Research

Emkay Research 11 October 2010 2

 Mahindra Satyam Re-initiating Coverage

Some of the recent appointments/hiring by Mahindra Satyam

Name Designation Time Details

Venki Prathivadi Country Head, Satyam ANZ June'0 An Industry veteran with prior work experience at SAP, Australia and
9 EDS, Australia and and has been with Satyam since 2003

Ram Head of Sales, ASEAN May'10 Ram,an SP Jain Alumni was at HCL Tech for >10 yrs and served in
Ramachandran several executive positions in Malaysia, Singapore, Australia and US

Darin Mckay Country Head, NZ May'10 Darin boasts of previous stints at Fujitsu and Vignette Corporation and
has been entrusted with stepping up co's nascent business in the
New Zealand region

Rahul Girotra Head, SAP, APAC May'10 Rahul has >15 yrs of experience across SAP sales, consulting. He was
Head of Wipro's SAP practice in ANZ before joining Mahindra Satyam

Pranab Choudhary Country Head, Thailand May'10 Pranab has >10 yrs of experience in the APAC IT Industry in various
technical and operational positions

Sudhir Nair Head, IMS Nov'09 Sudhir comes with >20 yrs of cross functional experience in IMS with
previous stints at Infosys(2002-09), HCL Tech(1995-2002) and Wipro
Infotech

Vikram Nair Head, Europe Oct'09 Vikram has led Tech M's European operations outside of BT since
Aug'2005

Aloke Head, Central Europe and Nordics Oct'09 Aloke has been based in Eastern Europe for the past 20 yrs and has
been with Mahindra Satyam Since 2003,. Previous stints include
experience with L&T Inftech as Head of Mktg, European region

Suneel Unni Head, South Europe and Benelux region Oct'09 >25 yrs of experience across various industries like Telecom, Consumer
Products and IT. Suneel has been working with Mahindra Satyam since
2005

Gulta Blake Head, Fin Svcs, Retail and Public Sector Oct'09 >18 yrs of experience and has been with Mahindra Satyam since 2008
Business, UK and Ireland

Roger Newman Head, Manufacturing and Digital Oct'09 Roger has been with the company since 2001 and would be responsible
Convergence,UK for business development and relationship mgmt for Manufacturing,
Energy and Utilities and Digital Convergence

Gaurav Gupta AVP, Strategic Partnerships Aug'10 Gaurav's earlier stint was as Director, Business Development for HCL in
UK

Bobby Gupta Head, Sales and Business Development Oct'09 Bobby has >18 yrs of experience with ~10 yrs of experience at IBM
wherein in his last assignment he was running Telecom Expense Mgmt
practice as AP sales leader

Roger Van Lier Business Development Executive, July'10 With >15 yrs of experience in ICT and prior stints at Intenzz Group,
benelux Capgemini and Atos Origin, Roger would be responsible for handling
manufacturing sector in the Benelux region

Azian Othman Senior Sales Manager, Malaysia Aug'10 A Malaysian IT svc veteran, Azian brings >18 yrs of experience with
previous work experience at HP,Logica and Teredata

Rasedi Mohamad Senior Sales Manager, Malaysia Aug'10 Rasedi joins Mahindra Satyam from IBM and has ~15 yrs of experience

Kunihiko Higashi Country Manager, Japan Sep'10 An industry veteran with >25 yrs of experience and has held several
senior positions at SSA, Computer Associates, Cisco, Peoplesoft,
Cognos

VijayanandVadrevu Senior VP, Strategic Initiatives Oct'09 Vijayanand boasts of vast experience in the IT Industry with >17 yrs of
experience at Wipro where in his last assignment, Vijay was VP and
Head, Life Sciences vertical
Source: Company, Emkay Research

Emkay Research 11 October 2010 3

 Mahindra Satyam Re-initiating Coverage

Further in our view Mahindra Satyam has seen disruption to it’s vantage position in select
areas of strength like Enterprise Services, Engineering services due to loss of key
resources as well as clients which though not impossible to recover , but surely will take a
lot of time to rebuild. The kind of revenue loss that Mahindra Satyam has seen (we believe
that Q4FY10 revenue exit rate would be ~US$ 240 -250 mn) from loss of several top tier
clients would be difficult to refill soon.

Mahindra Satyam has lost several top notch clients to competition since Jan’09
Clients who have quit Vendor Benefiting
State Farm Insurance Patni
Coca Cola EDS,Capgemini
Telestra EDS
Novartis not available
Pfizer TCS,Cognizant
Lowes Company not available
Euronet Worldwide not available
BP not available
Applied Materials Infosys, TCS
Agilent Tech TCS, HP
Cigna not available
Cisco n.a
Merrill Lynch n.a
Nissan n.a
National Australian Bank n.a
United Nations n.a
Source: Media Reports,Emkay Research

Despite Mahindra Satyam’s optimism that restatement of FY09 and FY10 audited financials
will help the company to bid for larger contracts as well as win more business within existing
clients as well as win lost client logos/ new logos we see that as a more difficult as well as a
more long drawn affair than it appears. In our view Mahindra Satyam faces a loss in
competitive positioning both from scale and relevance across some of it’s core
strength areas and will have a hard toil ahead to regain it’s vantage position.

Strong margin recovery difficult in the backdrop of weak revenue growth

Mahindra Satyam’s avg
employee costs is pretty
similar to larger peers like
Infosys and TCS, albeit
some room to cut non
employee expense
proportion through revenue
leverage
and significant wage pressures
Although we continue to build in margins improving by ~900 bps over FY10-13E (we expect
EBITDA margins improving to 15.2%/17.1% in FY11/12 respectively V/s ~8.3% in FY10),
we believe that these in itself could be stiff given (1) increasing industry wide wage
pressures (more so in case of Mahindra Satyam in our view as company tires to
retain/hire senior talent, our channel checks indicate that Mahindra Satyam hiked
salaries by ~25-30% in Jan’09 to stem attrition, further MS’s avg salary/employee is in
line with peers like Infosys and TCS at ~Rs 1.1 mn p.a ), (2) with limited scope to reduce
manpower going ahead, and (3)limited scope to cut non manpower expenses (Mahindra
Satyam’s non manpower expenses at ~19% of revenues compared to non manpower
expenses at ~15.1% for TCS and ~12.3% for Infosys)

Infosys TCS Mahindra Satyam

Avg Employee Costs( in Rs mn p.a) 1.1 1.1 1.1

Non manpower costs(% of revenues) 12.3 15.1 19

Source: Company,Emkay Research

Emkay Research 11 October 2010 4

 Mahindra Satyam Re-initiating Coverage

Expect the potential merger in favor of the parent Tech Mahindra

The management of Mahindra Satyam’s parent Tech M has always indicated the intention
to merge the two entities Mahindra Satyam and Tech M ever since they acquired ~42.7%
stake in the company in April’09. The top management has made it clear that it would take
steps towards the goal of merging the two entities after Mahindra Satyam’s Q1FY11 and
Q2FY11 results are announced in Nov’10. We believe that any potential merger between
the two entities would be loaded in favour of MS’s parent Tech M on account of (1) stake in
Mahindra Satyam is owned through Tech M, (2) higher promoter holding in case of Tech M
(promoter’s holding in Tech M at ~74%) and (3) class action lawsuits and legal liabilities
pending against Mahindra Satyam.

Expect earnings of Rs 5.1/6.4 for FY11 and FY12 respectively

Our rough cut analysis suggest a Q4FY10 exit revenue run rate of ~US$ 240-250 mn for
Mahindra Satyam (full clarity on quarterly revenues and margin performance would emerge
in Nov’10 when Mahindra Satyam reports results for Q1FY11 and Q2FY11 respectively and
would be important as they would give a more clearer picture of a possible recovery in
business given that Mahindra Satyam would have seen project closures/ client exits during
the course of FY10)

We have articulated the significant challenges that Mahindra Satyam faces in terms of
achieving revenue growth in the near term and hence build in ~6% YoY decline in revenues
for FY11, and forecast a 21% revenue CAGR over FY11E-13E. Similarly we assume
margins to improve by ~900 bps over FY10-13E to ~17% (we estimate margins at
~15.2%/17.1% in FY11 and FY12 respectively as we build in revenue leverage going
ahead) Our earnings assumptions of Rs 5.1 and Rs 6.4 for FY11 and FY12 build in tax
rates at 15%/24% for FY11/12 respectively (infact believe that tax rate assumptions
could turn out to be aggressive given minimal revenues derived from SEZ currently)
(note that our earnings estimates based on US$/INR of Rs 46/$ for FY11 and Rs 45/$
for FY12/13 respectively)

Key Assumptions FY11E FY12E FY13E

No of Employee ( Yr end) 34,000 40,000 46,000
Avg Employees 30,500 37,000 43,000
Support Staff (as % of overall staff) 10% 10% 10%
Onsite % of employees 16 16 16
Offshore % of employees 84 84 84
Onsite Revenue Productivity( in US$ p.a) 1,10,000 1,10,000 1,10,000
Offshore Revenue Productivity(in US$ p.a) 40,000 40,000 40,000
Onsite Utilization 92 92 92
Offshore Utilization 70 75 75
Co wide Revenues(in US$ mn) 1,090 1,378 1,602
Revenues(in INR mn) 50,144 62,026 72,084
EBITDA( in Rs mn) 7,623 10,613 12,277
EBITDA mgns, % 15.2 17.1 17.0
Tax Rate, % 15.0 24.0 24.0
Profits(in INR mn) 6,053 7,579 8,832
EPS 5.1 6.4 7.5
Source: Emkay Research

Valuations and Recommendation

Despite ~15% fall in the stock price post disclosure of Satyam’s audited FY09 and FY10
financials, we believe that valuations at ~17x/13.5x FY11E/FY12E earnings are rich given
Consistent operational
performance would need to the challenges that Mahindra Satyam faces as it toils ahead to rebuild itself from the ashes.
preclude any potential re- Our DCF based March’12 target price of Rs 81 implied ~11.5x 1 yr forward P/E which is fair
rating case. in our view and is in line with other mid tier peers. We believe that delivery of consistent
improvement in operational performance would need to preclude any case for potential
rerating to pre crisis levels (refer graph below which shows that the erstwhile Satyam
Computers used to trade between 15x-18x 1 yr forward P/E multiple)

Emkay Research 11 October 2010 5

 Mahindra Satyam Re-initiating Coverage

Satyam used to historically trade between 15x-18x 1 yr fwd earnings

900 (Rs)

600 18x
15x
12x
300 9x

0
Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09

Source: Emkay Research

Comparative Valuations
Infosys TCS Wipro* HCL Tech Tech M Mphasis Patni Mahindra Satyam

FY10 Revenues(in US$ mn) 4,804 6,340 4,391 2,705 977 872 656 1,159
Rev FY10-12E CAGR, % 22.4 20.1 18.3 21.4 9.2 21.5 11.2 9.1

FY10 EBITDA( in Rs mn) 78,616 86,799 59,852 24,813 11,325 11,275 7,412 4,569
EBITDA FY10-12E CAGR, % 17.8 16.1 13.3 16.3 -6.7 13.8 5.1 52.4

FY10 EBITDA mgns, % 34.6 25.8 22.0 19.7 24.5 26.4 23.4 8.3
EBITDA mgn FY10-12E change(in bps) (162) 320 (90) (145) (609) (194) (148) 877

FY10 Profits(in Rs mn) 62,666 68,733 45,935 12,172 8,341 9,087 5,723 2,930
Profits FY10-12E CAGR, % 15.8 12.6 11.8 30.5 7.8 9.9 3.7 60.8

EPS
FY11E 124.2 41.7 21.6 24.7 54 51.0 40.1 5.1
FY12E 146.5 44.5 23.4 29.9 61 52.3 39.9 6.4

P/E
FY11E 25.2 22.8 20.3 16.8 14.4 12.2 10.2 16.4
FY12E 21.0 19.7 18.7 13.9 12.6 11.9 11.1 13.1

EV/EBITDA
FY11E 17.4 17.4 15.0 10.2 10.4 9.1 6.2 10.3
FY12E 14.5 15.6 12.8 8.1 9.1 7.4 4.9 7.1

ROE's
FY11E 27.6 34.8 26.1 22.9 20.1 38.8 17.1 27.7
FY12E 27.8 34.5 24.1 23.9 18 30.0 17.6 26.5
Source: Companies, Emkay Research

* Note that EBITDA=EBIT in case of Wipro

Emkay Research 11 October 2010 6

 Mahindra Satyam Re-initiating Coverage

Key Financials
Income Statement Balance Sheet
Y/E, Mar (Rs. m) FY10 FY11E FY12E FY13E Y/E, Mar (Rs. m) FY10 FY11E FY12E FY13E
Net Sales 54,810 50,144 62,026 72,084 Equity share capital 2,352 2,352 2,352 2,352
Growth (%) (9) 24 16 Reserves & surplus 43,947 50,000 57,579 66,410
Total Expenditure (50,241) (42,522) (51,413) (59,808) Minority Interest 201 201 201 201
Growth (%) (15) 21 16 Networth 46,500 52,553 60,132 68,963
EBIDTA 4,569 7,623 10,613 12,277 Secured Loans 422 - - -
Growth (%) 67 39 16 Unsecured Loans - - - -
EBIDTA % 8.3 15.2 17.1 17.0 Loan Funds 422 - - -
Other Income 1,056 1,540 1,610 1,750 Total Liabilities 46,923 52,553 60,132 68,963
Depreciation (2,144) (2,041) (2,251) (2,406) Goodwill
EBIT 3,481 7,121 9,972 11,620 Gross Block 12,009 13,509 16,509 20,509
Interest (329) - - - Less: Depreciation (2,144) (4,185) (6,437) (8,843)
EBT 3,152 7,121 9,972 11,620 Net block 9,865 9,324 10,072 11,666
Tax (222) (1,068) (2,393) (2,789) Capital WIP - - - -
EAT 2,930 6,053 7,579 8,832 Investment 6,268 6,268 6,268 6,268
Growth (%) 107 25 17 Current Assets 39,799 40,982 47,781 57,540
EAT (%) 5.3 12.1 12.2 12.3 Inventories - - - -
Sundry debtors 9,230 10,304 11,895 13,824
Cash & bank balance 21,768 21,199 24,160 29,694
Loans & advances 3,845 4,121 5,438 6,715
Other current assets 4,956 5,358 6,288 7,307
Current Liab & Prov 24,222 19,233 19,203 21,724
Current liabilities 8,818 8,243 8,157 8,887
Provisions 15,404 10,991 11,046 12,837
Net current assets 15,577 21,749 28,578 35,816
Misc exps 15,187 15,187 15,187 15,187
Deferred Tax 26 26 26 26
Total Assets 46,923 52,553 60,131 68,963

Cash Flow FY10 FY11E FY12E FY13E Key ratios FY10 FY11E FY12E FY13E
Net Profit after Tax (1,239) 6,053 7,579 8,832 EPS (Rs) 2.5 5.1 6.4 7.5
Add : Depreciation 2,144 2,041 2,251 2,406 CEPS (Rs) 4.3 6.9 8.3 9.5
Add : Misc exp w/off Book Value Per Share (Rs) 15.9 21.1 27.5 35.0
Net changes in WC (3) (2,327) (3,924) (3,495) Dividend Per Share (Rs) - - - -
Operational Cash Flows 914 1,354 5,961 9,534 Valuations Ratios (x)
Capital expenditure 379 (1,500) (3,000) (4,000) PER 34.0 16.4 13.1 11.3
Investments (5,994) - - - P/CEPS 20.0 12.5 10.3 9.0
Investing Cash Flows (5,615) (1,500) (3,000) (4,000) P/BV 5.3 4.0 3.1 2.4
Borrowings (7,720) (422) - - EV/EBIDTA 17.1 10.3 7.1 5.7
dividend paid - - - - EV/Sales 1.4 1.6 1.2 1.0
Issue of shares 29,180 (1) - - M-Cap/sales 1.8 2.0 1.6 1.4
Share Premium - -

Financing Cash Flows 21,460 (423) - - Profitability Ratios (%)

changes in cash 16,759 (569) 2,961 5,534 RoCE 25.5 25.0 28.9 26.6
Opening balance 5,009 21,768 21,199 24,160 RoNW 58.5 27.7 26.5 24.0
Closing balance 21,768 21,199 24,160 29,694 EBITDA Margin 8.3 15.2 17.1 17.0
EBIT Margins 4.4 11.1 13.5 13.7
Net Profit Margin 5.3 12.1 12.2 12.3

Emkay Research 11 October 2010 7

 Mahindra Satyam Re-initiating Coverage

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