Patni Computer Systems: High Growth, Low P/E, Limited Shares

Indian IT outsourcing quiz: Which company has given the maximum investment return in the last year?

Well the answer is not Infosys (INFY), Wipro (WIT), Satyam (SAY) or Cognizant (CTSH), but Patni Computer Systems (PTI). Following is the table comparing the share prices of the above mentioned companies:

What is Patni computers doing differently

In two words “Nothing different." In fact, all five companies have more or less the same business model, based on the strong demand for India based outsourcing services. The basic reason for the difference in growth is because Patni was very recently listed in USA and was not very well known amongst the investment community; this is the reason its P/E is still around 23 , whereas the P/E of other companies as of yesterday is as follows:

Patni - 23.40
Satyam - 28.58
Infosys - 34.93
Wipro - 31.44
Cognizant - 45.21

From the above figures it is still evident that Patni is undervalued compared to its competitors. I agree that Patni is not counted as Tier-1 company, because one third of its revenues still come from its top two clients (GE and State Farm Insurance). And its growth in terms of headcount has been slower than that of tier-1 companies. But we should not forget that even Narayan Murthy (present Chairman of Infosys) got his initial knowledge of IT consulting while working for Patni. In fact he worked there for three years before founding Infosys.

If we step back in time and analyze the Indian IT consulting industry in the beginning of the 1980s, we would find that Tata and Patni were the leaders in the Industry then. Naren Patni (present chairman of Patni) started Data Conversion, Inc. in 1972, with the vision of supporting data processing activities for North American companies.

Another very important point as far as individual investors are concerned is the number of shares outstanding.

The above table shows that the supply of Patni shares is very limited. On top of this, the Patni brothers and General Atlantic partners together hold around 60% of the company. (Mr. Narendra K. Patni, Mr. Gajendra K. Patni and Mr. Ashok K. Patni, together with their families and entities controlled by them, and General Atlantic own 14.77%, 14.95%, 14.95% and 16.61% of outstanding equity shares.)

This brings to a logical conclusion that with the advent of the Indian outsourcing industry, investors are looking for undervalued companies in this sector; with a low P/E and such a short supply of Patni shares, its share value has gone up 78% in the last year.

Comments

[Nidhi]

Good comparisons. Can you tell how many big accounts (>3% of their revenue) each one of them have.

creating-wealth.blogsp.../

[sacsharma]

How about I-Flex which generated 100%+ returns in one year?
or a smaller one like SakSoft that generated 200%+ in one year?
or a NIIT Technologies that generated 300% in one year?

sagecapital.wordpress....

[RAJAT BHATIA]

I visited Mumbai, Gurgaon and Bangalore recently (May 2007). Here are a few observations:

1. India is changing dramatically - some for the better, some for the worse.

2. Brand new buildings have come up in these three cities but the traffic is terrible, the airports chaotic - in other words a complete mess.

3. At Bangalore airport you cannot find a decent restroom and that city is supposed to be the Silicon valley.

4. Coming to outsourcing firms, here is the heads up. All major international BPO firms are there in India. In addition major banks and financial institutions like JP Morgan, Lehman, Goldman, Morgan Stanley, Royal Bank of Scotland, Fidelity - have all set up huge offices in India. When I say huge offices, I mean literally whole buildings.

5. Therefore, Indian BPO firms are going to face competition and pressure on margins from many sources: (a). from the international firms like Accenture and IBM (b). from captive BPOs set up by the big firms (c). from rising wage costs - you cannot find decent people in India and if you do they eave soon as they get poached by other firms. Staff turnover is very high and Indian BPO firms cannot compete on salary and wages with top international firms. (d). the rising value of the Indian Rupee is eating away margins. (e). There is nothing special to tie the BPO industry to India. Hence, firms are now setting up shop in the Philippines, in Eastern Europe, even in Pakistan where there is a large untapped pool of labour. The BPO business is nothing but a form of labour cost arbitrage. As the arbitrage goes away, firms will move to other places.

No wonder that Infosys - the best managed Indian IT firm has lowered expectations about future earnings. Now Infosys is known to deliver more and avoid creating earnings hype. Yet the fact is that Indian BPOs and IT firms are under pressure.

Patni's stock price went up dramaticall in recet days from around Rs 500 in late May to as high as Rs 580 in June (an appreciation of 40% in one month !!!!). However, the stock is now back down to Rs 494 as I write.

The reason Patni went up is due to what a fund manager friend of mine called "local market dynamics". What he meant was that there was rift between the various Patni family founders of the firm and some private equity firms were interested in buying out there share. I was told the asking price was Rs 600.

Now it seems that the takeover of Patni has slowed down or perhaps stalled and that is why we are seeing a significant retracement in the firm's stock price. Anyone who has followed Patni on the National Stock Exchange will tell you the ratio of buyers to sellers has been very skewed in favor of sellers. I expect more selling pressure in this stock for the near future unless there is a renewed takeover interest of Patni by P/E firms or if there are excellent reults for 2Q 2007.