Patni: Hot As Indian Curry

The following is an excerpt from one of Buffet’s letters…..”If you like cheeseburgers and their price falls, then you would be happy because you can buy more of them”. Paralleling cheeseburgers to hot Indian curry, in this case I feel Patni Computer Systems (PTI) is as hot as curry.

Its price has fallen from $28.00 to $22.00 in last couple of months [22% drop]. Applying the covered call strategy I found its $25.00 strike price call option for Dec-07 is selling at $3.10 [14% premium of current stock price], which is pretty good by call option standards.
The following are some other call option strike prices of similar businesses as of Aug-2/2007.

Infosys Technologies Ltd. (INFY)
CURRENT STOCK PRICE : $49.00
JAN-08 PREMIUM FOR CALL STRIKE PRICE $55 : $3.50

Satyam Computer Services Ltd. (SAY)
CURRENT STOCK PRICE : $26.84
JAN-08 PREMIUM FOR CALL STRIKE PICE $30 : $1.65

Wipro Ltd. (WIT)
CURRENT STOCK PRICE : $14.36
DEC-07 PREMIUM FOR CALL STRIKE PICE $17.50 : $0.35

Cognizant Technology Solutions Corp. (CTSH)
CURRENT STOCK PRICE : $82.22
JAN-08 PREMIUM FOR CALL STRIKE PRICE $90 : $6.40

Even though Patni is in the same boat as other IT outsourcing companies that are battling the strong rupee and weak dollar, its small market cap differentiates it from its competitors. Patni’s market cap as of Aug-2 is $1.5bn compared to:

INFY……………$28.29bn
SAY……………$8.9 bn
WIT……………. $20.97bn
CTSH………….. $11.81bn

The investors are more likely to take larger bets on small cap companies rather than mid cap and large cap companies. As mentioned in one of my earlier posts Patni is as strong as any of the above companies in terms of its expertise in the IT outsourcing business. Its major weakness is low brand value which in turn obstructs it to increase its billing rates. This is the reason it remains a strong candidate for acquisition by a large consulting business.

VALUATION STANDARD FOR IT OUTSOURCING COMPANIES :

At the end of the day, the earning power of an IT outsourcing company is its headcount. So if a business consulting player like Cap Gemini is to acquire an IT outsourcing company then it will measure how many employees it will be buying by paying the acquisition premium. In this case Patni is pretty undervalued , even though its market cap is 20 times less than INFY. But its headcount is 12,804 as of Dec-31/2006 compared to 72,000 of INFY as of Mar-31/2007. What this means is that the brand value of Infosys makes its employee three times more valuable than that of Patni. This is true since INFY’s headcount is 6 times that of Patni , but market cap is 20 times higher. So 20/6 is approx 3.

The following scenario can be paralleled to the one above. If we have two Indian restaurants selling Indian food: One called “Infosys curry” which operates in downtown Chicago and a similar smaller Indian restaurant called “Patni curry” operating in Bloomington, IL. The average price of a dish at “Infosys curry” is $50 and the average price of “Patni curry” is $20. The reason being the location assuming food quality in both the places is same. If a restaurant owner in Chicago wants to get in the Indian restaurant business, then his best bet would be to buy “Patni curry’ and get all its cooks from Bloomington, IL to Chicago. The odds are the new restaurant will sell its dish for $50.

PTI 1-year chart

Comments

[satish.sharma]

A very good analysis.

[GS MKTS]

Solid work, but I would take it to the next level: comparative growth rates, incremental margins and pipeline of business -> which would influence valuation. There is a valuation differential that Patni gets hit on for a reason: what is it? Is the the scope of projects they are able to take on? Something else? I am not criticizing this blog. In fact, I think it is very good, but for me to take action on this, I would do the following analysis as well. Finally, a takeout premium would make for an interesting case given that this would an easy cash transaction for someone like HPQ or IBM.

[Nidhi]

Your earlier posting on Patni was more compelling though you have presented some extra info here.

creating-wealth.blogsp.../

[ratsharp]

You have a long way to go before becoming a good analyst. period.

margins are key ... compare that and that makes up for the diffrence between headcount and the MCap multiple.

higher headcount entails an ability to reduce base fixed cost so dont directly compare a 12K headcount with 72 K headcount

look at the cash on patni's books and infosys books .. see what that can buy and at what margins.. see what it adds to current bottomline and then then make the conclusions.. they will be more robust.

compare peak margins and trough margins .. see the std deviation ... for both adjust the mean margins to see how time dependant and volatile that can be ...

just to enlighten you .. buying an offshore company even at cheap valuation is not the gratest PE investment considering the risks on margins ... look at eds/mphasis etc ... 10% is where it can go and settle

look at EV/S of larger firms with 10% margins ... jus at abt 2X sales ..thats the trough where a patni can go to

dont use a call/put analysis to make a longer term analysis .. its like trying to get nickels infront of a steam roller!!! And if you ever think about paired trades : learn the golden rule ::: do you have the dough to hold it till maturity!!!

[Dayanand]

Friends,
Thanks for your time in reading my blog, just to give you a brief background about myself.I started my career with Patni, worked for seven years and last three years I am working independently through MNCs (by being third party contractor) on outsourcing assignments. In fact more than half of my staff is from Patni. So I know handson how the value of cooks change by changing the restaurant...)

People in the Industry very much value the experience that folks get while working for companies like PCS and TCS. The reason being these guys were the founders of IT outsourcing and have mastered the strategy of coverting fresh college grads into seasoned outsourcing pros.

Thanks,
Dayanand.

[ratsharp]

dont mix up analysis with experience.... i know of many analysts who do a much betterjob than Revolving ceo's by telling the ceo on what is strategically good for them!!!

Being a part of a company ..makes one biased .. not an insider.. and definitely not a automatically qualified good analyst. Insiders/experienced folks should focus on diffrentiating themselves through information and use that to make investment decisions only. Dont mix the two

Companies like sapient, kane, patni, polaris, niit, hexaware etc. will take years to bring a culture required for continuous success. Undoubedly they are great buys at trough .. but only at troughs ..not at peaks, so any form of relative valuation applies only at trough/near troughs... or in periods of excited bull runs .. the rest of the times ( like what we see now) is a time to ignore them.