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Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent update to clients on Indian IT outsourcer Satyam (SAY):

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Investment Conclusion. Based on slower revenue momentum – offset partially by a lower near-term tax-rate – we are adjusting our estimates as follows: fiscal 2009 GAAP diluted EPADS stays at $1.45 on revenue of $2.709 billion (27% YoY growth but down from our prior $2.821 billion projection); and fiscal 2010 GAAP diluted EPADS goes to $1.60 on revenue of $3.481 billion (29% YoY growth and down from $3.668 billion previously). Our estimates imply 30%/16% compound revenue/EPS growth in calendar 2007-09 – after factoring a one-time jump in the tax-rate due to expiration of prior tax benefits – second only to Cognizant among (U.S. listed) offshoring majors. Given continued investor concern over the U.S. IT spending environment (60.6% of revenue), we are resetting our target price from $36 to $32. In 12-months, this would correspond to 20x forward EPS of $1.60 – a premium to the current depressed valuation (16x).

4Q08 Results. GAAP diluted EPADS of $0.33 vs. $0.26 a year ago on revenue of $613.3 million fell short of our $0.35 estimate on revenue of $596.7 million. Results were held back by an $11.7 net forex loss (-3.1 cent EPADS impact) and $4.9 million Fringe Benefit Tax catch-up provision (-1.3 cents). Operating income advanced 50% YoY and exceeded our estimate by 4%. Highlights included 9.0% QoQ and 49% YoY revenue growth; durable growth in the Americas region (10.0% QoQ and 44% YoY) and Financial Services segment (6.2% QoQ and 32% YoY); a loss-to-profit swing at the BPO subsidiary; improvement in annualized quarterly attrition to 11.5% -- among the best in the industry; three $50+ million wins and the addition of four Fortune-500 Financial Services clients. Initial fiscal 2009 revenue guidance (implying a 3-4% QCGR) was characteristically conservative and not intended to be a warning, in our interpretation.

Takeaways. In fiscal 2008, Satyam recorded 46% YoY revenue growth vs. its original 28-30% guidance, while the operating margin declined only 90 bps despite stiff currency headwinds (350 bps). Revenue momentum over the preceding four quarters may have eclipsed Cognizant (scheduled to report on May 7). Satyam credited its performance to deeper client partnerships and a wider service offering.

Management noted the following: Satyam has not suffered any material project cancellations; however, economic conditions across major markets are hindering client spending in consumer- oriented sectors (Financial Services, Retail and Telecom) – and there have been some instances of projects being deferred pending better visibility; the pipeline of deals remains healthy and Satyam is increasingly being invited to bid on large business transformation projects; and there have been no client requests for lower pricing, which should hold at 4Q08 levels at a minimum. Fiscal 2009 guidance is based on 25% YoY revenue growth, no further billing rate improvements, annual salary increase (effective July 1) averaging 12-14% for offshore staff and 3-4% for onsite, 50 bps decline in the operating margin, and an exchange rate of INR 40.00 per U.S. dollar vs. 39.30 in January.

This week, Satyam agreed to acquire S&V Management Consultants for $35.5 million in cash. Founded in 1992, S&V is a respected Belgium-based firm with 60 Supply Chain Management consultants. Satyam will also acquire the Market Research & Customer Analytics operation/IP of Caterpillar for $60 million. These additions should strengthen its consulting and analytics capabilities. The units are profitable with combined annual revenue of an estimated $20 million. Revenue growth was driven by the Package Implementation & Consulting practice (up 58% YoY and 45% of the total); newer Technology/Media vertical (47% and 22%); and Asia-Pacific region (59% and 19%). Operating income of $121.1 million (19.7% margin) surpassed our $116.3 million estimate (19.5% margin). Profitability on a QoQ basis was helped by improved utilization, billing rates and offshore-mix.

Available levers for countering salary-related pressures (300-350 bps in fiscal 2009) and potential rupee appreciation comprise offshore-mix (200 bps), pricing (150 bps), ramp-up of the BPO/other subsidiaries and operating efficiencies. Hourly billing rates averaged $60.71 for onsite work (up 0.6% QoQ and 6.8% YoY) and $24.58 for offshore (up 0.5% QoQ and 5.5% YoY). Billed volume rose 8.8% QoQ. Offshore utilization (excluding trainees) stood at 85.6% vs. 78.4% a year ago but offers very limited headroom during fiscal 2009. Higher-margin offshore work contributed 52.7% of IT Services revenue vs. 52.1% in the December quarter. Excluding BPO, headcount rose 2.5% QoQ and 29% YoY to 45,969 in March. Hiring plans call for the (gross) addition of 14-15K associates in fiscal 2009, down from 15-16K in fiscal 2008. Attrition [LTM] improved to 13.1% from 15.7% a year ago. With professional development programs, early/empowered leadership and above-average salary increases, Satyam expects to maintain employee attrition in the 10-12% range. By industry, Manufacturing ranked largest (24% of revenue), followed by Financial Services (22%), Technology/Media (22%), Retail/Transportation (10%), Healthcare (7%) and Others (16%). Top-10 clients accounted for 30.9% of total revenue, down from 33.5% in the December quarter. Satyam now has 85 clients (vs. 79 in the December quarter) with an annual revenue run-rate of $5+ million and 50 (vs. 49) with $10+ million. Satyam added 32 new clients – including four from the Fortune-500 -- compared with 32 in the immediately prior period. It exited the quarter with an active roster of 617, up from 598 in December. Satyam BPO has positioned itself as a vendor of specialty offerings -- engineering, animation, analytics, claims, helpdesk, etc. -- with an integrated BPO+IT orientation. The unit swung to a net profit of $0.4 million on revenue of $18.3 million, up 60% YoY. Satyam generated CFFO of $107 million ($0.31 per ADS) in the quarter. Major outflows comprised capital expenditures ($31 million), budgeted to climb from $97 million in fiscal 2008 to $125 million in fiscal 2009. Satyam exited the quarter with net cash of $1.040 billion ($3.05 per ADS), up from $978 million on December 31. Accounts and unbilled receivables improved to 87 DSOs from 89 in December.

Source: Satyam: Client Engagements, Operational Execution Drive Ongoing Growth