Patni Computer Systems: A Hidden Gem

by: Sreeni Meka

Patni Systems (NYSE:PTI-OLD) incorporated on February 10, 1978 under the Indian Companies Act, registered at Pune, India and went public in 2003. Patni is one of the leading information technology service firms with multi-national operations, predominantly in North America. Patni provides comprehensive IT services through onsite and offshore delivery locations primarily in India. The majority of its customer base is in insurance, manufacturing, retail and financial service sectors.

In 2009 insurance, manufacturing retail, communications media and financial services accounted for 29.7%, 29.0% 13.5%, and 12.8% of its revenue. Patni’s revenue grew from $450.3 million in 2005 to $655.9 million in 2009, at compounded annual growth of 9.9% and net income grew from $ 60.9 million in 2005 to $119.8 million in 2009, representing a CAGR of 18.4%.

As of 2009, eighty percent of its revenue came from North American customers and the rest came from other parts of the world. The revenue trend appears to be more from North America and showing continuous growth in Japan and other countries.

Patni employs around 14,000 IT staff. Among them, 2,200 of them work in the US, and 11,000 of them in India. For the past five years, the number of employees grew from about 11,000 to 14,000.

Global Economy and IT Sector:

As global economies emerge from the great depression caused by the housing bubble, easy interests and financial troubles, the global economy is expected to grow 3 percent in 2010 and 4% in 2011 from negative one percent growth in 2009. As government spending declines in the near future, private spending will pick up. A major portion of capital spending in the private sector will be in IT spending. For many firms, spending on IT infrastructure and IT services makes good tactical strategy in the near term. Many firms in the US are outsourcing their non-core competencies, like IT services to third parties, to stay lean on operating expenses and to focus their efforts on core business practices. That emerging trend is going to help IT service firms like Patni.

Patni competes directly with other Indian software service providers like Tata Consultancy, Wipro (NYSE:WIT), Infosys (NASDAQ:INFY) and Satyam (SAY). On the global front Patni’s major competitors are Accenture (NYSE:ACN), IBM and Cognizant (NASDAQ:CTSH). Patni employs most of their workforce in India where development costs are low and skilled workforce is abundant. Patni’s revenue growth and profit margin align with major players, however its valuation and price ratios are relatively low. That is one of the reasons Patni looks attractive at this level.

Revenue and Margins:

Patni realized 9.86 percent aggregate growth in sales from 2005 to 2009 despite a dip in 2009 sales due to the Great Recession. 2009 sales reached $656 million from $579 million in 2006; Top 10 customers contributed fifty percent of Patni’s revenue in 2009, and 12 percent of revenue came from a single client.

Patni’s gross margins stayed at a strong 36 percent for the past five years. Most of their cost of services include employee salaries and sub contracting expenses.

Excellent Balance sheet:

The Patni balance sheet looks very healthy and liquid. Patni has a total of $900 million in assets and more than two thirds of it, current liquid assets. It’s a cash rich company. It is generating around $2 free cash a year and pacing rapidly. Patni is trading twice the book value and 12.5 times its past year earnings. At these price levels price ratios are very low and compared to its Indian peers, it is trading half of the competitors' price levels.

With virtually no debt on the balance sheet and rapid growth prospects, Patni is trading at utter bargain price levels. With a niche in financial and insurance sectors, any uptrend in the financial sector is a big plus for Patni in future.

Risk factors:

Most of Patni’s revenue is derived from the US and its revenue stream is correlated with the US economy. Dollar strengths and weaknesses and improper foreign currency hedging may impact its foreign currency translation. However, most US investors realize less impact and may not realize diversification benefits. Most of Patni's employees support client services in India or at client sites in the USA and other foreign countries, thereby stringent US immigration laws directly impact its ability to grow its operations abroad. Finally, demand for an Indian workforce put wage pressure on its cost of goods sold. However, the number of four year engineering degree holders in India reached close to seven to eight hundred thousand this year. That is ten to twelve times the US output, significantly diluting wage fears.

Reference: 10K statements from SEC EDGAR.

Disclosure: Long PTI