Is Syntel Ready to Become a Tier-1 IT Outsourcing Company?

| About: Syntel, Inc. (SYNT)

After reading an article in Business Wire on Syntel (NASDAQ:SYNT) being one of the top 50 global outsourcers, and discovering its stock has doubled last two years, I decided to peek into the company's annual report to analyze what is driving the its success and to get a general feel of its fundamentals.

NOTE : Syntel’s stock price was $16 in June 2005 and is now $32 in June 2007.

In the pure IT outsourcing arena the established companies (those that have revenues greater than $1bn) like Tata Consulting Services [TCS], Infosys (NASDAQ:INFY), Wipro (NYSE:WIT), Satyam (SAY), Cognizant (NASDAQ:CTSH) and HCL are considered to be tier-1 companies. I am not counting Accenture (NYSE:ACN) and IBM (NYSE:IBM) in this league because outsourcing is just one their businesses.

Companies like Syntel and Patni Computers (NYSE:PTI) are considered emerging tier-2 companies. These are the companies that have a good business model and have capabilities of reaching the milestones for tier-1 companies. The following article discusses Syntel’s strength and improvement areas for it to become a tier-1 company.

Application outsourcing: This is one of the various types of IT outsourcing and is considered to be least risky. The following example illustrates a typical application outsourcing deal:

An insurance company may have claims system that is maintained by around 50 programmers. For those without an IT background, IT departments of large financial and insurance companies spend a great amount of their IT budget in maintaining their systems because of ever changing business rules.

The IT department may be spending around $100,000 per programmer. So the money spent on programmers for maintaining the claims systems is around $5 million. An IT consulting company approaches the Insurance Company and offers to maintain the system for $3.5 million.

The It consulting company is able to offer this rate because it would have around 10 programmers on site and around 40 programmers offshore. The cost for 10 programmers would be around $1 million and cost of around 40 programmers would be another $1 million. Plus the overheads would be around $0.5 million. This gives the IT consulting company a profit of $1 million and gives $1.5 million (30%) cost savings to the Insurance company.

From the above example it is evident that Application outsourcing is a low risk business. If we analyze any tier-1 company like Infosys, Wipro or Satyam, we can see that they first mastered this kind of business before leaping into other kinds of Outsourcing deals like Infrastructure management.

What this means is that for any tier-2 company to succeed they have to master what there tier-1 counterparts did in the past. In Syntel’s case, they have been successful in growing their application outsourcing revenues from $143 million in 2004 to $194 million in 2006.

Headcount growth: The fundamentals of IT outsourcing is the number of billable resources one has. Looking at the growth over last five years trend this looks good.

Year 2002
Onshore Billable headcount 1,111
India Billable headcount 943

Year 2006
Onshore Billable headcount 1,405
India Billable headcount 4,006

Let's review Syntel’s onshore/offshore ratio; in 2002 it was around 55:% / 45%, but in 2006 changed to 25% / 75%. What this means that the company has transformed itself from an IT staffing company to a growing IT outsourcing company.

Even though the company is growing in terms of revenues, its fundamentals are not getting stronger. Following are some points to note.

28% revenue from the top two clients: American Express (NYSE:AXP) and State Street Bank accounted for 18% and 10% of its revenues. They need to diversify and create bigger accounts so that no one client is more than 5% of the revenue.

Inconsistent operating cash flow:
Cash flow from operating activities were $48 million(2004), $36 million (2005) and $45 million in 2006.

Declining book value: The book value for 2005 was $152 million and for 2006 was $149 million.

As the company grows and is valued by its customers, so too its stock grows; however, order to become a tier-1 company, Syntel‘s fundamentals have to match those of any other tier-1 IT consulting company, like that of Infosys, Wipro , Satyam and Cognizant.

SYNT 1-yr chart


About this article:

Tagged: , Information Technology Services
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here