FINANCIAL RESULTS: IT Czars Grow Stronger

Infosys Technologies

Infosys Technologies continues to throw surprises each quarter and the third

quarter results were no different. Unperturbed by the growing fears of a

slowdown, Infosys has reported an impressive performance in the third quarter

ended December 2000, with a higher than 100% growth in the top line and the

bottom line.

Hardly a slow down

Infosys’

third quarter revenues jumped 137% to Rs 537.1 crore, with software exports

contributing Rs 529.2 crore and domestic services contributing Rs 7.8 crore. Net

profit in the third quarter rose 125% to touch Rs 166.3 crore. The net profit

includes a provision for investment of Rs 13 crore made in EC Cubed Inc, a B2B

services company. If this had been excluded, the net profit would have been

higher.

A minor cause for concern is the sequential topline growth of only 20% over

the second quarter compared to the 25% sequential growth reported in the second

quarter over the first quarter. One of the major reasons for this can be

attributed to the decline in revenues from dot-com clients. The company claims

to receive $106,000 per person-year from dot-com clients as compared to $86,000

per person-year from the services clients. However, the company has been able to

sustain the operating margins, which remained flat in the previous quarter and

the immediate preceding quarter’s level of 40%.

De-risking business

With the growing concerns on economic slowdown and the global dot-com fall

out, Infosys has been moving fast to de-risk its business model. This is evident

from the gradual decline in its e-commerce revenues, and more importantly,

revenues from dot-coms. Revenues from e-business rose from 6.4% in the first

quarter of fiscal 2000-01 to 18.8% in the fourth quarter of fiscal 2000-01.

These jumped in the current fiscal, contributing 28.7% in the first quarter of

the current fiscal, peaked to 31.4% in the second quarter and are down at 28.3%

in the third quarter. Within this, revenues from dot-com startups were 5.8% of

the total revenues in the third quarter compared to 9.5% in the preceding

quarter. The rest of the e-business revenues came from providing e-commerce

services to Fortune 1,000 companies.

During the third quarter, revenues from software development

and maintenance rose from 66.2% in the second quarter to 68.1%, whereas

re-engineering rose form 9.5% to 9.9%. Internet and e-commerce related revenues

were down from 31.4% to 28.3% whereas others including package implementation,

consulting and product development was down from 24.3% to 22%. In terms of

verticals, the key industry segment remained banking, insurance and finance

bringing in 36.6% of revenues compared to 33.9% in the second quarter. Revenues

from manufacturing were down from 17.5% to 16.7%, telecom declined from 19.4% to

17.7%, retailing rose from 7.1% to 8.7% whereas others fell from 22.1% to 20.3%.

Geographically, revenues from North America declined from 75% in the second

quarter to 73.6% in the third. Revenues from Europe stood at 19%, India at 2%

and rest of the world at 6% in the third quarter.

Growing client base

Infosys continues to maintain excellent relationships with

existing clients apart from adding new clients, defying any fears of a slowdown.

Its top 5 clients contributed 28% of revenues and top 10 contributed 43%. The

company added 26 new clients to take its total to 250. Some of the new clients

include Providian, the Bank of Nova Scotia, Fairfax Financial Services, Subcorp

Metway, Schlumberger, the Business Depot and Dynegy.

Improved HR strength

Infosys

added 985 employees during the current quarter taking its total employee

strength to 7,824 professionals in December 2000. While attrition rate continued

to be on the lower side at 9%, the utilization rate was lower at 77.6% as

against 80% in the previous quarter. The high number of professionals kept on

the sidelines raises some concern. During the nine months ended December 2000,

the company spent Rs 325 crore on capital expenditure out of which Rs 125.2

crore has been spent in the third quarter. Infosys’ future expansion include

setting-up additional space in Bangalore, Pune and Chennai and new centers in

Mysore, Mangalore, Bhubaneshwar and Mohali.

Concerns allayed

There have been concerns about Infosys’ ability to sustain

the growth in the topline, which the company has been able to report for the

past four years. Although the company has reported impressive gains each quarter

in fiscal 2000-01, the performance in the third quarter raises concerns for two

reasons. First, the third quarter over second quarter growth has declined

compared to the growth rate in second quarter over first quarter and second, the

utilization rate of manpower has also declined considerably. While the decline

in the topline growth can be attributed to the decline in dot-com revenues and

therefore a shift towards offshore revenues, the fall in utilization rate causes

some concern, indicating a slowdown in business. However, the management allays

any such fears of slowdown and claims it is confident of utilizing the employees

sidelined in the last quarter.

Other concerns relate to the investments by the company. One

of them, EC Cubed, failed to get additional funding and filed for liquidation.

Infosys has written off the entire investment of Rs 13 crore in the current

quarter. Infosys’ other investments include one of Singapore $700,000 in

Singapore-based wireless venture fund, M-Commerce Ventures.

On the other hand, as far as the fears of slowdown in the

tech spending by US corporates are concerned, Infosys is confident of improving

its business in the future. The company surveyed its existing clients, which

have committed to increase their business in the coming years. The growing

client list is a proof of the company’s confidence in securing better business

in the coming years.

Still the best investment bet

Based on the current quarter performance, we believe that the

company would be able to clock revenues of Rs 1,950 crore in the current fiscal

and report a growth of 70% in the next fiscal. Infosys has been reporting the

highest operating margins among the software services companies and we expect a

slight decline in the margins as its massive investment in infrastructure would

lead to higher overheads. Nevertheless, we expect the company to report a net

profit of Rs 640 crore in the current fiscal and more than Rs 1,000 crore in the

next. The current share price of Rs 5,798 (January 15) discounts the projected

March 2001 EPS by 59 times and March 2002 EPS by 37 times. Infosys has the best

software delivery model coupled with excellent infrastructure and economies of

scales. We believe that the company would consistently outperform its peers on

the billing rate front. Going ahead, the company would benefit from its

de-risking strategy, of bringing down the revenues from riskier business and

would be on a more stable platform. Although the stock has declined after the

announcement of the results, we believe that Infosys remains the best bet among

the IT companies.

The decline in the share price provides good opportunity in

the medium to long term. Buy

Satyam Computer Services

Satyam

Computer’s third quarter results came as a surprise for all the investors and

analysts tracking the stock. Satyam’s stock has been under tremendous pressure

following the announcement of results in the first two quarters, wherein the

company announced reduced operating margins. However, the third quarter results

eased the pressure thanks to an increase in billing rates, offshore revenues and

improved business mix.

Results: Impressive

Satyam declared revenues of Rs 327.6 crore, which were up 85%

over the previous year. The bottomline growth was impressive at 142% with the

net profit soaring from Rs 36.2 crore to Rs 87.5 crore. Moreover, the company

has reported excellent sequential growth of 20% in the topline and 31% in the

bottomline.

Satyam’s operating margins improved in the third quarter

due to higher offshore revenues and better employee utilization. Satyam reported

an OPM of 37.8% compared to 36.8% in the third quarter of 1999-00 and 34.9%

reported in the second quarter of fiscal 2000-01.

Improved business mix

Satyam achieved major revenues from the Internet and

e-commerce business, which contributed 30.7% of the total revenues compared to

27.1% in the second quarter. Software development revenues stood at 33.8% as

against 37.1% in the preceding quarter, whereas maintenance revenues were 18.7%

compared to 20.9% in the preceding quarter. ERP revenues rose marginally from 6%

in the second quarter of the current fiscal to 6.8% in the third quarter.

Interestingly, revenues from dot-com clients were just 1% of the entire

revenues. Better offshore revenues resulted in higher operating margins.

Offshore revenues increased from 52.3% in the second quarter to 57.6% in the

third quarter. The company’s geographical mix continues to improve in line

with the overall business segments. While the share of revenues from the US has

declined 78% in the second quarter to 73% in the third quarter, that of Europe

declined marginally from 8% to 7%, Japan increased from 2% to 4% and rest of the

world rose from 13% to 15%.

Growth through consolidation

Addition in clients, employees and infrastructure are key to

success for any software services company. Satyam added 1,068 software

professionals to take its total strength to 7,427, while the total employee

strength jumped from 7,048 to 8,141, an increase of 1,093 employees. On the

other hand, Satyam is moving fast to increase its capacity of software

development centers by setting up new centers. The company has acquired 23 acres

of land in Bangalore to set up a new software development facility. The company

is also expanding its operations in Chennai, where it has taken a 38,000-Sq ft

area and in Hyderabad, where it has acquired 42,000 Sq ft on lease. Satyam

currently has more than 22 software development centers across India. To propel

growth initiatives, the company had engaged McKinsey and Company, which

completed an enterprise-wide exercise with the intention to refocus business

units during the quarter.

Satyam

added 24 new customers during the period to take the total client list to 225.

Among its new associations during the quarter was an agreement with Microsoft

Global Accounts to provide solutions within Microsoft’s consulting partner

domain. Apart from this, the company won new orders from Citibank, General

Motors, Ariba Inc and a few major contracts in the middle-east. The company’s

joint venture with TRW Inc–Satyam Manufacturing Technology–received a

$200-million order from TRW. The joint venture would provide software and

engineering consulting services in ERP, SCM and e-business in the next four

years to TRW. Satyam has also been selected as the preferred outsourcing vendor

by Merrill Lynch, which will allow the company to offer services in banking and

finance area.

High potential

We expect Satyam to close the current fiscal with revenues of

Rs 1,200 crore, growing by 70% in the next fiscal. The net profit in the current

and next fiscal is projected at Rs 305 crore and Rs 520 crore, respectively.

Satyam is currently traded at Rs 384 (January 15), which discounts its March

2001 EPS by 36 times and March 2002 EPS by just 21 times. Although we believe

that the stock is undervalued compared to other similar stocks, we feel that the

over-liquidity factor would continue to keep the price movement volatile. The

company’s shares were split into five shares of Rs 2 each last year, thereby

leading to high liquidity and volatility. Satyam’s stock has been moving in

the range of Rs 300 and Rs 390. However, the announcement of the third quarter

results has led to increased confidence in the stock and the stock has become

stable at Rs 380 levels.

Satyam’s third quarter has infused confidence among the

investor community, which was missing when the company had announced the first

and second quarter results. With a shift towards and increase in offshore

revenues, we believe that the third quarter performance necessitates a re-rating

in the stock. Moreover, a more stable performance in the fourth quarter would

lead to further improvement in the valuations. Accumulate.

Sushanto

Mitra is the founder of Technology Capital

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