Patni Computer Systems: Driving Costs Down

Managing costs has become serious business for the margin strapped Indian
software and ITeS sector ever since the days of 9/11. As salary and other costs
continue to inch upwards and clients become more cost focused due to
competition, the role of cost control in maintaining profitability and
investor's expectations has moved higher on the corporate agenda.
We believe this focus is another sign of consolidation of the sector.
This sector that has been a pioneer in many areas of business management and
will also show the path in cost control for Indian companies. 

Among companies who have continuously focused on cost control measures,
improving their overall value proposition among investors is Mumbai based Patni
Computer Systems.

 Patni Computer Systems (Patni)
was incorporated as Patni Computer Systems Private on February 10th, 1978 with
activities like computer time rental, resale of imported computer hardware and
software exports. The company has offices in 23 countries with eight offshore
development centers in India including Mumbai, Pune, Delhi, Banglaore, Chenna
and Hyderabad. Narendra K Patni is the chairman and CEO of the company as well
as one of the founders head the company. The promoter group holds 44.6% of the
equity of the company while institutional investors and ADR holders own 51.5%
and the Indian Public holds 3.8% of the company's shares.

Patni offers its services through industry-focused practices mainly to
insurance, manufacturing, financial services, and telecommunications sectors.
The company provides technology-focused practices for product engineering and
independent software vendors. The company also has offerings in areas like
embedded technology solutions, quality assurance, packaged software
implementation, infrastructure management and more recently BPO services.

During the financial year ended December 31st, 2005, Patni's revenues stood
at Rs 2024.2 crore, higher by 37.9% over Rs 1413.1 crore in FY 2004. Operating
income and income before income taxes during the year were at Rs 316.5 crore and
Rs 335.6 crore respectively, higher by 15.8% and 19.7% compared to the previous
year. Net income stood at Rs 273.6 crore, up 11.3% compared to Rs 236.6 crore.
During the year, Patni completed its offering of ADS successfully
comprising 7.9 mn ADSs raising around $140 mn. The company also entered into a
strategic alliance with i2 for marketing its master data management solutions.
Patni, via a series of measures, strengthened its BFSI practice both for
software and BPO services.

The company's results for the second quarter ended June 30th, 2006 were
encouraging. Revenues increased by 31.6% to Rs 656 crore from Rs 473 crore on a
y-o-y basis. Operating profits for the quarter ended 2006 stood at Rs 111.1
crore compared to Rs 66.2 crore in the same quarter last year. Due to certain
adjustments, the company shows a net loss for the period at Rs 14.7 crore
against a Rs 62.1 crore after tax profits for the same period last year.

During the quarter, Patni acquired US based ZAIQ Technologies, a design and
verification company, for ASIC design capabilities and to strengthen existing
verification and validation practice. It also announced strategic alliances with
Clear Technology, for solutions in the insurance and financial services domain.
Similarly, the company also partnered with Eagle Investment Systems for
investment management solutions. Patni added 460 employees during the quarter to
reach a head count of 12,608 employees as compared to 10,877 for the same
quarter last year.

During the quarter 2006, Patni's top client, GE contributed 14.5% of
revenue compared to 16.5% in Q1 2006, showing improved client diversity. On an
annual basis revenues from top 10 clients (excluding GE) grew by 38.7%
indicating the trend towards larger contracts being witnessed across the board.
The number of million-dollar relationships increased to 64 at the end of Q2,
2006 from 61 at the close of Q1 2006 against 50 at the close of Q2 2005. In Q2
2006, revenues from fixed price contracts contributed 36% to overall revenues as
compared to 37.3% in Q1 2006 and 39.0% in Q2 2005. T&M project revenues
expanded by 12.5% on a sequential basis and 38% on a corresponding basis, and
their contribution to overall revenues has steadily increased.

The company expects Q3 2006 revenues to grow by 4.5-5% and seems to be quite
upbeat about after tax profits. Those are expected to be in the range of
$18-18.2 mn corresponding to a little over Rs 82 crore. We believe that the
improved performance for the second quarter and the initiatives both in cost
control and strengthening of domain skills in BFSI bode well for the coming
quarters. We therefore expect the company maintain its revenue growth with a
slight improvement in margins for 2006 and 2007.

Patni currently trading at Rs 391.6 discounting projected 2006 EPS by 16
times and 2007 EPS by 11 times. We believe that while the company is expected to
continue its revenue growth with stable margins, the lower than industry margins
would continue to negatively impact its valuations. Market Performer.

Sushanto Mitra

The author is the director, Techcap India

sushanto@techcapIndia.com

The views reflected here are of the author and not of this publication. No
liability is accepted for losses based on the information presented here