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transcript
September 28, 2011
ICICIdirect.com | Equity Research
Initiating Coverage
ICICI Securities Limited
Rating Matrix Rating : Hold
Target : | 75
Target Period : 12 months
Potential Upside : 6%
Performance Highlights (| Crore) FY10 FY11 FY12E FY13ENet Sales 5481.0 5145.0 5974.4 6651.6EBITDA 256.7 455.1 817.7 1010.7Net Profit -124.6 -147.3 794.8 862.6EPS (|) -1.1 -1.3 6.8 7.3
Valuation FY10 FY11 FY12E FY13E
PE (x) -62.3 -56.8 10.5 9.7EV to EBITDA(x) 25.7 14.5 8.1 6.5Price to book (x) 1.8 1.8 1.5 1.3Target PE -65.8 -60.0 11.1 10.2Target EV/EBITDA 27.5 15.5 8.6 7.0Target P/BV 1.9 1.9 1.6 1.4
Stock Metrics Bloomberg/Reuters Code SCS IN/SATY BOSensex 16727Average Volumes (yearly) 2979531Market cap (| crore) | 8353 Cr.Debt (Mar-11) | 32 Cr.Cash (Jun-11) | 1800 Cr.EV | 6585 Cr.52 week H/L (|) 114 / 54Equity capital 235.30Face value 2.00DII Holding (%) 3.7FII Holding (%) 13.0
Comparable Return Matrix (%) Returns (%) 1M 3M 6M 12MMahindra Satyam 12.9 (15.2) 6.6 (25.9) Tech Mahindra (0.1) (12.5) (16.7) 21.2 HCL Tech 8.9 (19.5) (16.2) (5.7) Patni Comp 9.1 (12.4) (37.8) (34.4)
Price Movement
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020406080100120140
Nifty Satyam(RHS)
Analyst’s name
Abhishek Shindadkar abhishek.shindadkar@icicisecurities.com
Aishwariya KPL aishwariya.kpl@icicisecurities.com
Reincarnated!!! Yet uncertain macro weighs… Mahindra Satyam, once the fourth largest Indian IT services company, is recovering well and is in the third year/final leg of its three-year restructuring journey. Having salvaged the erstwhile Satyam Computers, the existing management has stabilised and invested in the business for the last two years, the outcome of which is encouraging. Q1FY12 sales have grown 4.3% QoQ led by 3.9% volume growth while operating (EBIT) margins improved by 9.5 percentage points (pp) since Q2FY11. With a majority of legal lawsuits settled, we believe the foundation of the rebuilding exercise has been laid with likely payoffs over the longer term. However, an uncertain macro merits attention as it could likely delay CY12 IT budget decisions, reminiscent of 2009 prospects of pricing pressure, elevated bench and modest volume growth. We initiate coverage on Mahindra Satyam with HOLD rating and price target of | 75.
Pending macro, ride the turnaround as restructuring draws to a close Subsequent to its acquisition of Mahindra Satyam, the new management had laid out its three-year transformation strategy of restoring customer and employee confidence in the first two years and growth in the third year. Q3FY11, Q4FY11 and Q1FY12 quarterly earnings suggest a likely conclusion of the rebuilding exercise. With foundations laid and a shift of management focus to profitable growth, we believe the time is ripe to ride the turnaround. However, the uncertain macro makes us cautious as its pertinent deterioration could weigh on IT sector valuations and remains the decisive factor in our HOLD rating.
Valuations Mahindra Satyam was impacted by a variety of issues led by financial irregularities of erstwhile promoters. However, the last two years have seen the management succeed at stabilising operations and invest for the future. At current levels, the stock is trading at 10.6x and 10x our FY12E and FY13E diluted EPS estimate of | 6.8 and | 7.3, respectively. From a Mcap/sales and EV/EBITDA perspective, Mahindra Satyam is trading at 1.4x and 8.1x on FY12E and 1.25x and 6.5x on FY13E basis, respectively. Though PE valuations appear reasonable post the recent 15-20% price correction, on a PEG basis it continues to trade at 1.1x on FY13E estimates, a premium relative to peer group average of 0.9x. This implies fair valuations at current levels. Further, pertinent deterioration in the macroeconomic environment could curtail CY12 client budgets and weigh on IT sector valuations. Consequently, we have valued the stock at | 75 i.e. at 10.2x our FY13E EPS estimate of | 7.3. We are initiating coverage on the stock with a HOLD rating. Exhibit 1: Financial performance (| Crore) FY09 FY10 FY11E FY12E FY13ENet Sales (| crore) 8812.6 5481.0 5145.0 5974.4 6651.6EBITDA (| crore) -200.6 256.7 455.1 817.7 1010.7Net profit (| crore) -8176.6 -124.6 -147.3 794.8 862.6EPS (|) -121.5 -1.1 -1.3 6.8 7.3PE (x) -0.6 -62.1 -56.6 10.5 9.7EV to EBITDA(x) -32.7 25.5 14.4 8.0 6.5Price to book (x) 2.7 1.8 1.8 1.5 1.3RoNW (%) NM NM NM 14.7 13.7RoCE (%) NM 5.5 9.8 15.1 16.1
Source: Company, ICICIdirect.com Research
Mahindra Satyam (SATCOM) | 71
ICICI Securities Limited
ICICIdirect.com | Equity Research Page 2
Company background Incorporated in 1987 by the two Raju brothers, Satyam Computers was the fourth largest Indian IT company, with ~53,000 employees and revenues in excess of $2 billion, providing services to 2000 global companies. The company’s historical focus has been manufacturing and package implementation services, thanks to its relationship with SAP. The Mahindra group acquired Satyam in April 2009 after the erstwhile founders reported financial irregularities in January 2009.
Business description
Mahindra Satyam primarily offers application development & maintenance (ADM), infrastructure management services, enterprise business application & engineering services to ~220 clients (annual revenue run rate of >$250k, with the total client base in excess of 350). The company offers its services across manufacturing, banking & financial services, healthcare & life-science, energy & utilities, insurance & telecom in areas such as product life-cycle management, treasury & risk management, core banking, asset management, regulatory compliance and risk management services. Exhibits 6-9 highlight the company’s offerings across vertical and service lines.
Revenues & EBIT margins have stabilised
Subsequent to its takeover of Mahindra Satyam and having faced several headwinds during the initial 12-18 months, the new management has laid the foundations for rebuilding the company in the first two years of the three-year resurrection strategy as reflected in the past three quarterly earnings. Note, Mahindra Satyam would not have likely participated in >$50 million total contract value (TCV) deals in the first half of FY11. Further, in Q1FY12, the company reported EBITDA and EBIT margins of 14.6% and 12%, respectively, vs. 5.9% and 2.5% in Q2FY11. For full year FY11, the company reported EBITDA and EBIT margins of 8.8% and 5.3%, respectively, vs. 4.7% and 0.5% in FY10. Finally, the client roster has stabilised at ~220 with the company adding >50 logos since restructuring started. Exhibit 2: Revenues have stabilised as reflected from past three quarterly earnings
5481.0
1248.0 1242.4 1279.3 1375.3
5145.0
1433.9
0
2000
4000
6000
FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 FY11 Q1FY12
| cr
ore
Revenues
Source: Company, ICICIdirect.com Research
Share holding pattern (Q1FY12)
Shareholder Holding (%)Promoters 42.7Institutional Investors 16.7Other Investors 1.9General Public 29.3
FII & DII holding trend (%)
42.7
42.7
42.7
42.7
42.7
13.7
13.2
11.1
12.6
16.7
0
8
16
24
32
40
48
Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12
(%)
Promoters FII & DII
`
ICICI Securities Limited
ICICIdirect.com | Equity Research Page 3
Exhibit 3: EBIT margins rise 230 bps to 12% vs. 9.7% in Q4FY11
62 30.6 172270.413443.829.1
5.0
2.53.4
5.3
12.09.7
0.5
0
60
120
180
240
FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 FY11 Q1FY12
| cr
ore
0
4
8
12
16
%
EBIT EBIT Margin
Source: Company, ICICIdirect.com Research
Exhibit 4: Revenue by geography as of Q1FY12
Rest of world26%
Europe24%
North America50%
Source: Company, ICICIdirect.com Research
Exhibit 5: Revenue by verticals as of Q1FY12
Others11%
Healthcare & Life Sciences
7%
Retail, T&L12%
BFSI 17% TME
20%
Manufacturing 33%
Source: Company, ICICIdirect.com Research, TME - Technology, Media & Entertainment
Mahindra Satyam
ICICIdirect.com | Equity Research Page 4
4 Error! Reference source not found.
Exhibit 6: Revenue by vertical & service lines
Verticals Segments Offerings Areas Customers
Engineering Services Manufacturing
Avionic Solutions Concept
Enterprise Business Solutions Design
Application Development and Maintenance Aftermarket Service
Business Process Outsourcing Product Lifecycle Management
RFID Solutions
Outsourcing and Electronic Data Interchange Solutions Product Development 8 of the top 10 original equipment manufacturers (OEMs)
Integrated Engineering Solutions Supply Chain Management 4 of the top 10 suppliers in the automotive industry
Manufacturing
Sales and Marketing
After Sales Service
Support Functions
Business Transformation
Manufacturing Operations Management
Plant Asset Management
Global Spend Analytics
Real-Time Order Processing
Pricing Management
Environment Health and Safety
Innovation Management
Product Development Farm Equipment
Supply Chain Management Construction/Mining Equipment
Manufacturing Forestry Equipment
Sales and Marketing Quarry & Aggregates
After Sales Service Paving & Compaction
Industrial Equipment
Manufacturing Aerospace and Defence 1 out of the Global Top 2 commercial aircraft manufacturers
Automotive
Chemicals 3 of the top 5 global chemical companies
Source: Company, ICICIdirect.com Research
Mahindra Satyam
ICICIdirect.com | Equity Research Page 5
5 Error! Reference source not found.
Exhibit 7: Revenue by vertical & service lines
Verticals Segments Offerings Areas Customers
Cloud Computing Cards 8 of Top 10 wholesale banking majors
Product and Application Testing Lending 4 of Top 10 retail banking majors
SAP SolutionsTreasury and Risk Management
3 of Top 5 credit card majorsElectronic Bill Payments
Online Banking
Lock Box Processing
Cheque Processing
Payments Processing
Cash Management
Core Banking
Product and Application Testing Market Data Research 3 of Top 5 insurance majors
Oracle Solutions Trading Systems Group 8 of Top 10 asset management majors
SAP Solutions Reference Data Systems
Business Intelligence and Performance Management Asset Management
Hedge Funds
Regulatory Compliance
Risk Management Services
Constituent Relationship Management
University Administration
Student Self-Help
eLearning
Grants Management
Technology solutions
Infrastructure solutions
Domain Solutions
Enterprise Business Solutions
SAP Solutions
IT infrastructure for Generation
Banking and Financial Services
Banking
Financial Services
Education
Energy and Utilities
Energy (Oil and Gas Industry)
Data services Exploration & Production, Oil Field
Midstream, Refining and Marketing
Trading and Risk Management
Environment Health and Safety
Enterprise Asset Management
Utilities
Smart Grid
IT infrastructure for Transmission
IT infrastructure for Distribution
IT infrastructure for Retail
Source: Company, ICICIdirect.com Research
Mahindra Satyam
ICICIdirect.com | Equity Research Page 6
6 Error! Reference source not found.
Exhibit 8: Revenue by vertical & service lines
Verticals Segments Offerings Areas Customers
2 of the top 5 global pharma majors
2 of the top 10 biotech majors
3 of the top 10 medical device majors
Application Development and Maintenance
BPO Services
Application Development and Maintenance
Enterprise Data Warehousing
CRM solutions
Analytics
Integration Services
Cloud Computing
SAP Solutions
Product and Application Testing Product development
SAP Solutions Benefit validation
Marketing & Distribution
Underwriting
Claims
TV Content Procurement Digital Rights Management
Print Content Distribution Media Process Outsourcing
Web Content Archival Animation
Mobile Content Retrieval Consulting
Insurance Property & Casualty (General Insurance
Media and Entertainment
Corporate IT
Health Insurance Vertical Underwriting
Rating
Claims & Benefits
Sales and Marketing
Manufacturing
Supply Chain Management
Product Lifecycle Management
Sales & Marketing
Healthcare and Life Sciences
Healthcare Infrastructure Management Services
Analytics
BPO
Electronic Health Record Services
Hospital Information System
Telemedicine Solutions
Life Sciences Vertical Research and Development
Source: Company, ICICIdirect.com Research
Mahindra Satyam
ICICIdirect.com | Equity Research Page 7
7 Error! Reference source not found.
Exhibit 9: Revenue by vertical & service lines
Verticals Segments Offerings Areas Customers
Governments
NGOs
IGOs
Central Banks
Development Banks
Higher Education
Retail Technology Architecture Consulting Merchandising
Consumer Process Goods Six Sigma ConsultingSupply Chain Management
Packaged Implementation Services Store Operations
Infrastructure Management Services Marketing
Business Process Outsourcing Product Development
Business Intelligence Manufacturing
Supply Chain Management
Sales & Marketing
Semiconductor Equipment Manufacturers
Software Development SEMI Standards
IDMs Maintenance &Support Fab Automation
Fabs Testing Productivity
Foundries Application Development and Support Semiconductor Manufacturing
BPO Services Operations Management
Infrastructure Services
Embedded Solutions
Engineering Solutions
Communication Design, development and testing Mobile devices
Computing System Software and Migration Services Network elements
Consumer electronics Set-top boxes
Technology Infrastructure
20 of the Fortune 500 companies
Semiconductor
Public Services Application Development and Maintenance
Retail and Consumer Process Goods
Source: Company, ICICIdirect.com Research
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 8
Management profile Vineet Nayyar is the Chairman of Mahindra Satyam and the Vice Chairman of Tech Mahindra. His earlier assignments include stints as Chairman & Managing Director of Gas Authority of India, Managing Director of HCL Corporation & Vice Chairman of HCL Technologies. He was also the founder & CEO of HCL Perot systems. Vineet holds a master’s degree in Development Economics from Williams College, Massachusetts. He held senior roles in the Indian Government including Director, Department Of Economic Affairs and served the World Bank for more than 10 years. CP Gurnani, Chief Executive Officer, held senior positions in various companies including HCL Hewlett-Packard Ltd, Perot Systems (India) Limited and HCL Corporation Ltd, including Chief Operating Officer and a co-founder of Perot Systems (India) Limited. CP holds a Chemical Engineering degree from National Institute of Technology, Rourkela. Vasant Krishnan, Chief Financial Officer, is a member of Institute of Chartered Accountants of India (ICAI), an associate member of the Institute of Company Secretaries of India (ICSI) and holds a diploma in Business Finance from the Institute of Chartered Financial Analysts of India (ICFAI). Prior to Satyam, he has held various positions in the Mahindra Group. He was the COO of South Asian Real Estate, a private equity fund and the CFO of the Adani Group (Realty). Rakesh Soni, Chief Operating Officer, is an alumnus of IIT Kanpur. In his career of over three decades, he was EVP - Perot Systems TSI and has held senior positions in Abu Dhabi Computer Centre, Tata Consultancy Services and Engineers India Ltd. AS Murthy, Chief Technology officer, is an electrical engineer from National Institute of Technology, Warangal and also holds a Masters' degree in School of Automation from the Indian Institute of Science (Bangalore). Murthy is a Satyam veteran having worked for >15 years. During his tenure, he has held various positions including Head of Global Delivery, Head of the Leadership Development, Head of Human Resources and Head of the insurance vertical. He was the CEO from February-June 2009. Hari Thalapalli, Chief Marketing Officer and Chief People Officer, is an old hand having served for 11 years at Satyam and >20 years in the IT industry. He is among the top HR professionals in the country. Vijayanad Vadrevu, Senior Vice President, Strategic Initiatives, has 20 years of IT services experience in sales, practise building, pre-sales, global delivery and customer advocacy functions across various verticals. He holds a Masters in Computer Engineering from IIT Kharagpur.
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 9
Investment Rationale Two years (of the three year restructuring strategy) have concluded Subsequent to its acquisition of Mahindra Satyam, the new management had laid out its three year transformation strategy of restoring customer and employee confidence in the first two years and growth in the third year. The first year (FY10) could best be described as ‘act of survival’ wherein governance, financial disclosure, business confidence and employee morale was at its trough. That said, during the second year (FY11) the management invested in the core business to arrest revenue decline and employee attrition. Concurrently, the company increased its efforts to improve customer and employee confidence. Q4FY11 and Q1FY12 quarterly earnings suggest that the management has been successful in stabilising operations and laying a foundation for growth with likely tangible results over the longer term pending any macroeconomic headwinds.
Ride the turnaround with likely payoffs over longer term
Q1FY12 revenues grew 4.3% QoQ in US dollar terms led by growth in the telecom, media, entertainment and retail vertical. Revenue growth was aided by 3.9% volume growth. Noticeably, Q4FY11 and Q3FY11 revenues grew 7.5% and 3% sequentially led by 3.5% and 2.5% volume growth. Revenue growth across quarters was accompanied by deal wins and signing of 50+ new logos.
Rationalisation of employee pyramid may yield operating margin expansion
Analysing the current employee pyramid suggests that employees with 0-3 years of work experience constitute ~20-25% of total employee base, 3-6 years - 34%, 6-10 years - 25% and the remaining with >10 years of experience as of Q4FY11. This could be largely attributed to minimal fresher hiring during the two year rebuilding process as Indian IT companies generally have ~45-55% of their employees in the 0-3 year band. This helps elucidate the employee costs disparity between Mahindra Satyam (~70% of FY11 revenues) vs. other Tier-I IT companies (~53-65% of revenues). Rationalisation of the employee pyramid coupled with fresher hiring (15,000 over the next three year) could yield meaningful EBITDA and EBIT margin expansion in FY12E/FY13E from 9.7% level in Q4FY11.
Exhibit 10: Employee pyramid skewed towards laterals as on Q4FY11
Source: Company, ICICIdirect.com Research,
The past two years have seen the management stabilise
and invest in the business. The results of this are
encouraging
The employee pyramid continues to be skewed towards
laterals. Increased fresher hiring could help flatten the
employee pyramid and yield EBITDA/EBIT margin
expansion. The number of employees under 0-3 years
stood at 24% as of Q1FY12
10+ years – 21%
6 - 10 years – 25%
3 - 6 years – 34%
0 - 3 years – 20%
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 10
Operating metric has room for improvement
Below, we analyse the operating metric data at Mahindra Satyam. Note that our analysis is limited to data availability as the company started publishing operating metric data only since Q4FY11. Mahindra Satyam operates at one of the highest onsite-to-offshore ratio of 56%:44% vs. industry average of 38%:62%. Though high onsite helps revenue growth performance, it impacts the operating margin as onsite costs are higher relative to offshore. Noticeably, a shift to offshore should help operating margin expansion. Separately, the company has managed to trim Q1FY12 last 12 month (LTM) attrition to 17% vs. 22% in Q4FY11 and 24% in Q3FY11 helped in part by historical HR initiatives – institutionalised by existing chief people’s officer – such as inculcating ownership behaviour among all its business associates by building effective communication, employee empowerment and Esops.
Exhibit 11: Operating metric highlights Offshore Onsite Attrition Utilisation Fixed Time &material Top1 Top 5 Top 10
HCLTech 72.9 27.1 17.0 78.6 42.0 58.0 NA 16.2 25.2Infosys Ltd 75.8 24.2 17.0 68.1 40.3 59.7 4.6 16.4 26.2TCS 51.0 44.0 14.4 76.2 49.4 50.6 7.4 21.4 29.6Tech Mahindra 64.0 43.0 NA 74.0 NA NA 41.0 70.0 79.0Wipro Ltd 48.3 51.7 22.7 77.0 NA NA 2.6 11.0 19.7
Average 62.4 38.0 17.8 74.8 43.9 56.1Mahindra Satyam 56.0 44.0 17.0 74.0 46.0 54.0 10.0 26.0 39.0Attrition is LTM basisUtilisation is on including trainee basis
Source: Company, ICICIdirect.com Research
Exhibit 12: Attrition levels in-line with industry average
14.414.8
17
15.8
20.9
23.2
1716.5
22
17
24.6
22.9
10
15
20
25
30
Q4FY11 Q1FY12
%
TCS Infosys Wipro HCL Tech Satyam Patni
Source: Company, ICICIdirect.com Research
Shift to owned facilities & subcontracting may add 1.5% to net margin in three years
During FY11, Mahindra Satyam surrendered 32 rented properties (~1520 spaces) across various locations. Leased facilities, classified as operating, are being replaced with owned facilities at Infocity SEZ, Hyderabad, which was completed in FY11 and created 4,304 spaces. Under construction facilities at the Hyderabad and Chennai SEZ, which are scheduled to be complete in FY12E, should create incremental 5,974 spaces. Further, subcontracting cost increased 1.33x during FY11 vs. FY10. Shift to owned
Q1FY12 LTM attrition declined to 17% vs. 22% in Q4FY11
Subcontracting and shift to owned facilities could aid net
margin expansion
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 11
facilities along with subcontracting could yield operating margin expansion and likely add 1.5% to net margin in three years.
Exhibit 13: Subcontracting costs have risen 1.33x YoY in FY11 vs. FY10
98.5
229.2
0
80
160
240
FY10 FY11|
Cro
res
0
4
8
12
16
20
24
%
Subcontacting costs As a % of Operating & Admin expenses
Source: Company, ICICIdirect.com Research
Exhibit 14: Leases decline 38% YoY in FY11 vs. FY10
199.5
122.7
0
50
100
150
200
FY10 FY11
| C
rore
s
0
4
8
12
16
20
%
Lease rentals As a % of Operating & Admin expenses
Source: Company, ICICIdirect.com Research
Merger resolution likely to reach Board in October
Though the debate on procedure and timing on merger continues, we believe the merger resolution could likely reach the Board of Directors (Board) in October. Our discussion with the management suggests winding down of the ADR programme and merger process can continue concurrently. The topical merger process entails Board and shareholder approval for both listed entities along with high court approval from both Maharashtra and Andhra Pradesh (headquarter location of Tech Mahindra and Mahindra Satyam, respectively). Assuming target PE multiple of 10x on our FY13 estimates of | 65.9 and | 7.3 for Tech Mahindra and Mahindra Satyam, respectively, yields potential swap ratio of 9:1 (one share of Tech Mahindra for nine shares of Mahindra Satyam). Exhibit 15 highlights the swap ratio sensitivity to different target multiples for both companies.
Discussion with the management suggests winding down
of ADR programme and merger process can continue
concurrently
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 12
Exhibit 15: Sensitivity analysis for swap ratio
9.0 7 9 10 11 13
7 9.0 11.6 12.9 14.2 16.8
9 7.0 9.0 10.0 11.0 13.0
10 6.3 8.1 9.0 9.9 11.7
11 5.7 7.4 8.2 9.0 10.7
13 4.9 6.2 6.9 7.6 9.0
Target PE,x for Tech Mahindra
Targ
et P
E,x
for
Mah
indr
a Sa
tyam
Source: Company, ICICIdirect.com Research
Top 10 client distribution broad based across verticals
We analysed Mahindra Satyam’s top 10 client distribution across verticals. Revenue generation from a diverse set of clients across verticals minimises revenue and earnings growth volatility during an uncertain macro environment. Exhibit 16: Top 10 client distribution across verticals
1
3
1 1
2
1 1
0
1
2
3
4
Auto
BFSI
Ener
gy a
ndut
litie
s
Aero
spac
e
Phar
ma
Tech
nolo
gy
Cong
lom
erat
e
Top 10 clients distribution across verticals
Source: Company, ICICIdirect.com Research
Synergies with parent likely to benefit manufacturing vertical
The external IT services spend from the manufacturing sector is expected to be ~$108 billion in 2011 and is expected to grow at a CAGR of ~3% between 2009 and 2013E. Note that manufacturing has been Mahindra Satyam’s expertise since inception. Currently, there are more than 130+ clients in this area (25 of the fortune 500 companies) and contributes ~31% of the total revenues. Sub-vertical wise discrete manufacturing contributes ~33%, automotive (29%), process manufacturing (22%) and aerospace & defence (16%). Mahindra Satyam, complimented by Mahindra & Mahindra (M&M) group’s strong engineering capabilities, continues to witness a demand pick-up in supply chain optimisation, plant modernisation initiatives, product life cycle management and regulatory compliance & sustainability.
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 13
Exhibit 17: Manufacturing verticals trends for Tier-I IT companies
-16.6-9.5
-0.4 -2.5
16.28.5
20.38.2
3.6
12.3 15.1
27.030.7
24.8
-26.3
38.1
-8.9
20.0
-40
-20
0
20
40
Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12
TCS Infosys
Source: Company, ICICIdirect.com Research
Enterprise applications continue to be key differentiator Historically, Satyam had a strong application software practice built around the manufacturing vertical given its association with SAP. The company continues to see positive demand trends in application rationalisation, software-as-a-service (SaaS) implementation, packaged application implementation and enterprise mobility services. Noticeably, the 10,800+ resources are competent across platforms and distributed across verticals with focus on manufacturing. With 1700+ employees hired in Q3 and Q4 and 60 new logs wins in FY11, we believe, customers still perceive the company’s enterprise application positioning.
Verticalisation of delivery function Historically, Satyam Computers had its sales force aligned to verticals while the delivery was aligned to services offerings, a practice common to a majority of Indian IT vendors. Though beneficial on multiple counts, the existing structure did not leverage the domain expertise of employees. Further, frequent rotation of resources would impede generation of domain knowledge, which could be shared for future projects through knowledge management. Reorganising the delivery function along verticals by the new management should help create customer-centric and vertical focused solutions, thus improving customer satisfaction.
Defence requirement alone may lead to $600-million IT opportunity As India finalises its purchase of 126+ fighter jets for $10.6 billion, its biggest since 1990, a large IT outsourcing opportunity draws near for Indian IT vendors. Remember, the Indian offset policy mandates that services worth 30% of the contract value should be sourced domestically. The ratio rises to 50% for purchases over $70 million. Though a majority of these would go towards component manufacturers, 20% of offset value would go towards sourcing IT engineering solutions. This implies an engineering solutions’ IT outsourcing opportunity of ~$600 million. Having built an engineering solutions practice with 4000+ associates over 15 years and a long-term relationship with five out-of-the eight leading aircraft OEMs, we believe Mahindra Satyam is better positioned to participate in the incremental demand. Exhibit 18: Engineering solutions portfolio Globalised R&D Art to Part Solutions Outsourcing Consultancy New Product Development Manufacturing Support and Global Sourcing System Integration Product Sustenance Plant and Process Engineering Life Cycle Management
Source: Company, ICICIdirect.com Research
Verticalisation of delivery function could help improve
customer satisfaction
Manufacturing vertical capabilities coupled with the
parent’s (M&M) exposure to defence, makes Mahindra
Satyam better positioned to participate in incremental
demand
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 14
Risks and concerns Winding down of ADR programme in US may have supply overhang
During Q1FY12 earnings, the company announced the winding down of its American depository shares (ADS, receipt issued by depository Citibank, NA) programme. Recall, the company’s ADS’ were delisted from New York Stock Exchange (NYSE) effective October 2010 but continued to trade on the over-the-counter market. The company expects to complete the programme in approximately seven months from September 2011. As of June 2011, ADS constitute 9.4% of the total O/S shares or 11.1 crore shares. Availability of limited options for ADS holders could create supply overhang in the local shares at higher levels. Further, we believe, winding down of the ADS programme could have a sentimental impact given Mahindra Satyam earns 50% of its revenues from the US.
Aberdeen lawsuit could likely mirror class-action settlement
In November 2009, a trustee of two trusts, representing claims of 20 investors who had invested in the company’s ADS, brought forward an individual action alleging losses in excess of $68 million. Though both parties are contesting the claims, recent class action lawsuit settlements may help size the losses. Recall, Mahindra Satyam settled a similar lawsuit in FY11 by paying | 641.1 crore ($141 million) including | 569 crore ($125 million) as settlement charges and | 72 crore ($16 million) as litigation expense. Recent discussions with the management suggest potential resolution to the issue include 1) mirror prior settlement terms, 2) continue dialogue till settlement, 3) wait and watch. Note that the company has not made any provisions against these claims.
SEC settled, claims from Indian Tax Authorities could be a drag
The company has already settled its dispute with SEC and made the final payment of | 46.7 crore in April 2011 and has filed an application seeking a binding advance ruling under the Income Tax Act 1961 regarding taxability of the said income. However, apprehensions related to Income tax claims continue to prevail. Recently, the company received draft notices of incremental demand for | 1037.7 crore and | 1075.7 crore for assessment years 2002-03 and 2007-08, respectively. Except for these incremental claims, the company has provided bank guarantee of | 617 crore for unfavourable ruling in its petition against the income tax department (Exhibit 19). An adverse ruling in case of incremental demands from income tax could lead to additional bank guarantees that could impact the cash balance of the company.
Exhibit 19: Details of claims from Indian Tax Authorities
Statute Nature of Dues Forum where dispute is Pending Amount (| cr) Period to which amount relatesIncome Tax Act,1961 Income Tax Income Tax Appellate Tribunal 256.2 2007-08Income Tax Act,1961 Income Tax Income Tax Appellate Tribunal 81.2 2006-07Income Tax Act,1961 Income Tax Commissioner of Income Tax Appeals 144.1 2004-06Income Tax Act,1961 Income Tax Income Tax Appellate Tribunal 134.9 2002-04Income Tax Act,1961 Income Tax Commissioner of Income Tax Appeals 0.8 2001-02Revenue & Taxation code, US New York State Income Tax New York State Taxation and Finance 9.3 2005-07Revenue & Taxation code, US California State Income Tax Franchise Tax Board, California 5.4 2003-05Revenue & Taxation code, US Pennsylvania State Income Tax Commonwealth of Pennsylvania - Dept. of Revenue 0.3 1998-2005Andhra Pradesh VAT Act, '05/CST Act, '56 Sales tax (including penalty) High Court of Andhra Pradesh 5.2 2007-2009Finance Act,1994 Service Tax (including penalty) Central Excise and Service Tax Appellate Tribunal 20.2 2004-05 to 2008-09
Source: Company, ICICIdirect.com Research
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 15
Accounts receivables rise but unbilled declines
Analysing the balance sheet metric suggests an increase in account receivables. Other debts considered good increased 28% YoY (faster than revenue growth) to | 1,078 crore in FY11 vs. | 841.5 crore in FY10. Doubtful debts outstanding for a period exceeding six months have also increased 2% YoY to | 491.6 crore in FY11 vs. | 484.3 crore in FY10. Q1FY12 days sales outstanding (DSO) of 102 days continue to remain at elevated levels relative to Tier-I average of 70 days but have declined from 107 days in Q3FY11. Finally, unbilled revenues declined 31% YoY in FY11 to | 313.9 crore vs. | 454.3 crore in FY10. Exhibit 20: Accounts receivables have risen YoY in FY11
1,078
492
842
484
100
500
900
Other debts -considered good Debts outstanding for a period exceeding sixmonths but considered doubtful
| Cr
ore
March 31,2011 March 31,2010
Source: Company, ICICIdirect.com Research
Exhibit 21: Unbilled revenues have declined YoY in FY11
Particulars (| crore) March 31,2011 March 31,2010Unbilled Revenue 314 454
Source: Company, ICICIdirect.com Research
Amount pending investigation suspense account
As of March 31, 2011, the company’s balance sheet carried an understated liability of | 1230.4 crore. This relates to the funds arranged by Ramalinga Raju while he was still the Chairman. Further, 37 companies, predominantly promoter firms, have staked repayment claims along with compensation at the rate of 18% per annum from the date of advance till date of repayment. Though the Enforcement Directorate has advised the company not to return the money, any ruling against Mahindra Satyam could have a negative impact on the cash balance of the company.
Significant currency volatility may impact operating margin recovery
Mahindra Satyam has announced average wage hikes of 12-20% offshore and 2-4% onsite effective Q3FY12 that could impact its operating margins (EBIT) by ~250-300 bps. Significant currency volatility from current levels could have a material impact on the operating margin recovery.
Political uncertainty in Andhra Pradesh may impact normal operations
Political uncertainty in Andhra Pradesh, current headquarters of the company, could adversely impact Mahindra Satyam’s operations.
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 16
Adverse ruling in FEMA violation may impact cash balances
The Enforcement Directorate issued a show-cause notice dated April 28, 2011 for contravention of the provision of the Foreign Exchange Management Act, 1999 and the Foreign Exchange Management Regulations, 2000. This relates to the realisation and repatriation of export proceeds of foreign exchange equivalent to | 50.6 crore for invoices raised during July 1997 to December 31, 2002. The company was granted 30 days to respond and we are anticipating further updates on the same.
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 17
Financials Modelling 16.1% & 11.3% revenue growth for FY12E and FY13E
We are modelling FY12E and FY13E revenues will grow 16.1% and 11.3% YoY to | 5,974 crore and | 6,651 crore, respectively. The growth would be driven by strength in enterprise application and package implementation aided by mining of existing customers. From a quarterly perspective, we are modelling revenue growth of 3.3% in Q2FY12, 2.5% in Q3 and 1.5% in Q4. Exhibit 22: Revenue growth forecasts
1375
.3
1433
.9
1481
.2
1518
.2
1541
.0
1579
.5
1626
.9
1688
.8
1756
.3
1000
1200
1400
1600
1800
Q4FY
11
Q1FY
12
Q2FY
12E
Q3FY
12E
Q4FY
12E
Q1FY
12
Q2FY
12E
Q3FY
12E
Q4FY
12E
| cr
ore
(1.2)
0.8
2.8
4.8
6.8
8.8
%
Revenue growth
Source: Company, ICICIdirect.com Research
Employee cost rationalisation, declining LTM attrition, rupee depreciation may aid EBITDA margin expansion in FY12E, FY13E
We expect the company’s EBITDA margin to increase by 490 bps and 150 bps in FY12E and FY13E, respectively, led primarily by cost rationalisation, utilisation improvement and decline in LTM attrition. Similarly, the EBIT margin could increase by 560 bps and 150 bps in FY12E and FY13E, respectively. However, on a quarterly basis, we expect the EBITDA margin to stay flat in Q2FY12 (15% vs. 14.6% in Q1FY12) and decline by 280 bps in Q3FY11 due to 12-20% offshore and 2.5% onsite wage hikes effective October 2011. Exhibit 23: EBITDA growth forecast trend
178.
3
210.
0
222.
2
185.
2
200.
3
236.
9
231.
0
261.
8
281.
0
150
200
250
300
Q4FY
11
Q1FY
12
Q2FY
12E
Q3FY
12E
Q4FY
12E
Q1FY
12
Q2FY
12E
Q3FY
12E
Q4FY
12E
| Cr
ores
10.0
14.0
18.0
%
EBITDA margins
Source: Company, ICICIdirect.com Research
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 18
Improving return ratios
We estimate Mahindra Satyam would continue to generate moderate return ratios between FY12E and FY13E driven by improving profitability. The RoE is expected to improve to 14.7% and 13.7% in FY12E and FY13E, respectively, vs. negative return in FY11. Similarly, RoCE is projected to increase to 15.1% and 16.1% in FY12E and FY13E vs. 9.8% in FY11.
Valuations Apart from the recession, Mahindra Satyam was impacted by a variety of issues including financial irregularities and the subsequent rebuilding exercise. However, in-line with its stated objective, the last two years have seen the management succeed at stabilising operations and client roster, improve customer and employee confidence, trim attrition and invest for the future. This is adequately reflected in the last three quarterly earnings. At current levels, the stock is trading at 10.6x and 10x our FY12E and FY13E diluted EPS estimate of | 6.8 and | 7.3, respectively. From a Mcap/sales and EV/EBITDA perspective, Mahindra Satyam is trading at 1.4x and 8.1x on FY12E and 1.25x and 6.5x on FY13E basis, respectively. Though PE valuations appear reasonable post the recent 15-20% price correction, on a PEG basis it continues to trade at 1.1x on FY13E estimates, a premium relative to peer group average of 0.9x. This implies fair valuations at current levels. Further, pertinent deterioration in the macroeconomic environment could curtail CY12 client budgets and weigh on IT sector valuations. Consequently, we have valued the stock at | 75 i.e. at 10.2x our FY13E EPS estimate of | 7.3. We are initiating coverage on the stock with a HOLD rating. Exhibit 24: One year forward PE(x) chart
0
30
60
90
120
Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11
price 15 12 9 6 3
Source: Company, ICICIdirect.com Research
Though earnings would not likely show near term
weakness, our HOLD rating stems from the uncertain
macro, which could impact FY13 estimates and valuations
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 19
Exhibit 25: Peer valuation Name Price (|)
FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY12E FY13E FY12E FY13E FY11 FY12E FY13ETCS 1044 44.4 52.2 60.0 23.2 19.8 17.2 17.0 14.7 13.1 1.1 1.1 5.4 4.5 4.0Infosys 2454 119.4 137.3 159.9 20.5 17.9 15.3 12.7 11.3 9.6 1.2 0.9 4.8 4.1 3.5Wipro 348 21.6 24.0 27.6 16.1 14.5 12.6 11.9 10.0 8.7 1.3 0.8 3.4 3.0 2.6HCL TECH 393 24.2 31.5 36.6 16.2 12.5 10.7 10.2 8.2 6.9 0.4 0.7 1.8 1.5 1.2Tech Mahindra 610 49.4 61.8 65.9 12.3 9.9 9.3 9.8 9.3 8.4 0.4 1.4 1.2 0.9 0.7
Patni 295 46.4 26.4 30.1 6.4 11.2 9.8 2.9 3.6 3.2 NM 0.7 1.2 1.1 1.0
Mphasis 330 39.31 37.7 41.4 8.4 8.7 8.0 7.2 8.9 7.9 NM 0.8 1.9 1.8 1.6Average 49.3 53.0 60.2 14.7 13.5 11.8 10.3 9.4 8.3 0.9 0.9 2.8 2.4 2.1
Mahindra Satyam 71 -1.3 6.8 7.3 NM 10.5 9.7 14.5 8.1 6.5 NM 1.1 0.8 0.8 0.7
Mcap/Rev (x)Diluted EPS (|) P/E (x) EV/EBIDTA (x) PEG (x)
Source: Company, ICICIdirect.com Research
Exhibit 26: Scenario analysis
Key Parameters Bear case Base case Best case
Legal Claims
Aberdeen Settlement Settlement amount in excess of class action settlement in-line less
i.e. (+) | 641.1 Crores | 641.1 Crores (-) | 641.1 Crores
Tax disputes
Existing claims for which |617 crore bank guarantee given loses dispute with tax authorities One time settlement wins the case
Addiitonal claims worth | 2113.42 crores either additional bank guarantee or payment under protest no payment but additional bank neither
guarantee required
Global Economic Outlook
Impact on economic uncertainity on CY12 IT budgets Decline >5% YoY Declines by 0-2% Flat
Revenue Growth 5-8% 11.30% 14-16%
EPS Growth 3-4% 8.7% 12.1-12.8%
EPS 7.0 7.3 7.6
Valuation Multiple (PE,x) 7 10.2 12
Target Price (|) 49 75 91
Source: Company, ICICIdirect.com Research
Exhibit 27: Trading at 1.1x PEG, premium relative to peer group average of 0.9x
1.10.9
0.80.7
1.4
0.70.8
1.1
0.0
0.5
1.0
1.5
2.0
TCS Infosys Wipro HCL TECH TechMahindra
Patni Mphasis MahindraSatyam
x
Source: Company, ICICIdirect.com Research
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 20
Tables and ratios Exhibit 28: Profit & loss account
(|crore) FY09 FY10 FY11 FY12E FY13ETotal Revenues 8,812.6 5,481.0 5,145.0 5,974.4 6,651.6 Growth (%) - (37.8) (6.1) 16.1 11.3 Total Operating Expenditure 9,013.2 5,224.3 4,689.9 5,156.6 5,640.8 EBITDA (200.6) 256.7 455.1 817.7 1,010.7 Growth (%) - (228.0) 77.3 79.7 23.6 Depreciation 839.4 227.6 184.7 167.7 179.1 Interest 62.1 32.9 9.7 9.4 0.5 Other Income 63.1 105.6 294.2 325.9 265.0 PBT before Exceptional Items (1,772.8) (101.7) 554.9 966.5 1,096.2 Less: Exceptional Items 6,242.8 - 641.1 - - PBT (8,015.6) (101.7) (86.2) 966.5 1,096.2 Growth (%) - (98.7) (15.2) (1,221.2) 13.4 Total Tax 159.0 22.2 57.8 171.8 233.6 PAT before MI (8,174.6) (123.9) (144.0) 794.8 862.6 Minority Interest 2.0 0.7 3.3 - - PAT (8,176.6) (124.6) (147.3) 794.8 862.6 Growth (%) - NM NM NM 8.5 EPS (121.5) (1.1) (1.3) 6.8 7.3 EPS (Growth %) - NM NM NM 8.5
Source: Company, ICICIdirect.com Research
Exhibit 29: Balance sheet
(|crore) FY09 FY10 FY11 FY12E FY13EEquity Capital 135 235 235 235 235 Share application money - - - - - Reserve and Surplus 1,610 4,395 4,386 5,181 6,043 Total Shareholders funds 1,745 4,630 4,621 5,416 6,279 Total Debt 814 42 32 12 - Deferred Tax Liability 5 4 7 7 7 Minority Interest 20 20 23 23 23 Amount Pending Investigation Suspense Account 1,230 1,230 1,230 1,230 1,230Source of Funds 3,813 5,927 5,913 6,688 7,539 Net Fixed Assets 1,239 987 950 1,107 1,290 Investments - 627 435 435 435 Deferred Tax Assets 7 7 8 8 8 Inventory 1 - 59 59 59 Cash 501 2,177 2,754 2,601 3,587 Debtors 1,552 923 1,159 1,662 1,479 Loans and Advances 466 385 378 378 378 Total Current Assets 5,436 6,729 7,625 8,233 8,893 Provisions 1,478 1,540 1,558 1,549 1,540 Total Current Liabilities 2,868 2,422 3,104 3,095 3,086 Net Current Assets 2,568 4,307 4,521 5,138 5,806 Deferred Tax Assets 7 7 8 8 8 Application of Funds 3,813 5,927 5,913 6,688 7,539
Source: Company, ICICIdirect.com Research
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 21
Exhibit 30: Cash flow statement
FY09 FY10 FY11 FY12E FY13EProfit after Tax (8,015.6) (101.7) (86.2) 966.5 1,096.2 Depreciation 907.2 227.6 184.7 167.7 179.1 (inc)/dec in Current Assets - (1,293.4) (896.0) (608.4) (659.2) (inc)/dec in current Liabilities - (507.4) 664.5 - - CF from operations 302.0 86.4 (61.2) (124.7) 1,094.8 Other Investments (163.5) (2,125.3) 547.2 325.9 265.0 (Purchase)/Sale of Fixed Assets (590.2) (95.1) (247.5) (325.0) (361.8) CF from investing Activities (753.7) (2,220.4) 240.1 0.9 (96.8) Inc / (Dec) in Equity Capital 51.3 2,908.5 - - - Inc / (Dec) in sec.loan Funds 588.0 (766.7) (10.7) (20.0) (11.5) Dividend & Divendend tax (275.7) - - - - Interest Paid on Loans (57.8) (38.2) (9.7) (9.4) (0.5) CF from Financial Activities 305.8 2,103.6 (20.4) (29.4) (12.0) Cash generating during the year (145.9) (30.4) 158.5 (153.2) 986.0
Amounts Pending Investigation Suspense Account (Net) 210.4 - - - - Opening Balance Adjustments (809.7) - - - - Cash on Account of New Subsidiaries 20.6 - - - - Effect of Exchange Rates (5.0) (26.1) 9.1 - - Opening cash balance 1,194.0 464.4 337.8 2,753.8 2,600.6 Closing cash 464.4 407.9 505.4 2,600.6 3,586.6
Source: Company, ICICIdirect.com Research
Exhibit 31: Key ratios
FY09 FY10 FY11 FY12E FY13EPer Share Data (|)EPS (121.5) (1.1) (1.3) 6.8 7.3 Cash EPS (108.9) 0.9 0.3 8.2 8.9 BV 25.9 39.4 39.3 46.0 53.4 Operating profit per share (3.0) 2.2 3.9 6.9 8.6 Operating Ratios (%)EBITDA/Total Revenues (2.3) 4.7 8.8 13.7 15.2 PBT/Total Revenues (91.0) (1.9) (1.7) 16.2 16.5 PAT/ Total Revenues (92.8) (2.3) (2.9) 13.3 13.0 Return Ratios (%)RoNW NM NM NM 14.7 13.7 RoCE NM 5.5 9.8 15.1 16.1 RoIC NM NM NM 13.4 12.9
FY09 FY10 FY11E FY12E FY13EValuation Ratios (x times)P/E (0.6) (62.3) (56.8) 10.5 9.7 EV / EBITDA (32.8) 25.7 14.5 8.1 6.5 Price to Book Value 2.7 1.8 1.8 1.5 1.3 EV/Total Revenues 0.7 1.2 1.3 1.1 1.0 MCap/Total Revenues 0.9 1.5 1.6 1.4 1.3 Total Revenues/ Equity 5.1 1.2 1.1 1.1 1.1 Turnover Ratios (x times)Inventory Turnover - - - - - Debtors Turnover Ratio - 4.4 4.9 4.2 4.2 Creditors Turnover Ratio - - - - -Fixed Asset Turnover ratio - 4.9 5.3 5.8 5.5 Solvency Ratios (x times)Debt / Equity 0.5 0.0 0.0 0.0 - Current Ratio 1.9 2.8 2.5 2.7 2.9 Quick Ratio 1.9 2.8 2.5 2.7 2.9 Debt / EBITDA (4.1) 0.2 0.1 0.0 -
Source: Company, ICICIdirect.com Research
Mahindra Satyam (SATCOM)
ICICIdirect.com | Equity Research Page 22
RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/20% for large caps / midcaps, respectively; Buy: Between 10% and 15%/20% for large caps / midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more;
Pankaj Pandey Head – Research pankaj.pandey@icicisecurities.com
ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No. 7, MIDC Andheri (East) Mumbai – 400 093
research@icicidirect.com
ANALYST CERTIFICATION We /I, Abhishek Shindadkar MBA Aishwariya KPL MBA research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.
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