Patni Computer Systems - Operational challenges remain

Broadly in-line results with no positive surprises in operating metrics. A subdued management commentary and flat 3Q08 growth guidance could weigh on the stock. However, the ongoing share buyback and Rs106 cash/share should support downside. Hold, with a reduced target price of Rs226.

2Q08 results: no positive surprises; operational triggers missing
Consolidated revenues grew 3.5% qoq to US$182.6bn, in line with our estimates and marginally ahead of guidance. We estimate volumes grew 3% qoq while blended realisation was up 0.4% qoq. Rupee depreciation pushed the revenue growth (Rs terms) by 11% qoq to Rs7.84bn, and EBITDA margin (ex-forex gains) by 33bp qoq to 15.6% (vs our 16.2% estimate). Reported PAT was up 43.1% qoq to Rs1.04bn. However, ex-forex losses, normalised PAT was up 49%, in line with our estimate. Weakness in operational metrics continued. Headcount declined by 108 (we estimated 500 additions) while revenues from the Top 10 clients were up 2.8% qoq.

Management commentary cautious; flat 3Q08 growth guidance
Management reiterated that visibility on near-term demand remains low, guiding for flattish top line for 3Q08, despite a modest outperformance to guidance in 2Q08. It also expects 2008 normalised EBITDA margins to trend near the current quarter’s level of 15.6% despite a favourable currency. This is in line with our thesis of significant margin erosion in 2008 (we estimate a 195bp yoy decline). PAT guidance of US$18m-18.5m represents a qoq decline of 23.4-25.5%, building in lower other income after a seasonally strong 2Q08.

We retain Hold; buyback programme should support the downside
We cut our volume growth projections, factoring in the lower headcount in the quarter. However, our financial forecasts (in Rs terms) are up, due to a about 6% change in the exchange rate vs our earlier estimate. However, we cut our PE-based target price to Rs226 (from Rs275), based on 8.3x 2009F EPS (vs 11x earlier), reflecting a 45% discount to Satyam, which is near the historical peak discount valuation of Patni. We expect the stock to be range-bound; Patni’s current valuation - with a 4% PAT (ex-forex) growth over 2007-10F - looks expensive relative to its mid-cap peers where we see better growth prospects. However, the ongoing buyback (0.8m out of the minimum 7.3m plan has been bought back) should provide downward support till the duration of the programme (July 2008-Februay 2009).