Patni (PTI) - Part 3 – Investment Outlook - Indian Software Outsourcer Research

Market capitalization matters big-time in this industry and so consolidation is the name of the game. So far the company is doing the right thing by growing through acquisitions. Further, organic growth may pick up. They should be able to achieve synergies through their Logan-Orviss International (LOI) acquisition. LOI expertise is in the area of IT Services Telecom Verticals where the company already has a strong presence in the US made possible with the acquisition of Cymbal Corporation in 2004. Also, EMEA (Europe, the Middle East, and Africa) is an untapped growth area and the LOI acquisition should get them in the door for many deals. However, given the enterprise value is below the $2B mark, the company has a long way to go before they are able to play in the big leagues.

A private equity (PE) stake, as is rumored, is not in the best interest of shareholders. The philosophy behind PE acquisitions is
  • Acquire undervalued assets at an attractive price,
  • Fund interest payments of the acquisition amount through cash flow from operations,
  • Sell out at a large premium when the market turns and becomes attractive, and
  • Pocket the difference.

PE taking a sizeable stake is considered undesirable since that distracts management. The idea behind big stakes is to influence management in a way that benefits the PE in the short-term. Again, private equity involvement is a bad deal for shareholders and it is no different in Patni's case. The rationale behind this rumor is that it is a relatively easy way for two of the three brothers who are rumored as wanting to cash out their ownership stake. If unloading their stake is indeed their primary concern, then the odds are low for them wanting to wait for a better deal later on.

An acquisition by a US based large consultancy firm, on the other hand, is a far better alternative. For such a firm, Patni has a lot to offer. A majority of these firms are trying to grow their outsourcing operations to realize the benefits of "following the sun", lower wages, decrease time to market, and growth in the third world areas. An established business with reasonable valuation gives such a firm immediate access to all of the above and a large labor pool. Further, a larger US based business can be expected to realize larger revenue per employee from Patni employees than Patni will be able to do on their own. This is so because big US consultancy firms charge more per billable hour.

Given the industry appetite for size, selling out at a sizeable premium is the most likely outcome!

Patni Computer Systems Limited Analysis:
  1. Part 1 - Financials.
  2. Part 2 - Business Issues.
  3. Part 3 - Investment Outlook.

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