Narendra K. Patni, Chairman & CEO, Patni Computer Systems: A late surge

It's a midsummer morning in May and the press is gathered at Patni Computer Systems' corporate office in suburban Mumbai for an important announcement. Narendra K. Patni, Chairman and CEO, breezes in with a cheery "good morning" but it does little to mask his nervousness. The 50-something CEO of one of India's biggest it companies has hardly faced the press in the 25 years since he founded Patni. He has remained resolutely private and his approach to work is best compared to the beaver, an animal he admires. "It quietly builds dams under the water," he reflects during a conversation with this writer. The beaver also happens to be the mascot of his alma mater, the Massachusetts Institute of Technology, where he graduated in electrical engineering over twenty-five years ago.

As the power point presentation unfolds, Patni's nervousness ebbs. With a CAGR (cumulative average growth rate) of 51 per cent (in Rs) over the past four years and a projected growth of 30 per cent-plus for the current, Patni's sales growth clearly outstrips the current industry average of about 25 per cent. Add to this the warchest of $100 million (Rs 470 crore at today's rates) that global private equity major General Atlantic Partners brought to the table in one of the largest private equity deals last year and it is not difficult to understand why Patni is marching ahead with aggressive plans for the year ahead. The first step includes a series of acquisitions that will give the company critical size before it makes the big move, a public offering towards the end of 2003 or in early 2004. An ADR offering will follow within a year of the IPO.

The press conference had been called simply to announce the first of these milestones, the acquisition of Boston based financial services firm The Reference Inc. Patni expects to conclude a couple of acquisitions by the year end and the inorganic growth strategy will add a sizeable 10-15 percent to Patni's revenues. Clearly, Naren Patni, an aficionado of rock, ("I was at Woodstock, an experience that your generation will never know") and modern art, is currently orchestrating a crucial phase of the company's lifecycle as it transits from a privately held, family controlled, conservative enterprise to a public entity charting a fast growth trajectory.

CAN TCS SPOIL THE IPO PARTY FOR PATNI?

S. Ramadorai, CEO, TCS: Ready to go public As Patni waits in the wings for its public offering. old-time competitor TCS is also moving ahead with its plans for an IPO. Investment bankers feel that Patni's timing will be crucial this time around. "The challenge is that investors will want to bet on a maximum of three-to-four companies and no one can afford to ignore TCS once it hits the market. There is an embarrassment of riches in the IT sector today and Patni will be up against major competition if TCS comes out with an offering at the same time," says one analyst with a leading foreign brokerage. Most investment bankers see a window for the Patni offering between September and November this year (depending on what the September quarter results for IT look like, of course) or from January to July next year.

The Story So Far

For starters, some interesting trivia: Patni was one of the first three prominent software firms to be set up in the country; the others are Tata Consultancy Services (TCS) and Datamatics Ltd. All three owe their current marquee status to MIT graduates (Dr Lalit Kanodia at Datamatics and Dr F.C. Kohli at TCS) and all three continue to be privately held. There's more: the three have been mulling a public offering for a while now and the dominant perception is that they have missed the boat as far as the tech boom goes.

Speaking about Patni, Naren Patni is surprisingly candid about the timing. "Basically, we missed the possibility of an overseas listing in 1998, which was the go-go era for software, primarily because we had to separate the hardware part of our business from the software and then list the software company. Once this separation of the software business was done, we took GE in as a strategic investor and were ready once again for a public listing in 2001 but the markets had turned." (See Company History). This time around, Patni began to talk to General Atlantic Partners and the deal was concluded last year when GE took a minority stake in the company (approximately a third) for $100 million, thereby fixing the company's valuation at about $300 million (Rs 1,440 crore) last year. So will it be third-time lucky for Patni on the IPO front?

The progress has been steady. A month ago, major investment banks like DSP Merrill Lynch, Salomon Smith Barney, Kotak and JM Morgan Stanley participated in the first round of pitches or "beauty parade" as one investment banker puts it. The mandate will be awarded soon and Naren Patni says the company will be in a "state of preparedness" from September 2003. If the mandatory 10 per cent dilution clause by SEBI be considered, the issue size would be Rs 150-200 crore, at the very least. "We believe that if companies have a good story to tell the transaction will happen irrespective of how the markets are behaving," says S. Sriniwasan, VP and Co-Head, Investment Banking Services, Kotak. Having said that, the fact remains that tech sector stocks are currently trading at an average multiple of 14 times the projected earnings for the year, down from 18 last year. "We still believe that the company has enough differentiators, particularly in terms of size, customer profile, and a strong management to command a fair price," says another investment banker who wishes to remain unnamed. The company's revenues for 2002 stand at Rs 914 crore and Naren Patni expects to close 2003 with revenues of between Rs 1,150 crore and Rs 1,250 crore. While company officials are tight-lipped about the bottomline, Patni's net margins are understood to be hovering around the 23-25 per cent range, which pegs the net profit at around Rs 200 crore. "The company has been ready to go public from the day we invested and the equity markets should be right by the fourth quarter of this year, so the timing seems right," says John Wong, General Partner, General Atlantic Partners.

"We are clearly positioned as a scale player and intend to stay in the top five; that is the only way we will absorb the costs" Deepak Sogani, CFO, Patni Computer Systems HYA

The Business Model

Patni Computer Systems ranks fifth among listed infotech majors and sixth if TCS is added to the list. Its suite of offerings includes horizontal it services like maintenance, application development, enterprise application solutions and e-business among others. "We are clearly positioned as a scale player and intend to stay in the top five; that is the only way we will absorb the costs of the business," states Deepak Sogani, CFO, Patni. The company's commitment to growth and client acquisition is borne out by the fact that its selling and general administration costs as a percentage of revenue is actually a "few percentage points higher than that of competition", according to Sogani. "We tend to absorb higher costs than some of our competitors since we do not believe in the optimum utilization model," explains Naren Patni. "I believe there should be enough redundancy to cater to the customer's peaks and valleys; this is how we create stickiness with the customer."

And Sogani maintains that unlike leading industry players who have seen margins plummet in recent times, Patni's 20-odd per cent net margins have stayed pretty much unchanged even with the recent meltdown in the it sector. This is attributable to two factors, the fact that the company's costs tend to be on the higher side while ITs pricing has always been moderate.

This can, in large part, be attributed to GE's stringent pricing where its vendors are concerned. In fact, leading industry players have, in the past, declared GE's rates downright unviable. "We think we price ourselves very fairly and tend to be in the low to moderate band; this hedges us against margin volatility," explains Sogani.

On the revenue mix, Patni's revenue basket tends to be heavily skewed in favour of one of its oldest customers, GE. About 45 per cent of the company's revenues currently come from GE, while the second-largest revenue contributor, a US-based auto insurance company, contributes about 7 per cent to revenues; the rest comes from several medium-to-smaller sized clients (totally, Patni has 130 customers).

This heavy reliance on a single client could have a flip-side at the time of the IPO. "Every analyst tracking the scrip will discount a large exposure to one client quite heavily; this will be discounted in the stock price," says an industry analyst. Other analysts feel that GE's insistence on rock-bottom prices could have a longer-term impact for the company in terms of its margins, but Patni is working on correcting all this. "We expect (the) GE (business) as a proportion of the revenues to be down to 38-40 per cent by the year-end. Three years down the line, we envisage ourselves as a half-a-billion dollar company with GE contributing about 25-30 per cent of revenues while 75 per cent of the revenues would come from 25 of our top customers," says Mrinal Sattawala, Chief Marketing Officer, Patni.

The market perceives Patni as a complacent company on the field (one competitor says that Patni is not even on his competition tracking list since he hardly encounters the company at pitches). The company's defense: "We are not interested in running after just about any client. Ninety per cent of our business is repeat business and we believe in growing our smaller customers till they make significant contributions to our revenue," says Sattawala.

About 65 per cent of Patni's revenues comes from onsite work and 35 per cent from offshore projects. The ratio goes against industry norms, claims Sogani, because, "we account for the billings of every single person onsite in the onsite revenues, whereas some of the other major players tend to account for the revenues project wise, which means that the onsite professionals who are part of an offshore project get accounted for in the offshore revenues." Still, Patni Computer Systems executes over half its projects on the basis of fixed price contracts (a hedge against price fluctuations), well over what companies like Infosys (around 37 per cent) does.

The bulk of Patni's revenues comes from maintenance and analysts see merits and demerits to this. "You could on the one hand say that this is lower value add work but it adds to the comfort level given that it represents a steady revenue stream" says Ajay Mathrani, an information technology analyst at Edelweiss Capital. "Overall, I see Patni as a long-term player and expect it to remain among the top five it services companies in coming years," says another analyst.

Heading For A DNA Change

The Patni family is the majority shareholder in the company with well over a 50 per cent stake. GE holds under 10 per cent and the remainder is held by gap. The company has hired McKinsey and Co to put in place a leadership programme that will also serve as an exercise at succession planning. "In the last 12 months, we have hired a handful of senior managers and there is some succession planning underway," says gap's Wong. "While nothing is in black and white, Patni will in all probability be a completely professionally managed company in the coming years." Naren Patni intends to continue in the CEO chair for the next five-to-seven years, but he has already begun to scout around for a successor. "This is going to be my hardest task. The DNA of this company is family-owned, and ultimately, we are going to have to change that. I cannot do it too fast or I may destroy the company; at the same time the pecking order is not well-defined and it's something I am working on," he says. So will the future CEO be from within or outside the company? "It could be either way, I simply haven't decided yet."

Patni won't let on whether his son Anirudh, also a Massachusetts Institute of Technology (MIT) graduate who has opted to work for McKinsey in the US, is likely to join the business. As part of the leadership programme, Patni Computer Systems has instituted an executive management council or "corporate centre", which comprises top management that serves as "hands and legs to the CEO". McKinsey has also put in place a restructuring program, which divides the company into various Strategic Business Units that will primarily allow for easy integration of the company's planned acquisitions. Patni is clearly ready with its blueprint for the future. The acid test remains the public offering.