SYNT - Syntel

[Guest Schwab711]

I think this company is of higher quality and with lower earnings volatility than the market is giving it credit for. The company has significant exposure (>45% revenue) to 3 large customers, Amex, State Street, and FedEx. FedEx being the fastest growing account of the three. I think Amex and State Street will ultimately survive their issues and maintain/grow their relationships with SYNT. If these assumptions are inaccurate then the below investment thesis should be disregarded.

 

I can go into the details of the business if anyone is interested but here is a summary of the business from Yahoo! Finance:

Syntel, Inc. provides digital transformation, information technology (IT), and knowledge process outsourcing (KPO) services worldwide. The company operates through Banking and Financial Services; Healthcare and Life Sciences; Insurance; Manufacturing; and Retail, Logistics and Telecom segments. It offers managed services, including software applications development, maintenance, and digital modernization testing, as well as IT infrastructure, cloud, and migration services. The company also provides a range of consulting and implementation services built around enterprise architecture; data warehousing and business intelligence; enterprise application integration; and SMAC technologies, including social media, Web and mobile applications, big data, analytics, and Internet of things. In addition, it offers KPO services that provide outsourced solutions for knowledge and business processes; and business intelligence, enterprise resource planning, and business and technology consulting services.

 

Basically, SYNT is not like the average IT outsourcing companies like INFY, G, and WIT. A large percentage of SYNT's workforce has graduate degrees and SYNT is well-known for providing the highest quality outsourcing services. SYNT invests heavily in new technology to "stay ahead of their competitors" (obviously there's no guarantee with this) and it seems to be paying off in recent years. They have reduced their reliance on their top 3 customers and have expanded operating margins by 50% in the past 10 years (from 19.6% in 2006 to 29.3% in 2015).

 

Over the past 10 years:

• Revenue has grown at a compounded rate of 15.3%
  
• Operating income CAGR is 20.5%
  
• EPS CAGR is 19.1% (=> that stock dilution has been trivial [0.3% CAGR share growth])
  
• BV/shr CAGR is 25.7% (30% CAGR since dividend was suspended
  
• The founder (no longer CEO) still owns a large stake in the company and the dividend was suspended for tax reasons from his perspective. Future dividends will likely be very predictable and solely based on dividend tax rates for billionaires/large income earners
  
• The company is careful with their cash and they now have >USD $1b in net cash (no long-term debt), equivalent to roughly $11.90/share
  
• Ex-cash, SYNT is trading at ~ 11x P/E and <10x P/EBT. The company generally expenses long-term business investments (R&D like SyntBots), which makes this more impressive
  
• Over the past 10 years, ROIC and ROE have never fallen below 20% and generally exceed 25%! ROA fell to 19% in 2015, the first time it fell below 20% in over a decade. The doubling of their tax rate over this period (to ~23% in 2015) is a big reason for the decline in returns.

 

SYNT appears to be the best-of-breed in their industry, they have outstanding return efficiency, and they are trading at 10x P/E (if you believe they will return capital to shareholders at some point during your holding period). There is a risk that the Indian Rupee will appreciate and cause operating margins to contract (they receive revenues in USD and pay expenses in INR). I think SYNT's customer concentration is the primary driver for their current valuation and Amex's "normalizing of financials" in 2017 could be a catalyst for SYNT. Overall, if there had to be heavy customer concentration, FDX, AXP, and STT are fairly high-quality customers to have.

 

I think one could make the argument that if SYNT can continue to grow low-single-digits (they are still relatively small) and they do return the cash to shareholders, expected returns could be 20%-30% compounded over your holding period. I do not understand this industry as well as I'd like but I think E® should be >15% compounded over a >5 year period and I like the choices management has made over the past 10 years. Depending on the election, I think there exists some probability >0% that a special dividend could be initiated (since qualified dividend tax rates don't appear to be going down in the near-term).

[Guest roark33]

I looked at this company.  Obviously, looks cheap ex-cash and margins look great.  My biggest issue when I spend 30 minutes looking around their website and white papers, it is clear that I have no idea what they are doing.  Snytbots?  Check out a few of their white papers, and I couldn't tell you what half the words even mean.  So, despite the impressive numbers, I couldn't get comfortable with the idea that I am unable to predict how well their competitive advantage is compared to their competitors.  Too hard pile...despite good optics on financials. 

[Guest johnnystago123]

I looked at this briefly as well, probably about 18 months ago.  The financial track record is obviously great, and I like the fact that there's significant insider ownership.  On the other hand, I agree with roark33 that it's tough to understand the company's long-term moat, if any.  Does the company really have a "secret sauce" or are they just exploiting the gap in labor cost for highly-educated workers in India vs. the US?

 

The other big issue that turned me off is taxes.  The vast majority of their cash balance ($930M out of $1.04B as of the most recent 10-K) is held at Indian subsidiaries.  The most recent 10-K discloses that they would incur ~$306M in taxes if they decided to repatriate all their cash to the US.  At the very least, you need to take this tax liability into account when you do your ex-cash valuation.  If you want to be conservative, you should also haircut future earnings to account for the taxes they would incur if they repatriated those earnings.  The company doesn't seem to have great reinvestment opportunities, so earnings don't really accrue to shareholders' benefit unless they're paid out via dividends / buybacks.  Unfortunately, SYNT can't pay dividends / buy back stock without incurring taxes upon repatriation.

[Guest Schwab711]

http://www.marketwatch.com/story/syntel-to-pay-special-dividend-after-repatriating-cash-held-overseas-2016-09-12

 

Huge news! SYNT will have outstanding ROE after this. It's trading at ~9x pre-tax income after the dividend right now.

[Guest Schwab711]

I'm guessing Desai has not been happy with the growth trends of the #4-30 customers and pressured the former CEO to step down. That and Trump's talk of reducing/eliminating visas and investigating visa users are probably hurting the stock. I don't think the US can afford to reduce the number of visas from India but we'll see what actually happens.

 

SYNT also announced a small buyback of $10m the other day (<1% of shares outstanding). I would think (and hope) the authorization is expanded soon. I thought mgmt seemed like opportunistic capital allocators when I first went long and I'm glad to see they are proving it over the last few months. Shares are really cheap below $20. I wouldn't be surprised to see Desai take this private.

 

Anyone have thoughts on the company or industry? I don't think there is any moat here (or for anyone else in the industry). It seems like the source of the returns/growth is SYNT's strong reputation in the industry and willingness to remain in their niche.

 

http://www.crn.com/news/channel-programs/300082717/syntel-ceo-steps-down-coo-named-as-interim-replacement.htm

https://www.sec.gov/Archives/edgar/data/1040426/000119312516769865/d222033dex991.htm

[valcont]

I'm guessing Desai has not been happy with the growth trends of the #4-30 customers and pressured the former CEO to step down. That and Trump's talk of reducing/eliminating visas and investigating visa users are probably hurting the stock. I don't think the US can afford to reduce the number of visas from India but we'll see what actually happens.

 

SYNT also announced a small buyback of $10m the other day (<1% of shares outstanding). I would think (and hope) the authorization is expanded soon. I thought mgmt seemed like opportunistic capital allocators when I first went long and I'm glad to see they are proving it over the last few months. Shares are really cheap below $20. I wouldn't be surprised to see Desai take this private.

 

Anyone have thoughts on the company or industry? I don't think there is any moat here (or for anyone else in the industry). It seems like the source of the returns/growth is SYNT's strong reputation in the industry and willingness to remain in their niche.

 

http://www.crn.com/news/channel-programs/300082717/syntel-ceo-steps-down-coo-named-as-interim-replacement.htm

https://www.sec.gov/Archives/edgar/data/1040426/000119312516769865/d222033dex991.htm

 

I am looking to short the basket of these offshoring companies(TCS, INFY, Hexaware,SYNT) after Trump got elected. From what I've learned so far, these are purely body shop companies with no value add and compete on cheap labor from India. There are multiple allegations of visa abuse against them. Jeff Sessions who is appointed as an Attorney General is a big opponent and Trump announced yesterday that he will ask DOL to investigate the visa abuse. Most likely there will be a legislation to set up the minimum salary at $110K and/or stop the third party placements. That will be a death knell for a lot of them. They are already facing headwinds due to the automation and a move towards the cloud computing.

[arcube]

 

I'm guessing Desai has not been happy with the growth trends of the #4-30 customers and pressured the former CEO to step down. That and Trump's talk of reducing/eliminating visas and investigating visa users are probably hurting the stock. I don't think the US can afford to reduce the number of visas from India but we'll see what actually happens.

 

SYNT also announced a small buyback of $10m the other day (<1% of shares outstanding). I would think (and hope) the authorization is expanded soon. I thought mgmt seemed like opportunistic capital allocators when I first went long and I'm glad to see they are proving it over the last few months. Shares are really cheap below $20. I wouldn't be surprised to see Desai take this private.

 

Anyone have thoughts on the company or industry? I don't think there is any moat here (or for anyone else in the industry). It seems like the source of the returns/growth is SYNT's strong reputation in the industry and willingness to remain in their niche.

 

http://www.crn.com/news/channel-programs/300082717/syntel-ceo-steps-down-coo-named-as-interim-replacement.htm

https://www.sec.gov/Archives/edgar/data/1040426/000119312516769865/d222033dex991.htm

 

I am looking to short the basket of these offshoring companies(TCS, INFY, Hexaware,SYNT) after Trump got elected. From what I've learned so far, these are purely body shop companies with no value add and compete on cheap labor from India. There are multiple allegations of visa abuse against them. Jeff Sessions who is appointed as an Attorney General is a big opponent and Trump announced yesterday that he will ask DOL to investigate the visa abuse. Most likely there will be a legislation to set up the minimum salary at $110K and/or stop the third party placements. That will be a death knell for a lot of them. They are already facing headwinds due to the automation and a move towards the cloud computing.

 

I think you need to read up a little more on INFY and TCS before you put them in a basket of purely body shopper companies. They do place a ton of people but they do a lot more than that.

[oddballstocks]

Very familiar with this industry.  I went through the web and their whitepapers.  Nothing more than some marketing speak around typical consulting services.  The bots thing is interesting.  I implemented something similar in 2004/2005 around security monitoring. 

 

The "moat" here is two-fold, their ability to sell at a higher billable rate compared to competitors and their ability to pay workers less.  That's it.  If top sales people leave rates might fall.  Or if labor costs increase then their margins are squeezed. 

 

Looks like their main business is taking large applications with high licensing fees and rolling their own solutions.

[valcont]

I was just trying to figure out the industry/sector that would be hurt by Trumps' protectionism and the offshoring seems to be the clear target. My knowledge is limited to the internet reading and few friends who work in the management side of the technology industry for the big banks. Basically they are hired for cheap labor. The visa that is offered to bring these people is called "High Skilled visa" but its more like an indenture labor. Infosys and TCS has been fined for the illegal use of the visas.

http://www.wsj.com/articles/SB10001424052702304200804579163604195741612

https://www.ft.com/content/a7196022-1115-11e5-9bf8-00144feabdc0

 

So the main business is the labor cost arbitrage and they are easily replaceable.The margins will definitely squeeze once the Trump administration takes over. The indian trade association lowers the growth estimate recently.

 

http://www.computerweekly.com/news/450403434/Nasscom-lowers-sales-growth-prediction-for-Indias-IT-industry

 

They have been trying to reinvent themselves for almost a decade but have been unsuccessful so far. Hard to spur innovation when the corporate culture is centered around cheap labor, cutting costs and getting around the visa requirements.

[Jurgis]

Positive writeup in Barron's: http://www.barrons.com/articles/skepticism-about-syntel-creates-an-opportunity-1485582253

 

OK, so they probably made a mistake with cash repatriation not expecting Trump to be elected.

And there's risk with their healthcare revenues due to ACA uncertainty.

And there's maybe risk with AXP revenues - not clear though.

And there's risk with visa clampdown.

 

Still, isn't it quite cheap here?

Schwab711, any updates?

Bears, any further criticism?

[Guest Schwab711]

Nomura just released a report citing risks to Indian outsourcing companies. There's also rumors that the next EO will include changes to the visa programs.

http://www.cnbc.com/2017/01/30/india-news-trump-h-1b-visa-reforms-could-affect-viability-of-india-outsourcing-companies-according-to-nomura.html

 

http://www.cnbc.com/2017/01/30/trumps-next-executive-order-draft-to-target-tech-companies.html

 

http://www.myvisajobs.com/Visa-Sponsor/Syntel-Consulting/523297.htm

 

The shift to cloud computing has put pressure on revenue growth in new engagements and was discussed in the most recent CC. Desai made it seem like that pressure is here to stay. I think SYNT is a prime candidate to go private. Outside of that, I have no idea what to think.

 

It's probably worth assuming Trump will at least temporarily halt the visa programs, either completely or essentially. He's said he will do as much. SYNT is cheap but there's no reason to fight reality. This should probably be in my too-hard category but I continue to hold a small position at the moment.

[valcont]

Still short on a basket of these. As I have said before, they really add no value and the game is labor arbitrage ie get imported cheap workers and place them at higher rates. The whole operation is a scam at every level. Bloomberg just reported that Trump's next executive order will crack down on these companies.

 

https://www.bloomberg.com/news/articles/2017-01-30/trump-s-next-move-on-immigration-to-hit-closer-to-home-for-tech

 

 

[Jurgis]

I disagree with valcont's assessment that "The whole operation is a scam at every level.", but I agree that Trump will likely issue more idiotic orders that will likely hurt SYNT and other tech companies.

[gjangal]

Having worked in one a decade ago, i can tell you it's not a scam. These are legitimate companies fulfilling work projects for American companies that have decided to outsource entire systems/projects. It is labor arbitrage definitely and where they can improve is in attempts to hire local talent. But hiring 10 people here to maintain a product is not going to happen ever again. The reality of the business of software is that old creaking systems exist and they are tough to replace especially when they are integrated into the business workflow.It takes a lot of effort to successfully replace software.  I am not talking about companies like google , apple or amazon but companies like insurance, medical that do need software systems to conduct business

 

The people that come onsite may or may not be technical resources. They usually do a lot of co-ordination of work happening in teams overseas. They work with American counterparts to communicate and co-ordinate requirements either to build a product or maintain software that is too expensive to maintain in the USA. Hope this provides some color on these companies

[valcont]

Having worked in one a decade ago, i can tell you it's not a scam. These are legitimate companies fulfilling work projects for American companies that have decided to outsource entire systems/projects. It is labor arbitrage definitely and where they can improve is in attempts to hire local talent. But hiring 10 people here to maintain a product is not going to happen ever again. The reality of the business of software is that old creaking systems exist and they are tough to replace especially when they are integrated into the business workflow.It takes a lot of effort to successfully replace software.  I am not talking about companies like google , apple or amazon but companies like insurance, medical that do need software systems to conduct business

 

The people that come onsite may or may not be technical resources. They usually do a lot of co-ordination of work happening in teams overseas. They work with American counterparts to communicate and co-ordinate requirements either to build a product or maintain software that is too expensive to maintain in the USA. Hope this provides some color on these companies

 

I know someone passed a comment that this is one of Trump's idiotic orders without even understanding the context of this. I am guilty of that too so perhaps I should have explained my reasons before passing on the judgement. Also I didn't mean to disrespect you or anyone who came here to work. I am looking at it from a business model point of view and I find a huge discrepancy between their claims of value add and independent studies of their role

in the technology chain.

 

Just look at the visas that are used to bring these people here. Its called "High Skilled Visa" but if you look at the labor applications filed , the majority of the applications are for low level "system analyst" work that pays $50-60K/year. Also, these companies misuse the visas that are intended for business visits and conferences by placing these people to client's site for actual work.

 

The more I have read about it, I am convinced that there is not much of a STEM shortage here in the US as is being claimed by the likes of Google,Microsoft etc. To these companies, indentured labor is much more valuable than the cheaper labor since there is a lot of poaching going on in the valley. One way to verify the shortage is to look at the wage gain of IT professionals that has stayed neutral in the last 15 years.

 

Now as a free market proponent, I should be fine if the companies are trying to cut costs by hiring cheaper labor. But the labor is cheap because it is indentured and they stay because they like to immigrate to the US and that is the ONLY pathway for them. So essentially ,the US government is subsidizing the costs to the company at the back of the US taxpayer's money. This is an inherently unfair system.

 

I believe in Buffet's model of win-win business and this is not one of them.There is a 'subsidy' associated with this model and once the government pulls the rug under them they will be valued based on their quality. Trump is spot on on this and hopefully this should bring down one or two of these companies.

 

 

 

[rukawa]

I have an extremely poor opinion of this type of business model. And I have an even worse opinion of their big customer State Street having worked there.  State street tended to be reticent to implement any measure that a 10 year old could figure out would save money and time. But they were all too willing to throw cheap labor at a problem. I could never understand what the hell they were doing. I welcome the end of this stupid outsourcing...all it did is enabled incompetent management and incompetent companies to avoid important changes for much longer than they should have.

 

I'll give you an example of what I am talking about. State Street has a valuations service where they value each position of every valuation service client daily. A lot of this work is done manually by people. Some of this is very simple..sometimes its more complicated in the case of less liquid or more complex securities. Anyways its likely that many different clients of SS hold the same security. Logic would dictate that the valuation for a security should be done once and shared across all customers. Instead SS has different teams handle valuations of the same security for different customers. This obviously is an enormous duplication of effort. The main reason for this is that they don't have the technological infrastructure to avoid this duplication of effort. Its only now that they have finally gotten around to trying to fix this. Most of their effort has instead been on trying to outsource the valuations, compliance and other services to Indian and Poland to save money. Its fantastically idiotic.