Description

Long SYNT @ $26.06 / $2.3b market cap / $2.6b TEV

Syntel (SYNT) is a struggling Indian IT Services company that just did a $15/share special dividend (entirety of their cash balance + some leverage), trading at PF 10.5x 2017 PE / 10.0x 2018, that I think is dressing itself up for a sale. The company could get acquired in the next 3-6 months at a $38-$40 price range for 45%-50%+ upside from current levels. In the event of no sale, I think the stock will still re-rate to low $30s / 20%+ upside from current levels.

Prior to paying the special dividend, SYNT had ~30% of its market cap in cash and has traded in a 14-16x NTM PE band vs. comps in the same range. The stock has always been cheap on an ex-net cash PE basis since investors didn’t know what the company would do with their cash balance; it was a question that would always come up during earnings calls. The overhang from uncertainty around use of cash has been lifted and the stock should re-rate from current levels.

Why is SYNT likely to get sold

The Chairman and CEO, Bharat Desai, is the largest shareholder and owns ~60% of the company. He’s done a great job building the company up, but the general view is that he wants to move on. There was a question on M&A and use of cash during the last earnings call and his answer was strange, with a lot of stuttering / stammering around how he couldn’t address that question.

The special dividend makes the company more saleable as the company took the tax hit (~$260m) on repatriating the cash themselves + brought down the market cap by $1.3b+. Negotiations would also be easier since an acquirer doesn’t have to deal with paying a premium on cash / looking like they overpaid for the company.

The announcement of the special dividend on 9/12 was initially met with a positive reaction followed by negative reactions from the sell-side and buy-side community. The biggest concern investors have is that Bharat is just treating the company like his own personal bank / paying himself a huge sum (~$700m) / isn’t investing in the future of the business / potentially doing this special dividend to soften another bad earnings quarter. I think the reality is that Bharat is a savvy CEO who cares a lot about his reputation / money and he probably has some indications of interest around the company and is making the business more saleable.

The last time a special dividend was announced was on December 7, 2012, a few days after they negatively previewed the quarter. There have been no negative previews this time and IR has pointed to the December 2012 precedent as a data point.

How much could someone pay for SYNT

The most relevant precedent was Capgemini’s acquisition of iGate announced in April 2015; the multiples paid were 20x PE / 13x EBITDA for a company that was growing faster than SYNT but worse margin profile.

SYNT has best in class operating margins @ 29% and is growing low / mid single digits. I think a deal @ 15-16x PE / 10-11x EV/EBITDA is reasonable and would be 45-50% upside from current levels. The margin profile of the business means that this would be an extremely accretive deal for any of the logical buyers + would still allow them to reinvest in the business as needed.

Who are the potential acquirers

I think the most logical buyers are Genpact / CGI / CAP / Conduent. Any of these acquirers could finance a deal given the size of the business has come down meaningfully post the dividend + a deal would be extremely accretive.

What is the downside

I think the downside case is that there’s no sale of the business and growth continues to be challenged next year + margins compress and the multiple stays as the lowest in the entire peer group. @ $2.40 in 2017 earnings @ 10x PE downside is to $24 / ~8%.

Catalyst

Sale of the business