While new to the Fund, Syntel (SYNT) is a name that has crossed our screens multiple times over the years.There has always been an excuse to pass: too illiquid, too expensive, too much customer concentration, or too many other investment opportunities. Yet each time it has crossed, it has been larger and more profitable. During its 15 years as a public company, Syntel has a remarkable record of compounding revenue at 12% while expanding margins, leading to earnings per share compounding at 21%, all with deminimus acquisitions and while generating significant excess cash. The company's growth can be attributed to the ongoing demand for outsourcing solutions as global corporations look everywhere to cut costs.
Syntel's recent appearance on our screens followed management's cut to its forecast in December 2012,calling for less growth as a large customer froze some of its spending. We revisited our notes after shares fell and noted a few changes:
• Freely tradable shares or "float" remain limited as founders Desai and Sethicontinueto own about 58% of shares out (aligning their interests), but the company's larger size has been mirrored by improving shareliquidity;
• Customer concentration remains relatively high, but concentration is mitigated by (i) a 5- to 8-year extension of one of its major contracts earlier in 2012 and (ii) the sticky, recurring nature of applications maintenance and business process outsourcing work;
• An unencumbered balance sheet with 15% of the company's market cap in cash (more than twice as much cash as total liabilities);
• Alowteensearningsmultiple, 6% freecash flowyield, reasonably attractive valuationmetricsfor a business of Syntel's quality and compelling growth prospects.
Third Avenue's Founder and Chairman Marty Whitman has long commented that the next perfect investment he finds will be the first and, similarly, Syntel is not without its imperfections. As noted, the company has two very large customers: American Express and State Street represent 44% of revenue combined. Syntel also operates in a highly competitive business, meaningful changes to the tax regime in India or the U.S.could hurt the company's economics, and downside protection is provided more via the growing and stable cash flows than by tangible asset values. Should another temporary hiccup emerge, we would look to build a meaningful position at a more discounted valuation.
From Third Avenue Management's semi-annual 2013 commentary.