14 May 2014 4QFY14 Results Update | Sector: Technology Tech Mahindra Ashish Chopra ([email protected]); +91 22 3982 5424 Siddharth Vora ([email protected]); +91 22 3982 5585 BSE SENSEX S&P CNX CMP: INR1,838 TP: INR2,350 Buy 23,871 7,109 Bloomberg TECHM IN Equity Shares (m) 233.5 M.Cap. (INR b) / (USD b) 425.4/7.1 52-Week Range (INR) 1,936/895 1, 6, 12 Rel. Per (%) 0/-7/71 Financials & Valuations (INR b) Y/E Mar 2014 2015E 2016E Sales 188.0 217.3 250.2 EBITDA 41.8 46.8 53.9 Adj. PAT 25.8 31.9 37.1 AdjEPS(INR) 121.0 145.9 170.0 EPS Gr. (%) 30.4 20.6 16.5 RoE (%) 36.4 30.1 27.2 RoCE (%) 34.7 31.8 29.7 Payout (%) 16.6 9.6 10.0 P/E (x) 15.2 12.6 10.8 EV/EBITDA () 8.3 7.0 5.6 4QFY14 revenue above estimate: TECHM’s 4QFY14 revenue was USD825m, +4.3% QoQ, above our estimate of USD809m, +2.3% QoQ. EBITDA margin was at 21.2%, down 190bp QoQ, in line with our estimate. PAT after adjusting for restructuring fees was INR6.03b, down 6.3% QoQ, marginally higher than our estimate of INR5.93b. Comviva and one-off project drove revenue growth: Adjusted for amortization, revenue grew 5% QoQ and volume growth was 4.6% during the quarter. Seasonally strong quarter for Comviva and execution of a small project in Nigeria added USD10m incremental revenue (1.2pp growth). Gross margin below estimate: While EBITDA margin was in line, gross margin declined 290bp QoQ to 35.8% (below our est. of 36.5%). Wage hikes impact was 200bp and amortization revenue discontinuation impacted margins by 50bp. Lower SG&A (90bp QoQ decline to 14.6% v/s est. of 15.1%) offset the below estimate gross margin. Revenue outlook strong, margins may be stable: Deal pipeline is up 30-40% YoY. Network deal has potentially increased the addressable market opportunity in Telecom. Growth remains the primary focus, margins may see headwinds from onsite-centric revenue and hence remain stable. Marginal upgrades, maintain Buy: We upgrade the revenue estimates by 1.7%/2.6% and consequently EPS by 1.4%/2.5% for FY15E/16E. Our margin estimates are unchanged. Success in large deal wins in FY14 (USD1.2b TCV) is an encouraging indicator of TECHM’s improving competitive prowess even in the Enterprise segment, post the integration with Satyam. We expect TECHM to clock USD revenue at a CAGR of 16% over FY14-16E and EPS at a CAGR of 19% during this period. Maintain Buy. Investors are advised to refer through disclosures made at the end of the Research Report.
4QFY14 revenue above estimate: TECHM’s 4QFY14 revenue was USD825m, +4.3% QoQ, above our estimate of USD809m, +2.3% QoQ. EBITDA margin was at 21.2%, down 190bp QoQ, in line with our estimate. PAT after adjusting for restructuring fees was INR6.03b, down 6.3% QoQ, marginally higher than our estimate of INR5.93b.
Comviva and one-off project drove revenue growth: Adjusted for amortization, revenue grew 5% QoQ and volume growth was 4.6% during the quarter. Seasonally strong quarter for Comviva and execution of a small project in Nigeria added USD10m incremental revenue (1.2pp growth).
Gross margin below estimate: While EBITDA margin was in line, gross margin declined 290bp QoQ to 35.8% (below our est. of 36.5%). Wage hikes impact was 200bp and amortization revenue discontinuation impacted margins by 50bp. Lower SG&A (90bp QoQ decline to 14.6% v/s est. of 15.1%) offset the below estimate gross margin.
Revenue outlook strong, margins may be stable: Deal pipeline is up 30-40% YoY. Network deal has potentially increased the addressable market opportunity in Telecom. Growth remains the primary focus, margins may see headwinds from onsite-centric revenue and hence remain stable.
Marginal upgrades, maintain Buy: We upgrade the revenue estimates by 1.7%/2.6% and consequently EPS by 1.4%/2.5% for FY15E/16E. Our margin estimates are unchanged. Success in large deal wins in FY14 (USD1.2b TCV) is an encouraging indicator of TECHM’s improving competitive prowess even in the Enterprise segment, post the integration with Satyam. We expect TECHM to clock USD revenue at a CAGR of 16% over FY14-16E and EPS at a CAGR of 19% during this period. Maintain Buy.
Investors are advised to refer through disclosures made at the end of the Research Report.
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USD revenue growth significantly above our estimate TECHM reported revenues of USD825m grew 4.3% QoQ, above our estimate of
USD809m, +2.3% QoQ. Volumes grew 4.6% QoQ, driving solid revenue traction. Adjusting for the restructuring fees impact of ~USD6m, revenue growth would be 5% QoQ, v/s our estimate of 3% QoQ growth.
Growth during the quarter was boosted by a project in Nigeria, and seasonally strong Comviva revenues. The two factors combined to add USD10m incremental revenues during the quarter (1.2pp growth).
USD revenue growth was above our estimate of 2.3%
Source: MOSL, Company
Revenue mix shifted in favor of onsite by 1pp QoQ to 53%. Offshore revenue
grew 2.1% QoQ to USD380m, while onsite revenue grew 6.3% QoQ to USD437m. Onsite-heavy nature of growth was on account of ramp up of large deals during the quarter.
In rupee terms, revenue was INR50.58b, 3.3% QoQ, above our estimate of INR50b, 2.1% QoQ. Average currency realization was INR61.45/USD (v/s our assumption of INR61.8).
Gross margin below estimate, offset by lower SG&A EBITDA margin was 21.3% down 190bp QoQ, in line with our estimate of 21.4%.
However, gross margin declined 290bps QoQ to 35.8%, and was below our estimate of 36.5%. Wage hikes provided during the quarter which had an impact of 200bps along with absence of amortized revenues (50bps) and transition costs on large deal execution.
SG&A declined 90bps to 14.6% below our estimate of 15.1%, partially offsetting the impact of decline in gross margins.
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Tech Mahindra
OPM in line with our estimates, but GPM was below estimate, offset by lower SGA
Source: MOSL, Company
PAT after adjusting for restructuring fees INR6.03b, down 6.3% QoQ; above our
estimate of INR5.93b. Higher PAT was due to revenue beat, lower tax rate (25.1% v/s estimate of 26%) and lower other income loss of INR867m v/s our estimates of INR927m. Forex losses totaling INR1,670m contributed towards negative other income v/s our estimate of forex loss of INR1,533m.
Telecom and top clients drove growth, Americas was flat Telecom drove growth among verticals, growing 8.7% QoQ and
Retail|Transport|Logistics declined 10.6% QoQ. Telecom vertical in spite of being weak for the industry at large, has grown at a healthy 4-qtr CQGR of 4.8% for TECHM, higher than company average of 4.3%.
Telecom grew while Retail | Transport | Logistics declined
Among geographies, after last quarter only America growth, this quarter growth
came in from Europe and RoW. Momentum in Europe continues to be healthy with 4.3% QoQ growth and RoW grew 13.8% QoQ helped by a project in Nigeria, and seasonally strong quarter for Comviva.
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Europe and RoW drove growth among geographies
Geographies Contr to Rev. (%)
Growth – QoQ (%)
Contr to incr. rev (%)
4Qtr CQGR (%)
Americas 45.0 -0.1 -1.5 6.1 Europe 31.0 4.3 31.0 2.6 ROW 24.0 13.8 70.5 3.2 Total 100 4.3 100.0 4.3
Source: Company, MOSL
Growth during the quarter was driven by top clients contributing more than
100% of the incremental revenues. Top 5 and 6-10 clients grew at 7.1% QoQ and 13% QoQ respectively while Top 11-20 clients grew at company average rate.
Top Clients drove the entire incremental revenues during the quarter
Client concentration (QoQ) Contr to Rev. (%)
Growth – QoQ (%)
Contr to incr. rev (%)
4Qtr CQGR (%)
Top 5 clients 38.0 7.1 61.3 5.0 Top 6-10 clients 13.0 13.0 36.3 4.3 Top 11-20 clients 12.0 4.3 12.0 6.6
Source: Company, MOSL
Takeaways from Management Commentary Demand outlook: TECHM’s deal pipeline is up 30-40% compared to this time
last year. The strength in deal pipeline is reflected in both Telecom as well as Enterprise segments. Though the IT budgets have not moved dramatically, but Businesses are spending a little more from their marketing, innovation and R&D budgets too.
Outlook on margins: TECHM is looking at maintaining the operating margins at current levels. Wage hike cycle has been reset to January 1st going forward. SGA will also be maintained between 14.5-15%, as a lot of investments in the front end have been made. Transition costs in large deals will be a factor for the margins. The company remains more focused on growth.
Telecom vertical: Growth in Telecom was broad based. With the Network deal progressing successfully, the addressable market in Telecom has increased. TECHM had identified a short list of clients who could be potential users of the new service and early conversations with all of them have elicited encouraging feedback.
Enterprise verticals: While Manufacturing and Retail declined sequentially during the quarter, deal signings have been healthy and full year growth is still significant. Deal pipeline remains healthy
Onsite : Offshore mix: TECHM is featuring in more end-to-end deals, which were traditionally being rendered from onsite. While these will eventually be offshored, it will be a gradual process. Higher offshoring will be a lever to margins going forward.
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Change in estimates: Upgrading revenue1.7-2.6%; EPS by 1.4-2.5% On the back of a healthy pipeline, strong 4Q exit, continued deals momentum
and strong execution; we have upgraded our USD revenue estimates for FY15E/FY16E by 1.7%/2.6%. We expect TECHM to grow its USD revenue by 17% in FY15 to USD3.62b and 15% in FY16 to USD4.17b. We factor ~USD60m revenues from acquisitions, implying organic growth estimate of 15% in FY15.
Despite our outlook of healthy USD revenue growth, we have retained our margin estimates at 4Q levels for both FY15 and FY16. Higher revenue proportion at onsite, on the back of transition work and end-to-end deals which will move to offshore only gradually, could act as margin headwinds. Our EBITDA margin estimate of 21.5% for FY15 and FY16 is unchanged.
Consequently, on the back of moderate revenue upgrade and stable margin estimate, our FY15E/16E EPS estimates are higher by 2.5%/1.4%.
Change in estimates Revised
Earlier
Change
FY15E FY16E
FY15E FY16E
FY15E FY16E
INR/USD 60.0 60.0
60.0 60.0
0.0% 0.0%
USD Revenue - m 3,621 4,169
3,562 4,064
1.7% 2.6%
USD rev Gr.(%) 16.9 15.1
15.6 14.1
132bp 103bp
EBIDTA Margin (%) 21.5 21.5
21.6 21.6
-4bp -2bp
EPS - INR 145.9 170.0
142.3 167.6
2.5% 1.4%
Source: Company, MOSL
Well placed to address demand trends; prowess overshadowing headwinds; Buy Success in large deal wins in FY14 (USD1.2b TCV) is an encouraging indicator of
TECHM’s improving competitive prowess even in the Enterprise segment post the integration with Satyam, and alleviates growth concerns emanating from client-specific issues like BT. Also, its expertise in the Telecom vertical has thus far overshadowed the structural concerns in the clients’ business, as it continues to increase its share within its top accounts, opportunity going forward offered by Continental Europe.
With the Networks deal progressing successfully, and encouraging early indicators from other clients on the service, TECHM’s potential addressable market could see a substantial increase.
We expect TECHM to grow its USD revenues at a CAGR of 16% over FY14-16 and EPS at a CAGR of 19% during this period. Our Target Price of INR2,350 discounts FY16E EPS by 14x. TECHM remains among our top pick in the Technology space.
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Other result highlights Net headcount increased by 2,042 to 89,441 led by increase in Software
professionals by 3,396; BPO reduced by 1,383 on exit from low margin business and in sales support increased by 29.
Revenue proportion from Onsite/Offshore moved in favor of onsite by 1pp to 53%/47%.
Utilization including trainees at 74% was down 1pp and excluding trainees at 78% was up 1pp.
LTM attrition rate during the quarter was 18%, up 1pp from 17% in 3QFY14 Number of USD10m+/USD20m+ clients increased to 52/27 (v/s 47/25 in
3QFY14). Capex during the quarter was INR2,708m (INR1,316m in 3QFY14). Receivable days including unbilled improved by 4 to 96. Total Borrowing increased by INR215m to INR3,631m. The company has USD783.9m hedges at a strike rate of INR60.6 and GBP170.5m
at a strike rate of INR95.3.
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Story in Charts
Telecom prowess reflected in vertical mix
Source: Company, MOSL
Scale and diversity lent by Satyam acquisition
Source: Company, MOSL
Active on the acquisition front – building scale and competencies
STANDALONE TECHM Time Valuation (USD m) Revenue (USD m) Employees
Mahndra Satyam Apr-09 1,133 481 (FY11) 48,000
Hutchison Global Services Sep-12 67 170 11,500
Comviva Sep-12 95 70 1,500
MAHINDRA SATYAM
Complex IT (Brazil) Feb-13 45 45 500
COMBINED ENTITY
Mahindra Engineering Services Nov-13 121 42 1,300
BASF Business Service Consult Feb-14 NA NA 60
Fix Stream Apr-14 10 NA NA
Source: Company, MOSL
Strong execution reflected in much improved efficiency
Tech Mahindra: an investment profile Company description Tech Mahindra represents the connected world, offering innovative and customer-centric information technology services and solutions, enabling Enterprises, Associates and the Society to Rise™. It is a USD3.1b company with ~89,000+ professionals across 51 countries, helping over 500 global customers including Fortune 500 companies. It is a part of the USD 16.7 billion Mahindra Group that employs more than 180,000 people in over 100 countries. Key investment arguments Satyam’s acquisition has helped Tech Mahindra to
diversify its client base and industry focus. Large deals like those of KPN and a gradual revival
in the Telecom vertical will help volume growth. Deals have kept growth coming (outside the BT
account) despite challenged IT budgets in the Telecom vertical.
Key investment risks The company is dependent on a single vertical,
Telecom for 48% of its revenues. Revenues from BT are expected to continue
declining going forward, which could be a drag on growth.
Growth is skewed towards lower margin services like new telco rollouts and domestic BPOs.
Recent developments Won 11 large deals with a TCV of USD270m. TECHM signed an agreement with BASF business
Services Holding GmbH to acquire its business with third party customers.
Valuation and view We expect Tech Mahindra to post USD revenue CAGR
of 16% and an EPS CAGR of 19% during this period FY14-16.
Stock trades at 12.6x FY15E and 10.8x FY16E EPS. Buy with a TP of INR2,350, based on 14x FY16E EPS.
Sector view With strengthening demand in the US and large deals
traction in traditional services in Europe, industry growth in FY15 should be better than FY14.
We see better risk-reward in Tier-I v/s Tier-II, and do not expect further bridging of the valuation gap on the following counts: [1] tier-II growth continues to at best, match tier-I, [2] Current tier-II discount to top-tier is lower to historical P/E discount, and [3] Cash conversion capability at tier-II is inferior.
Currency is a key risk to valuations, and Tier-II has a higher sensitivity to the same v/s Tier-I.
Comparative valuations TECHM HCLT MPHL
P/E (x) FY15E 12.6 14.1 9.9
FY16E 10.8 12.6 8.7
P/BV (x) FY15E 3.2 3.9 1.5
FY16E 2.6 3.2 1.4
EV/Sales (x) FY15E 3.2 2.3 0.9
FY16E 2.6 2.3 0.8
EV/EBITDA (x) FY15E 7.0 9.3 5.1
FY16E 5.6 9.7 4.2
EPS: MOSL forecast v/s consensus (INR) MOSL
Forecast Consensus Forecast
Variation (%)
FY15 145.9 140.3 4.0
FY16 170.0 160.1 6.2 Target price and recommendation
Current Price (INR)
Target Price (INR)
Upside (%)
Reco
1,838 2,350 27.9 Buy
Shareholding pattern (%) Mar-14 Dec-13 Mar-13
Promoter 36.5 36.5 47.4
Domestic Inst 9.5 8.9 16.0
Foreign 40.2 41.5 27.7
Others 13.8 13.0 8.9
Stock performance (1-year)
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Financials and valuation
14 May 2014 12
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Disclosure of Interest Statement TECH MAHINDRA LTD 1. Analyst ownership of the stock No 2. Group/Directors ownership of the stock Yes 3. Broking relationship with company covered No 4. Investment Banking relationship with company covered No
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