04 April 2013

Update |Sector: Technology

Tech Mahindra

CMP: INR978

TP: INR 215

BUY

TECH MAHINDRA: Price correction amid multiple concerns, weak

4Q; BT is becoming increasingly irrelevant; Satyam continues to

gear up for large deals

(TECHM, Mkt Cap USD2.3b, CMP INR978, TP INR1,215, 24% Upside, Buy)

‐

Stock correction on multiple factors: Tech Mahindra has corrected by ~13% on

the back of series of developments, compounded by the sale of shares by C P

Gurnani, a member of the company’s Board and CEO of Mahindra Satyam. Key

concerns are: [1] Additional headwinds at BT, revenue run‐rate from which

could decline further 10‐15%, [2] Some slowdown in new business wins at

Satyam, and [3] Depreciating GBP, the currency for ~40% of revenue bookings at

Tech Mahindra.

‐

Growth opportunity in standalone telecom‐heavy entity: Growth prospects in

the near term remain healthy in our opinion, even in the telecom‐heavy

standalone entity, as ramp up in one of the large deals comes about from

1QFY14, and also since it remains in contention in 5‐6 large deals.

‐

Changing characteristics at Mahindra Satyam: New business may have eluded

Satyam in 4QFY13, but we expect deal characteristics to improve over time. The

company now qualifies for much larger deals (USD50‐80m) than before and is

refurbishing its sales engine to be able to convert the opportunities.

‐

Impact from GBP depreciation: Average GBP in FY13 was USD1.58, while current

GBP rate is USD1.51, which is depreciation of 4.4%. This has a revenue impact of

1.8pp on FY14 USD revenues and also ~70bp impact on operating margins at

TECHM.

Valuation and view

‐

TECHM trades at 9.8x FY14E and 8.5x FY15E EPS. We expect USD revenue CAGR

of 12% over FY13‐15E for the combined entity, including revenues from

acquisitions and further drop in revenues from BT. We do not factor any growth

in revenues from Comviva and HGS in our estimates.

‐

BT revenues are getting increasingly irrelevant for the combined entity

especially after acquisitions of HGS, Comviva and Mahindra Satyam’s Complex

IT. These bring revenue dependency on BT down to ~10.5% as per our

estimates.

Despite a justified discount to the combined entity for higher Telecom exposure,

we believe that the correction in price makes valuation attractive. Buy with a

price target of INR1,215 (24% upside), which discounts FY15E EPS by 10.5x (25%

discount to HCLT).

1

Tech Mahindra

Revenues: Headwinds at BT compound to depreciation of GBP for TECHM;

Lackluster deal signings in this quarter to impact growth at SCS

‐

Tech Mahindra: There are a few new headwinds at BT, as a result of which the

company expects BT to stabilize at possibly 5‐15% lower than current levels (in

constant currency). GBP is an additional hit, as a result of which, in USD terms,

BT could decline 8‐10% QoQ in 4QFY13. There has been some restructuring

work in BT which has led to merger of 2‐3 departments, making quite a few IT

employees and projects redundant. Outside of BT, organic growth will be

marginal in the other segments. Comviva will add ~USD15‐17m incremental

revenues in 4QFY13. With the help of the same, overall revenue growth at

TECHM in 4Q is expected to be 2% QoQ in 4QFY13.

‐

Mahindra Satyam:

Revenue growth is likely to be weak in 4QFY13. Negative

impact from cross currency is expected to be ~30‐40bp. Revenues are likely to

remain flat. The key reason for the same is failure to close deals and replenish

the completed work with new business. However, even at Satyam, 1Q is

expected to be a stronger quarter as the company is seeing better traction on

the ground.

04 April 2013

2

Tech

h Mahindra

TECHM: 2% QoQ grow

wth on account on Comviva inte

egration, organic

c

reven

nues to decline

SCS: revenues to remain flat given lackluste

er performance i

in terms of

winning new

w deals

Margins: D

Depreciation of GBP and Comviva inte

egration to d

drive margin decline at

TECHM; ex

x one‐time ga

ains in 3Q, ma

argins to exp

pand slightly a

at SCS

‐

Tech M

Mahindra: TE

CHM’s GBP‐b

booked reven

nues have a s

sensitivity of ~40bp on

every 1% change i the curren

in

ncy. Given th the com

hat

mpany has ~4

40% of its

revenu

ue bookings in

n GBP and assuming a 4‐5% depreciatio

on, expect a margin hit

of 80‐1

100bp from cross currenc alone. Also, full quarte revenues from low‐

cy

er

margin

n integration of Comviva w

will be another 100bp dra

ag on the margins, as a

result o

of which the company exp

pects margins

s to be softer by 200bp Qo

oQ.

‐

Mahindra Satyam:

Margins are likely to decline by ~100b

bp QoQ at Sa

atyam, the

primar reason be

ry

eing that the company h

e

had some up

ptick in 3QF

FY13 from

employ benefit r

yee

reversal (pos

sitive impact of 180bp). O a like‐to‐

On

‐like

basis,

margin

ns should imp

prove margina

ally during the

e quarter.

TECHM: 2% QoQ grow

wth on account on Comviva inte

egration, organic

c

reven

nues to decline

SCS: revenues to remain flat given lackluste

er performance i

in terms of

winning new

w deals

Deals: Pipe

eline remains

s healthy at T

TECHM, large

deal readine

ess continues

s at SCS

‐

Tech M

Mahindra:

O the 5‐6 de

Of

eals in the p

pipeline, the company is close to

e

s

clinchin one. How

ng

wever the clo

osure and ramp‐up is like only from 1QFY14.

ely

m

Also, t ramp‐up in KPN deal has been slo

the

ower than w

what the com

mpany had

expect

ted, but shou come in 1 Therefore 1Q is expe

uld

1Q.

e,

ected to be a stronger

a

quarter. Overall, fo TECHM sta

or

andalone, the company still suggested that the

e

d

Tech Mahindra

‐

Impact from GBP depreciation: 1.8pp on revenues and 70bp on operating margins

‐

Tech Mahindra books ~40% of its revenues in GBP, much higher than peers.

Average GBP in FY13 was USD1.58 and closing GBP is USD1.51. Assuming

USD1.51 as the rate for FY14, 4.4% depreciation in GBP YoY implies ~1.8pp

impact on USD revenues.

‐

Also, the impact of 1pp change in GBP on margins in GBP‐booked revenues in

~40bp. Therefore, overall company margins are impacted by ~80bp as a result of

cross‐currency. However, part of the consequent impact on the bottom line will

get cushioned by GBP252m worth of hedges booked by the company.

‐

In 4QFY13, while there will be some forex gains on GBP for TECHM, there will be

significant losses towards translation of the balance sheet, as the closing GBP is

weaker than the average.

outlook for FY14 remains better than that in FY13. Including revenues from

acquisitions, the company should grow in line with industry in FY14.

Mahindra Satyam:

Satyam competes with all the biggies in the large deals’

space and hence conversion rates is a challenge. The company has brought on

board a new head of sales, and is seeing itself make the cut in the final 3‐4

shortlist in these deals, though winning them has thus far remained elusive. It

feels the engine is ready in terms of what it had to do, and expects to close

some deals going forward.

04 April 2013

4

Tech Mahindra

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Tech Mahindra

No

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04 April 2013

5