The MindTree Consulting stock has delivered strong returns to its IPO (initial public offer) investors, with a 78 per cent jump from its offer price. For 2006-07, the company met earnings forecast made at the time of the IPO. The stock remains a preferred exposure among mid-size IT companies, considering that the bright growth prospects and the increasing revenue contribution from high-value services could be engines for higher realisations. Over the past year, the stock valuation has risen about 30 times the trailing earnings, which is a significant premium to other mid-cap IT companies. Shareholders can retain the stock, while fresh exposure can be timed to price weaknesses.
MindTree Consulting delivers broadly IT and Research and Development services. While the former consists of application development and maintenance, business intelligence solutions, ERP (enterprise resource planning) and supply chain management, testing, and mainframe, the latter is focussed on product-realisation services in product and semiconductor design, operating systems, protocol engineering, embedded applications, product testing and licensing of intellectual property.
This segregation gives the company a blend of volume-driven services on the one hand, and high-value services (in terms of execution complexity and revenues), on the other.
Business Outlook
A closer look at some of the key metrics and the rising trend in the contribution of some of its services indicate that the company has reasonable prospects in the medium/long-term.
Better spread: In terms of geographical spread, the company derives a chunk of its revenues from the US though it has significant presence in Europe, Asia-Pacific and India (all contributing about 36.7 per cent to last year’s r evenues). This augurs well on two counts. One, it gives greater visibility across locations and broad-bases its clientele. Two, there is better protection against currency risk, thus helping revenue realisation.
Service mix: Services such as consulting contributing 4.7 per cent of revenues, independent testing (3.4 per cent), and IP (Intellectual Property) licensing (0.8 per cent) have shown a rising trend on a sequential basis, which is healt hy.
One, all these services are high-revenue-earners and an increasing trend could mean smooth realisation; and, two, it indicates that the company may be climbing the services value-chain.
Trends relating to verticals of operation, client adds and repeat business are also worth noting. In the March 2007 quarter, the Banking and Financial Services (BFS) vertical contributed 24.6 per cent of the company’s revenues replacing the manufacturing vertical as the biggest contributor, which is a positive for MindTree. IT spend by overseas clientele is normally higher in the BFS vertical compared to other sectors.
The company added 17 clients this quarter; two are million-dollar clients. Sustaining this will help the company scale up its level of operations and realise better margins on its projects. MindTree generates 92 per cent of its revenues from repeat business. This compares favourably even with Tier-1 companies.
Risks: The utilisation level, at 62.7 per cent, has declined 7.7 percentage points on a sequential basis (March quarter); this along with a slight increase in attrition are execution risks.
Of the 155 active clients, the top 10 contribute 50.7 per cent of its revenues, indicating a high top-clients concentration. This also indicates that nearly half the company’s revenues comes from a large number of low-value projects, which could pose challenges in terms of optimal resource allocation. The company may also face execution risks on account of this.
The company’s recent foray into IMS services, which is a niche area for Indian players, needs to be watched, considering the competition from some of the Tier-1 players. Lastly, there is the risk of rupee appreciation vis-À -vis the dollar (only $13 million of revenues was hedged last quarter).
Valuation: The stock trades at a significant valuation premium to players such as Hexaware Technologies and I-Gate Global. Considering that MindTree has been able to scale up its operations above its peers in a relatively short perio d, a premium valuation for MindTree appears justified.