Mindtree, Geodesic, HCL Technologies

Mindtree

MindTree Consulting (MindTree), a mid-sized IT and R&D services company, has strong management bandwidth. It services marquee clients like Volvo, AIG, LSI Logic, United Technologies, Symantec, Avis and Unilever. However, a high share of development services in revenues creates a project-based business profile, which lowers sales productivity, hurts utilization and leads to poor client mining. Thus, contrary to street expectations of an expansion, we see margins declining by 170bp over FY07-09 due to rupee appreciation and salary inflation. The management has cut its FY08 earnings guidance after Q1FY08 results, but we see further risk to consensus estimates for FY09. While the stock price has fallen 23% in just one month, further downside is likely at valuations of 19.8x FY09E earnings (19.2x for Infosys). Initiating coverage with Underperformer and a price target of Rs510.


Superior quality management: A strong management has successfully steered MindTree even through troubled times, which is a testimony to its ability. MindTree registered a robust 65% revenue CAGR over FY04-07 on the back of its positioning as the second best choice for clients offshoring IT and R&D services and looking for management attention. While R&D services are a good differentiator, we believe MindTree offers generic IT services with little differentiation.

Project-based nature of business and poor client mining haze visibility: Mindtree derived 65% of its FY07 revenues from development services, which tend to be volatile as they are project-based. Despite having a 71% share of offshore revenue compared to 35% for Hexaware (a comparable peer), MindTree fares poorly in terms of client mining with an average of just 15 billed people per client compared to 23 for Hexaware. Poor client mining lowers sales productivity, reduces visibility and affects utilization.

Valuation premium to tier-1 peers unjustified: Mindtree trades at premium valuations even to tier-1 companies, which we attribute to its superior management. However, we expect margins to decline by 170bp over FY07-09 due to the impact of rupee appreciation and salary inflation. We do not see too many operating levers playing out as most of the metrics are inherent to the business. At 19.8x FY09E earnings and 12.1x EV/EBITDA, we initiate coverage with Underperformer and a price target of Rs510.

HCL Technologies

HCLT’s Q4FY07 (June- year ending) results were marginally below our expectation, though, $ terms revenues were exactly in line. HCLT’s realized rate at Rs40.74/$ was below our assumed rate of Rs41.33/$. Hence revenues at $396m (9.2% qoq and 45.3% yoy) were in line but in Rupee terms revenues at Rs16.12b (2.2% qoq and 28.6% yoy) was lower than our forecast of Rs16.36b. HCLT reported 7 large deal wins in Q4FY07. With HCLT continuing to win large deals of over $50m (it has signed 3 large deals so far of $200-500m), we believe, sales productivity would keep rising. The company indicated a gross hiring target of 25,000 people including just 8,000 freshers, which points towards the imminent growth momentum in business. It also indicated that margins would remain stable as pricing moves away from a people-based model to a transaction oriented one. As the realized exchange rate was lower than our earlier forecast we are lowering our revenue forecast by 1.4% for FY08 and FY09. We are maintaining our earnings forecast for FY08 but raising FY09 earnings by 2.4%. We believe, HCLT has scaled up significantly and given its large deal market share, at 17.3x FY08 and 13.4x FY09 earnings, there is likely re-rating possible in FY08. It is one of our top picks in the sector. Maintain Outperformer.


Geodesic

Geodesic Information System (Geodesic) reported 18.2% qoq (+70.6% yoy) growth in revenues, the highest growth in last 6 quarters, to Rs579m against our expectation of Rs507m. The performance beat our forecast mainly because of advance received from a few enterprise customers including BenQ as initial fees for Mundu. EBITDA margins grew significantly from 64.8% in FY07 to 66.2% in Q1FY08 mainly due to the incremental fees booked from enterprise customers. Accordingly, PAT at Rs287m beat our estimate of Rs252m despite Rs36m loss on account of forex movement. Geodesic added five new clients including a large publishing house in Malaysia, a social networking site in Europe and an India based wireless service provider. Geodesic has managed to sign up with a few handset manufacturers including BenQ, Mitac and Asus and is in discussions with others, which would enable it to scale up its customer base. It is also planning to pursue initiatives to strike relationships with service providers both local as well international. Its other products including the Simputer, Spyder and Radio (could bundle along with the IM and offer to users for an annual fee rather than a one-time fee) would provide additional revenue streams. We are raising our revenue forecast by 14% and 19% and earnings forecast by only 2% (due to expected higher marketing expenses) and 24% for FY08 and FY09 respectively. At 19.4x FY08 and 11.9x FY09 earnings, we maintain out performer.