Tech Mahindra

The steep correction in the price of Tech Mahindra’s shares over the last several months can be traced more to adverse sentiment towards mid-sized IT companies, than to any material change in fundamentals. This offers an opportunity for investors to consider investments in the stock with a two-year perspective.

At Rs 723, the stock trades at 12 times its current earnings and 10 times its FY-09 earnings. This puts valuations on a par with Tier-2 IT players, though the company’s much larger revenue base and net profit margin (20 per cent) is comparable to Tier-1 IT players. Strong business prospects driven by an established relationship with British Telecom offer scope for capital appreciation.

Tech Mahindra broadly caters to three sets of clientele — telecom service providers, telecom equipment manufacturers and independent software vendors. The company is also working with clients on latest Internet technologies to cover newer delivery standards such as WiMAX.

These three segments, along with associated IT and BPO services, cover the entire gamut of IT/network operations for any telecom company. This makes Tech Mahindra a fully integrated player, a model not easily replicable even by Tier-1 software players, providing it with a significant competitive advantage. The other critical aspect is Tech Mahindra’s focus on the European markets, a critical geography for telecom spending. The client base of Tech Mahindra comprises, among others, AT&T, Motorola, Alcatel-Lucent, Convergys, Vodafone, and O2. Tech Mahindra derives 70 per cent of its revenues from European clientele.

Europe is also the biggest telecom market, home to top service providers and equipment makers (such as Ericsson, Alcatel, Nokia-Siemens) and the largest market for value-added services.

Tech Mahindra already works with some of these players. In the Business Support Systems and Operations Support Systems segment (areas where a lion’s share of telecom-software outsourcing happens), Tech Mahindra is among the top ten players in the world.
Business Drivers

Deal wins and strong pipeline: Tech Mahindra has recently won a $350-million, five-year deal with British Telecom Group (BT). This deal is largely for provision of application support and maintenance services and is structured for payment evenly spread over five years, giving sustained revenue visibility in an environment of global uncertainty over IT spends. This being a volume service deal, BT has indicated that a good part of the work is to be carried out offshore, suggesting scope for higher margins. This deal is over and above the $1-billion deal that the company had won from BT in December 2006.

The deal also envisages higher compensation to Tech Mahindra if it betters BT’s standards on certain project metrics. BT has also indicated that there may be more such “multi-hundred million” dollar deals in the offing, which may buoy Tech Mahindra’s prospects.

This apart, AT&T, Tech Mahindra’s second-largest client, has won a chunk of spectrum in the recent auction by the American telecom regulators. This will enable it to enhance its voice and data services delivery and tap new customers.

Other recent deal wins are from mobile virtual network operator (MVNOs), WiMAX providers and select media and entertainment companies. These are spread across West Asia and Europe. These services and geographies are high growth, portending more business for Tech Mahindra.
Operational Metrics

The geographic spread is now expanding with US also contributing 20 per cent of Tech Mahindra’s revenues. Revenue concentration (BT being the top client) has been reducing, with BT’s contribution down from 75 per cent levels earlier to 61 per cent now.

Utilisation levels as of December 2007 stood at 69 per cent, much lower than Tier-1 peers. Tech Mahindra may need to hike this level substantially to generate higher volume-driven growth, especially during turbulent quarters.
Risks

Attrition at 21 per cent, higher than Tier-1 players, is a key execution risk. Vendor rationalisation process of top clients may mean that large deals could be sliced into smaller ones, affecting deal size and revenues. In this light, Infosys and TCS, in particular, may offer stiff competition to the company.