Tech Mahindra

Investors with a two-year horizon can consider buying the shares of Tech Mahindra, a software service provider catering to the telecom sector.


Growth in its core business, driven in part by its non-BT (British Telecom global services) clients, improvement in its key operating metrics and the synergies from the potential merger of Mahindra Satyam are key factors to potential capital appreciation in the stock.

Now that the results of Mahindra Satyam for the last couple of fiscals have been disclosed, it may be pertinent to examine valuation of Tech Mahindra by including its 42.7 per cent stake in the former.

Based on likely FY11 earnings and assigning a price-earning multiple of 13 times (at a discount to several peers), the value of its core business works out to Rs 572 . With regard to its stake in Mahindra Satyam, based on a 15 per cent EBITDA margin estimate for FY11 and giving a 15 per cent holding company discount, we arrive at a value of Rs 265 for this business, giving a total value of Rs 837. Tech Mahindra's current market price is Rs 767. Investors may thus have to take a call to hold on to the stock over a two-year period for significant gains.

These calculations are based on conservative estimates. With a broad turnaround in IT spends, Mahindra Satyam's diversified operations may be expected to turn in robust numbers in FY12.

After a challenging couple of years for all large and mid-tier IT companies with reference to declining contribution from their telecom verticals, a well-positioned Tech Mahindra has been able to tap domestic opportunities and make inroads into newer geographies as well.

With strong client wins and expansion in capex spending by telecom players — equipment manufacturers, chip makers and handset producers, Tech Mahindra appears well placed to capture a significant pie of the incremental market, thus providing scope for further capital appreciation.

In FY10, Tech Mahindra saw its revenues expand by 3.6 per cent over the previous fiscal to Rs 4,625.4 crore, while net profits fell by 31 per cent to Rs 700.4 crore. The revenue growth compares favourably with most large IT companies.

But the decline in net profits was primarily due to increase in wage costs and the interest burden incurred due to the debt taken for the acquisition of Satyam Computer.

non-BT contribution

BT has been Tech Mahindra's biggest client. Over the last couple of years, the contribution of BT to its revenues has come down from over 60 per cent to about 45 per cent currently. This has been due to a combination of BT bringing in more vendors to cater to its needs as well as reduction in IT spends due to the challenging economic situation in the UK.

But what has been heartening for the company is that there has been ramping up of other clients of the company, thus reducing concentration risk.

The top 10 client contribution has been stable at over 80 per cent over the last several quarters. Large clients such as AT&T are also steadily increasing the outsourcing pie to Tech Mahindra.

The company has also made strong inroads into the domestic telecom market. Tech Mahindra bagged an IT outsourcing deal worth $400 million from Etisalat DB spread over 10 years, late last year. Etisalat DB has telecom licences to operate in 15 circles in India. Tech Mahindra's ability to mine clients also comes to the fore as Etisalat is an existing client, with the company having done system integration work for the latter's Egypt operations.

If the revenues are booked equally over 10 years, it would give an annual run-rate of $40 million for Tech Mahindra, about 4 per cent of its 2009-10 revenues. Tech Mahindra is also one of three players in a contract worth Rs 750 crore from the same client for providing contact centre operations.

Improving metrics

In the past 3-4 quarters, the company has been able to add several $10 million-plus and a $20 million-plus clients, suggesting a revival in the telecom segment.

From being focussed largely on Europe, the company now derives a little under a third of its revenues from North America and about 13 per cent from the rest of the world, giving it an increasingly healthy geographic-mix.

A recent report from Gartner indicates that worldwide, semiconductor capital equipment spending is projected to approach $36.9 billion in 2010, a 122.1 per cent increase from 2009.

Also, another of its reports points out to a robust increase in mobile handset sales and a strong spike in smart-phone buying.

These facts suggest an improvement in the telecom macro-environment for vendors such as Tech Mahindra that cater to the entire telecom value chain.

Tech Mahindra also has a very favourable cost structure with 63 per cent of its revenues coming from services delivered from offshore (largely Indian) locations. This is much better than the near equal proportion between offshore and onsite of all top-tier IT companies as well as some mid-tier players.

Mahindra Satyam MERGER

A call on the timeframe for the merger of Mahindra Satyam with Tech Mahindra is yet to be taken. But once this is done, the merged entity would have the scale to participate in large deals. Many global clients are embarking on a vendor consolidation exercise and towards this end, are tightening the number of vendors that they work with to about three-four global majors and two-three top Indian IT players.

A merged entity would make it well positioned. Most large and mid-tier IT companies' results over the last three quarters indicate a revival in volumes (person-months billed) and an improving billing environment. Going forward, Mahindra Satyam, with significant deal wins (multi-million, multi-year) from its major clients and as many as 44 new ones added in FY10, too may be expected to deliver on these fronts.

Being a cash generating company, the merger with Mahindra Satyam would also mean that Tech Mahindra may be able to use the cash to pay off debt, taken for the acquisition of the former in 2009.

via BL