Mphasis

Mphasis – Q1FY2011 results & conference call highlights – poor results, lack of disclosure and apathy of HP towards minority shareholders justify the sharp correction in the stock





Weak Q1FY2011 results were extremely weak both in terms of qoq decline in revenues and a sharp dip in the operating margins. The management has cited multiple reasons for the weak performance but the main issue with Mphasis is the lack of growth in business from its parent HP (68% of revenues) and reduction in the billing rates from HP channel clients. Both the issues are quite intriguing as the demand environment in general has improved significantly and most companies are witnessing an uptick in billing rates. Thus, the lackluster volume growth and declining billing rates from HP shows the parent companies neglect for financial performance of Mphasis and apathy towards interest of minority shareholders.



The consensus estimates are likely to witness ~25% decline in earning estimates to around Rs39-40 per share for FY2011 (October ended). After today’s correction also the stock trades at around 12-12.5x one-year forward earnings which is around 17-18% discount to HCL Tech. We believe that the valuation discount to increase further to 20-25% (CMP range of Rs450-500) and the stock to trade around 11-12x one-year forward earnings (as compared to 14-16x range earlier). Apart from the downgrade of earnings, the lack of transparency, reduced disclosure level and weak performance in the coming quarters (full impact of billing rate cuts in Q2 and effect of wage hikes) would remain as a drag on the valuations. The hope for minority shareholders could be a possible buyback and delisting of Mphasis by HP (done that earlier in case of Digital Globalsoft) or usage of huge cash on books for inorganic growth initiatives.





Q1 results & concall highlights

· Revenues for the quarter were down 8.5% QoQ at $271 million. In INR terms, revenues were down 8.3% QoQ at Rs1233.5 crore. Just to put in context HP services revenues were down 5.7% for Q1FY2011 due to client shutdown. Lower number of working days (5 days in onsite and 4days in offshore) due to closure adversely impacted revenues by 3.5%, lower pricing adversely impacted by 1%, milestone based revenues in Q4FY2010 not there in Q1FY2011 adversely impacted 3% and rupee appreciation impacted by 0.7%.

· The company took pricing cuts of 5-10% from few HP direct channel clients w.e.f. December 2010. The adverse impact was for 2 months in Q1FY2011 and balance would happen in Q2FY2011.

· EBITDA margins gross of write backs were down 480bps at 17.4%. Reported EBITDA margin was down 210bps at 20.8%. EBITDA margins going forward would be +/- 1% from the current level of 17.4%.

· Net Profit gross of write backs was down 29.8% at Rs183.2 crore. Reported PAT down 20.2% at Rs226.6 crore.

· The company has entirely changed the reporting matrix to industry vertical segments from services based segments.

· The pipeline looks sluggish in the HP channel whereas it is improving in the direct channel.

· The tax rate for Q2FY2011 would be 15% and for H2FY2011 would be 24%.

· The net headcount addition during the quarter was 1,097 and the total number of employees as on 31 January 2011 was 41,059. The utilisation for applications – offshore was down 300bps to 71% inline with company expectations to create a bench.

· Cash & cash equivalents stood at Rs1785.5 crore.

· At CMP of Rs500 the stock trades at 12.5x Fy2011 (Oct ended) earnings which is not cheap given the 25% downgrade in earnings, expectations of weak performance in coming quarters, lack of disclosures and transparency. It would be better to avoid bottom fishing at these levels.