Investors with an appetite for risk can participate in the book-built public offering from Tech Mahindra. Bidding at the cut-off price,which has been fixed between Rs 315 and Rs 365 per share, would be appropriate. While this will involve an upfront payment of Rs 365 per share, investors will be eligible to invest even if the final price is fixed lower.
As a software services company focussed on the telecom vertical, Tech Mahindra represents a good choice for investors seeking to diversify their IT portfolio. At the proposed price band, the price-earnings multiple works out to 15.5-18 times the consolidated 2005-06 earnings on an expanded equity base. At these levels, the stock is reasonably priced relative to its domestic frontline software peers.
However, investors will have to moderate their returns expectations from this offer, as a plethora of choices are available (practically all companies in the Nasscom Top 20 are listed entities).
Strengths
Slowly but steadily, global companies in the telecom space are investing in `next generation' converged networks, which carry both voice and data to replace legacy voice networks.
While fixed-line telecom service providers are investing in convergent IP networks to offer services such as Voice over Internet Protocol, mobile companies are deploying data intensive 3G (third generation) mobile services to make up for the slowing revenues from voice.
Global telecom companies are investing enormous resources in developing innovative value-added services to stay competitive in a mobile market where the Average Revenue Per User will remain under pressure, or in fixed-line telephony where volumes will continue to shrink.
As the telecom industry enters this new phase, companies with specialised focus on select verticals will be better placed to grab a bigger slice of business volumes and will be preferred over generic second rung players. Tech Mahindra, with its exclusive focus on the telecom sector, will stand to gain from this trend in the medium term. With its expertise in the Telecom Service Provider (TSP) segment, the company can either offer a range of high value data and content services or use business intelligence/billing optimisation tools to reduce overall costs.
From being a player predominantly focussed on the TSP segment, the company has expanded its presence to the Telecom Equipment Manufacturers (TEM) segment with its acquisition of Axes Technologies in November 2005. The Axes acquisition has brought in Alcatel, North America, as its key client, with significant business in the area of product engineering services. This acquisition is also expected to help open doors in the highly competitive TEM space consisting of players such as Siemens, Motorola, Nokia, Cisco Systems and Ericsson.
Its established client relationships, especially the likes of British Telecom or Alcatel are expected to help widen its base and expand its geographic footprint. At the same time, the company is also well placed to deepen its existing client relationships by offering a much wider range of services.
After a highly turbulent phase in 2003-04, the financials of Tech Mahindra has improved significantly. In the latest year ended March 31, 2006, the company clocked a revenue growth of 31 per cent to Rs 1,242.6 crore and a two-fold rise in post-tax earnings to Rs 235.4 crore.
The operating profit margin, which had touched a low of 10 per cent in 2003-04, has jumped to 21.5 per cent in 2005-06. The company has sustained the OPM in the first quarter ended June 30.This, however, is considerably lower than the 31-35 per cent OPM logged between 2001 and 2003.
Risks and challenges
British Telecom (BT), one of the controlling shareholders of Tech Mahindra, holding about 36.2 per cent of its equity, is also its key client. As its top client, BT accounted for 69 per cent of Tech Mahindra's revenues for the year ended March 31, 2006. This engagement with BT, recently renewed for three years, is expected to lend stability to Tech Mahindra's overall earnings stream. On the flip side, it also leaves the company vulnerable to any delay or freeze in spending (say, in 21st Century Network, BT's large transformation initiative involving the development of a converged network to carry voice and data) or downturn in overall IT spending on telecom projects.
The proportion of revenues accruing from the top five clients at 85 per cent is also quite high. Tech Mahindra has indicated that BT, Alcatel and AT&T are its three key clients, with whom it has entered into long-term agreements.
The offer document states that Alcatel recently announced a merger agreement with Lucent Technologies. The impact of this acquisition on Tech Mahindra's relationship with Alcatel is not clear at the time of the offer. Tech Mahindra is likely to face heightened competition from domestic frontline peers such as TCS, Infosys and Wipro, or global players such as Accenture, HP and IBM. For these players, telecom happens to be one of the segments in a de-risked portfolio of verticals ranging from financial services to manufacturing.
Unlike these players, since Tech Mahindra derives all its revenues from telecom, it remains exposed to a potential downturn in business, greater billing rate pressure from select clients, and volatile quarterly performance.
Finally, the principal risk remains an unanticipated downturn or slowdown in the telecom sector. Since telecom growth is linked strongly to the spending plans of Fortune 500/Global 1000 customers, any economic/sectoral slowdown can impact the company adversely.
Offer details: Tech Mahindra is coming out with a book-built public offer of 1.27 crore equity shares in the price band of Rs 315 to Rs 365 per share. The offer consists of a fresh issue of 31.8 lakh shares and an offer for sale of 95.5 lakh shares by Mahindra and Mahindra, and British Telecom.
Part of the fresh issue proceeds is to be used for enhancing the delivery infrastructure in Pune. The book running lead managers are Kotak Mahindra Capital and ABN Amro Securities. The stock will be listed on the NSE and the BSE. The offer opens on August 1, and closes on August 4.