Tech Mahindra: Buy

Investors can buy the Tech Mahindra stock with a two-year horizon considering the healthy growth prospects for its service offerings in Europe, its blue-chip clientele and status as an integrated telecom software player.

The stock was marked down significantly during the recent meltdown in mid-tier IT stocks; investors can use this opportunity to buy.

The stock trades at 23 times its current year’s earnings and is at a discount to other telecom software companies such as Sasken, as well as larger IT companies such as HCL Technologies and Wipro, making it a reasonable investment option.

Tech Mahindra broadly caters to three sets of clientele — telecom service providers (TSP), telecom equipment manufacturers (TEM) and independent software vendors (ISV). Its IT services offerings include application development and maintenance, system integration, product engineering, managed platforms and services, consulting, testing and BPO services, among others.
Business Analysis

Integrated business model: Starting with a one-off client — British Telecom— Tech Mahindra (TechM) has over time broad-based its service by catering to other telecom service providers and equipment-makers and independent so ftware vendors. Together, these three segments along with associated services cover the entire gamut of IT/network operations for any telecom company. This makes TechM a fully integrated player, a model not easily replicable even by Tier-1 software players, providing it with a significant competitive advantage.

In the Business Support Systems and Operations Support Systems segment (areas where a lion’s share of telecom-software outsourcing happens), TechM is among the top ten players in the world.

The company’s telecom equipment revenues have grown nearly five times over the past year, pointing to growth prospects for its other businesses.

Blue-chip clientele: The client base of TechM comprises, among others, AT&T, Motorola, Alcatel-Lucent, Convergys, Vodafone, and O2.

This elite clientele has helped it build complex telecom network-related and telecom business-related IT service delivery capabilities. This has also helped it to tap newer high-value clients, through partnerships and tie-ups.

Opportunities from European telecom players: The company derives three-fourths of its revenues from European clientele.

Most telecom service providers (including BT, Vodafone and O2) there are grappling with falling realisations and are looking to innovate through value-added services and converged products (networks and devices that can support voice, data and video) to increase revenues.

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. TechM already works with some of these players.

With increased spending on IT and network infrastructure by these players, the company can achieve deeper penetration of this market ahead of other vendors.

In North America, the engagement is more with ISVs such as Convergys, Oracle and Microsoft.

This can help it penetrate telecom billing software markets in the US. With Lucent and AT&T, it has managed to penetrate equipment-makers as well as the service provider space.

Together, TechM’s presence in these two locations and the increasing levels of engagement, point to robust prospects.

Operational metrics: BT, as a client, contributes about 64 per cent of the company’s total revenues. Although this is a concentration risk, this percentage has been coming down steadily as the company works with new clientele.

Restructuring at BT has resulted in the slowdown of revenues from this source, but the management has indicated that these issues are likely to be sorted out and reasonable growth can be expected from BT from the third quarter.

In the June quarter, the company added four million-dollar clients, including a $5 million and a $15 million-dollar client, underlining its ability to mine its clients.

Risks

A significant exposure to the dollar enhances currency risks. With Infosys seeing a significant ramp up in its telecom vertical’s operations (with BT as a key client), and other Indian IT vendors on BT’s shortlist, TechM may be faced with heightened competition, leading to pricing pressures.

The attrition rate, at 18 per cent, is on the high side and represents an execution risk; while an annual wage increase of 15 per cent is also a source of margin pressure.

The company hopes to mitigate some of this by hiking fresher recruitments to about 70 per cent.

The utilisation rate at 67 per cent is on the low side and suggests that the company has been unable to capitalise fully on volume-driven growth in a turbulent quarter (with factors such as rupee appreciation playing a role)