Mindtree, Reiterate REDUCE, this time on core business concerns:: Kotak Sec,

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Reiterate REDUCE, this time on core business concerns. Even as course correction
on the (costly) mis-step to invest in handset products business is welcome, we note
reasons for concern on the core business and would be wary of any re-rating in a hurry.
In its acquisitive and bold pursuits (into unrelated areas), MT appears to have taken its
eye off the ball on core business – underperformance on revenue growth as well as
margins, the unpleasant outcomes. We cut our TP 18% to Rs450; reiterate REDUCE.


Products (3G Android handset) investments – a costly mis-step…
What started as an unnecessary diversification into an unrelated area (in our view) is ending as a
costly (~US$20 mn) mis-step. MindTree has decided not to pursue its ‘white-labeled handsets’
(products) ambitions any further. The company has already invested close to US$5 mn on this
foray and indicates that closing this business would entail a further US$12-14 mn charge over the
next 2-3 quarters. This charge would be on account of (1) some fixed-asset write-off, (2) noncancellable
purchase orders for handset/prototype components, (3) severance pay for a few
employees who will be let off, and (4) penalty on cancelling sub-contracting commitments.
…adds to the previous disappointments
The product investments mis-step adds to the list of disappointments from MindTree as a public
listed company, which includes among others – (1) entering into exotic forex derivative contracts –
this continues to lend volatility to the company’s reported quarterly financials, (2) weakly timed
acquisitions, and (3) poor guidance management – the company had to do away with giving
annual revenue/EBITDA/PAT in beginning-FY2011E.
Moving on – core business margin concerns drive EPS and target price cuts; REDUCE
MT’s revenue performance for the Sep 2010 quarter was marginally better than expectations,
however, and more importantly, core business margin performance disappointed. The 120 bps
qoq improvement in core (ex-product investments) margins was aided to the tune of 330 bps on
account of provision reversals, indicating a 210 bps underlying decline in margins. In a quarter
with strong tailwinds in the form of strong volume growth and currency benefits, such margin
performance is disappointing and reflects the pricing/wage pressure facing the company.
Even as we remain positive on revenue growth for MT (in line with our sector view), our margin
outlook for the company has weakened further. We take our FY2012E margin estimates down
220 bps (in effect a 450 bps downgrade, as we remove the earlier assumed product investments).
We cut our (pre-exceptional) FY2011E and FY2012E EPS estimate to Rs27.4 and Rs39.3,
respectively. Reiterate REDUCE with a revised target price of Rs450/share (Rs550 earlier).