MphasiS downgraded by HSBC Research,

Top-line volume growth not a worry: We believe MphasiS has so far only captured 5% of
the addressable share of the HP services division and there is still further scope to increase
wallet share. MphasiS’s revenue growth from the HP channel is likely to be driven by its share
of the HP’s incremental revenues and wallet share gains in the un-addressable divisions (so
far), such as technology services (which offers maintenance/preventive support services,
warranty support and bespoke solutions). Appointment of HP veterans to the MphasiS board is
likely to accelerate MphasiS’s share of the pie.
Margin concerns have increased. While revenue growth is likely to be robust, we expect
earnings growth will remain muted due to margin dilution expected in FY11. The reasons
for our expectations are: 1) decline in hedging gains, which cushioned FY10 margins by
c240bps, 2) likely investments in sales and marketing to grow the direct business channel
and 3) employee costs will grow faster than revenues as current pricing, even if assumed
stable in FY11, will be 4.5% below the FY11 realisation on a blended basis. Furthermore,
earnings growth will be impacted by an increase in the tax rate in FY11 and FY12 to 18%
and 25% respectively, from c10% in FY10.
Valuation and forecasts – We cut our FY12 EPS estimates by c5% to factor in the margin
concerns outlined in this note and our target PE multiple to 13x on FY12 EPS from 14.5x on
FY11 EPS (similar to what HCLT is trading currently and c38% discount to Infosys). We
believe the discount is justified due to MphasiS’ high client concentration risk. The stock is
currently trading at c12x FY11e EPS and we believe is unlikely to significantly re-rate from
these levels in the light of our expectations for flat earnings growth in the next two years. We
therefore, cut our TP to INR700 (from INR770) earlier, based on 13x FY12e EPS. With
7.4%potential return indicated, we downgrade from Overweight (V) to Neutral (V).