Mphasis BFL- Margins disappoint; net income gets a forex boost.:: Kotak Sec

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Mphasis BFL (MPHL)
Technology
Margins disappoint; net income gets a forex boost. Mphasis’ net income of Rs2.84
bn for the Oct 2010 quarter came in 6.6% ahead of our estimates, despite a 110 bps
miss on EBITDA margin, on the back of higher-than-expected forex income and lowerthan-
expected ETR. Revenue performance was in line with expectations. The stock
could see some uptick post recent underperformance but we remain unconvinced on
revenue/margin fundamentals. We shall review our estimates post the earnings call.





Oct 2010 quarter – revenues in line, margins disappoint
Mphasis reported revenues of US$290.2 mn for the Oct 2010 quarter (+7% qoq, +24% yoy), in
line with our expectation. We note that the previous quarter revenue performance was impacted
by one-off issues in the Telecom vertical – vertical split of revenues suggests a recoup of these
revenues in the Oct quarter. Net income of Rs2.84 bn came in 6.6% ahead of our estimates even
as EBITDA margin of 23.8% fell 110 bps short of our estimate. Margins were impacted by a sharp
drop in ITO utilization, step-up in S&M investments and normalization of G&A expenses. Net
income outperformance was aided by higher-than-expected forex income and lower-thanexpected
ETR.


Segmental performance – strong quarter for apps, ITO margins and BPO revenues disappoint
Mphasis reported a strong quarter on revenue growth (+7.6% qoq, US$ terms) as well as margins
(+140 bps qoq) for the applications segment. ITO performance was a mixed bag – robust revenue
growth (+8.4% qoq) failed to translated into strong margin performance; margins for the segment
fell 460 bps qoq. BPO segment performance was disappointing with revenues up a modest 1.7%
qoq; margin expansion of 250 bps qoq for this segment was likely aided by the absolute qoq
headcount decline in the segment; Mphasis’ BPO headcount declined by 1,141 during the quarter.
We shall review our estimates post earnings call; remain unconvinced, fundamentally

We shall review our estimates post the earnings call. We expect some uptick in the stock post the
recent correction, a part which was driven by expectations of a weak quarter; the earnings report
has come in better than the pre-result whispers in the market.

We see several challenges ahead for Mphasis of which some are – (1) Mphasis has captured a fairshare
of HP revenues and further share gains would be limited, in our view. Growing non-HP base
of revenues would need sharp S&M step-up, which would have an impact on the margins (2) Re
appreciation - hedging gains for Mphasis may not last for long - margins may come under pressure
once benefits of these hedges wear off and (3) sharp increase in tax rates in FY2012E from 9.8%
for year ending Oct 2010. Seemingly inexpensive valuations on a P/E basis should be weighed
against the revenue growth/margin risks and sharp increase in tax rates in FY2012E.