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Good news – product (3G handset) investment write-off is
likely to be lower at US$5-7 mn versus earlier indicated US$12-14 mn. Bad news –
revenue momentum continues to be weaker than the Tier-I players with R&D business
still a drag on overall growth. Even as the management remains confident of margin
revival to 18-20% levels for FY2012E, we see the same challenging if revenue growth
lags peers. We reiterate our REDUCE rating on the stock with a TP of Rs450/share
Product investment write-off is likely to be lower than indicated earlier
MT management indicated that the eventual product investment write-off is likely to be much
lower at US$5-7 mn than the US$12-14 mn communicated at the 2QFY11 earnings call. The
company is likely to take the entire write-off in the Dec 2010 quarter. Lower-than-anticipated
write-off is on account of (1) potential sale of certain parts of IP created, (2) lower-than-anticipated
penalties on third-party contract closures, (3) productive use identified for some of the fixed asset
base built for the products business, and (4) lower-than-expected people restructuring costs.
The company expects complete closure of the products business by early Jan 2011.
Demand environment – robust for IT services, R&D segment relatively weaker
MT management indicated “fair bit of volume momentum” and expressed that the confidence
level on demand is “much higher this December than last”. The company indicated a better-thanhistorical-trend December quarter and expects better visibility on FY2012E only after client IT
budget closures (late Jan, early Feb 2011). That said, pre-budget discussions with top accounts
suggest strong growth potential for IT services in FY2012E, and a relatively weaker outlook for
software product engineering and R&D services. The issue is, SPE/R&D services account for 43% of
MT’s revenues (substantially higher than most full-service players in the industry) and could prove
to be a drag on MT’s relative revenue performance in FY2012E.
Margins – we do not share management’s confidence
MT management expressed confidence on taking the core business EBITDA margins up to 18-20%
levels in FY2012E from the 14-15% levels reported for the past two quarters. We note that we do
not share the management’s confidence on margin revival and build in 15.3% EBITDA margin for
FY2012E (at Re/US$ rate of 44.5; there could be some upside on this front). Our caution on
margins stems from – (1) supply-side pressure; wage inflation could remain in the double-digit
territory (offshore) next fiscal; MT’s high attrition levels (35% qtr annualized in 2QFY11) does not
help matters much, (2) sub-contracting costs could hurt further – high-attrition, especially if its in
the high-demand skill sets, could keep subcontracting costs high in the coming quarters, and (3)
sustained pressure on offshore billing rates.
Course correction post the failed products gamble underway but the journey
could be long and arduous
In a bid to diversify (unnecessarily), MT took its eye off the ball on core business, in our view.
This has reflected in the sustained revenue and margin underperformance on core business
for the past few quarters. We resist the urge to give MT the benefit of doubt on
accelerated turnaround, and expect the core business recovery process to be a longdrawn affair. Weak outlook for the SPE/R&D business (per the company) could continue to
be a drag on relative revenue performance, which also happens to be the only margin lever
in the current high-growth high-attrition environment. Nonetheless, while we remain
cautious on margin improvement, we are building in a reasonable 23% US$ revenue growth
in FY2012E and do not see much upside risk there.
The stock is trading at 13.2X FY2012E EPS, expensive in our view. We reiterate our REDUCE
recommendation with a target price of Rs450/share.
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