Citi: MindTree- Sell: Quarter below Expectations

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MindTree (MINT.BO) 
Sell: Quarter below Expectations 

 Muted quarter — QoQ volumes were flat with onsite down 2.1% qoq (offshore up
0.2% qoq). Management attributed this to the lower number of billing days and
higher leave taken by employees in 3Q. Realizations improved qoq (onsite 1.6%;
offshore 5.2%) – management commented that this was partly due to $600K of
licensing revenue. This led to $-term revenue growth of 3.5% qoq ($85.3m; CIRA
$88.1m). EBITDA margins were down 40bps qoq – however, this includes $3.2m
of restructuring charges for the closure of the Products business.

 High attrition a worry — Gross hiring in 3Q was 1,021 while the net addition was
only 75. In effect, the number of people leaving the company in 3Q was 946 (2Q
833) implying that the quarterly attrition (annualized) was ~39% (on 2Q base).
However, management suggested that this figure was 25.6% (2Q 26.8%), the rest
due to involuntary attrition. Even 25%+ is high and remains a cause for concern as
the demand environment remains buoyant in the near term.
 Key highlights — (1) America was down 1.0% while Europe was up 11.5%
(favorable cross currency should have helped). (2) Application development was
down 6.2% qoq (does not tie in with positive commentary on discretionary spends)
while maintenance was up 10.1%. (3) BFSI was up 15.5%, Manufacturing +11.6%
while Hitech was down 1.7% qoq. (4) Forex gain Rs79m (2Q Rs21m).
 Maintain Sell — Management expects volume growth to return in 4Q. The stock
trades at ~12x FY12E EPS which is towards the higher end of the mid cap
universe. The difference in performance between Tier-I names and smaller
companies continues – both on volumes as well as supply-side challenges. Exit
from the products business in a short span is a negative – we remain Sellers


MindTree
Valuation
Our Rs500 target price is derived from 7x Mar'12E EV/EBITDA. This is inline
with mid cap IT Services multiples and factors management's decision to enter
and then exit the telecom products business within a short span of time. We
believe that this is appropriate as the company has already spent ~$4-5m in the
business and will need to take charges in excess of $10m in 2HFY11.

Risks
We rate MindTree shares Medium Risk which is in line with other mid caps
under our coverage, despite our quant risk rating system suggesting Low Risk.
Upside risks to our target price are: (1) faster than expected recovery in the
US/global economy; (2) earlier/higher than expected pricing increases; (3) INR
depreciation; and (4) clarity around the wireless business.