Credit Suisse:: Mindtree: Waiting for a clear strategy to emerge

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Credit  Suisse:: Mindtree: Waiting for a clear strategy to emerge 



● Mindtree reported 3.5% QoQ revenue growth (US$ terms), in line
with our expectations. A positive surprise on tax rates led to EPS
beating our estimates by 13%.
● EBIT margins in the quarter were negatively impacted by the
restructuring costs of US$3.7 mn pertaining to the product
business. Excluding these costs, EBIT margins could have been
close to 10.7% (versus reported margins of 6.3%).
● Over the past five years, Mindtree has more than tripled its topline, but there has been no positive scale effect on its margins.
Due to lack of margin leverage, and significantly higher volatility
associated with its business model, we remain cautious.
● Further, post the failure of the recent venture in telecom product,
we also await some clarity on future strategy from management.
● The stock is not expensive at a P/E of 11x FY3/12; however, a
lack of clear strategy from management prevents us from being
more constructive. We thus reiterate our UNDERPERFORM rating
and target price of Rs525
Decent results
Mindtree reported decent Dec-10 results with US$-revenue growth of
3.5% QoQ, in line with our expectations. EBIT margin dropped 70 bp
QoQ versus our assumption of flat margins. As a result, EBIT was 8%
below our estimate. Significantly lower effective tax rate led to PAT
coming ahead of our estimate by 13%.
Management explained that its merger with the Mindtree Wireless
entity had led to losses and restructuring costs getting consolidated,
which led to the one-off tax benefits.
Final restructuring cost of the product business = US$3.7
mn
Of this, US$3.2 mn is included in direct costs and SG&A expenses for
the quarter, and the remaining US$0.5 mn corresponding to writedown of goodwill related to Kyocera acquisition is included in
depreciation expenses. Adjusted for this, the EBIT margin for the
quarter would have been higher by 430 bp at 10.7%.
The final restructuring cost of US$3.7 mn was significantly lower than
the original estimate of US$12-14 mn indicated in the previous quarter.
Management explained that: (1) the company closed contracts with
vendors at significantly lower costs than previously anticipated and (2)
assets were written down to a lower extent as management found that
a significant proportion of assets were reusable.
Mixed performance across segments
IT services grew smartly by 7.6% QoQ (US$ terms), driven by volume
growth of 3.9% QoQ, with remaining due to price increases and crosscurrency benefit. Volume growth was driven by strong traction in the
BFSI and Manufacturing segments. IP sale of US$0.6 mn helped
pricing by ~1%.
On the other hand, product engineering services declined by 2.1%
QoQ (US$ terms) largely due to a 4.9% QoQ decline in software
product engineering. Management explained that some of its clients in
this segment had run out of budgets and that the decline was
seasonal.
Retain UNDERPERFORM
We make minor changes to our model to incorporate the results of the
quarter. At 11x FY3/12 earnings, the stock appears inexpensive, and
its core business could improve going forward. However, the lack of a
clear strategy from management prevents us from turning positive.
Thus, we retain our UNDERPERFORM rating and maintain our target
price of Rs525.