Mphasis - no respite in the medium term; visit note; Reduce : Edelweiss

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Mphasis (MPHL IN, INR 461, Reduce)

Mphasis’ recently declared results for quarter ending January 2011, came in as a shocker with actual results differing significantly against expectations, despite anticipated concerns. We met with Mr. Ganesh Murthy, CFO, Mphasis to understand business outlook going forward from direct and HP channel. We summarize the takeaways below:

Expect moderate growth through HP channel (1-2% Q-o-Q)

Driven by decline in HP’s services revenues, management has indicated sluggish revenue growth (meager 1-2%) from the HP channel for the next few quarters. Factors such as volatility in HP’s services revenues, short-term signings or project based revenues lower than expected and migration work losing traction are resulting in overall bleak growth outlook from the HP channel.

Revenues from direct channel to grow faster than HP channel

With a view of increasing direct channel’s contribution (currently 32% of revenues), Mphasis is hiring talent to develop industry specific solutions in the banking and capital markets (BCM) and insurance verticals. Also, two-third of its sales force is dedicated to direct channel. Management expects these initiatives to be fruitful and believes it to grow 3-5% Q-o-Q for the next three quarters.

Operating margins to drift down further

Management expects EBIT margins in the range of 16-18% for the next three quarters. We believe persisting price pressure and wage hikes (~10% offshore and 2-3% onsite) effective May 2011 - are key reasons for margin detractors.

Acquisition to reduce HP dependence and add new logos

Mphasis is actively looking for an acquisition to utilise part of its accumulated USD 380 mn cash pile. However, we will be cautious on the same, given its primary rationale is to add new logos and revenues to reduce dependence on HP.

Outlook and valuations: No respite; maintain ‘REDUCE’

Mphasis’ business continues to have structural issues, with HP determining the growth trajectory. Muted revenue growth and margin decline trend is expected to continue. We, thus, maintain our ‘REDUCE/ Sector Underperformer’ recommendation/rating on the stock. At CMP of INR 461, the stock is trading at P/E of 11.9x and 11.5x our FY12E and FY13E estimates, respectively.