Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
A quality mid-cap at a good entry point
MindTree might have lost steam post some of its strategic
mis-calculations, but it still has strengths relative to its
peers in the Indian IT services mid-cap space which we
believe are not currently priced in. A diversified and fairly
de-risked portfolio of services and clients lends support to
likely better than peer revenue growth. In fact, we believe
its large exposure to Application development (46%) would
likely lead to higher than peer top line growth as
discretionary spending picks up in FY12. With investments
in smart phone venture behind it, margins are set to
improve. We believe the recent correction in stock price
based on concerns regarding Mr Soota’s exit and the likely
short term blips in growth that this might entail would be
good points for entry. We initiate coverage with a BUY
rating and a target price of Rs506.
�� Standalone business growing well: Although in-organic
growth strategy has not paid off, MindTree has been
growing well on a standalone basis. It had a revenue CQGR
of 5% since Q1FY10 and 6% in first three quarters of FY11.
The same numbers for Hexaware, Patni and Infosys are
2%/6%, 1%/2% and 5%/6%, respectively.
�� Focus on services will help improve profitability: With
no more investment required in smart phone business,
restructuring cost of $3.2mn behind it and focus back on
being a services company, MindTree’s EBITDA margin will
likely improve. We model a 160bps improvement in
margin till FY13E on a conservative basis. MindTree has
margin levers in utilization and fixed price component.
�� Revenues are de-risked to greater extent compared to
other mid caps; ROIC is relatively strong and FCF
generation to be good going forward: MindTree has a
repeat business of ~99% which renders stability to revenue
and shows client’s confidence in MindTree which would be
helpful in times when vendor consolidation is eating away
mid-cap companies’ market share. With client
concentration levels similar to Tier-1 companies, we
believe sharp downside risks to growth would be relatively
limited compared to other mid-cap companies. Company
has a healthy balance sheet. We expect FCFF generation to
improve going ahead.
�� Valuation attractive; BUY with TP of Rs506. We believe
the stock has been beaten down on misplaced concerns.
Strong financials and improving prospects entail a rerating
of the stock. Despite scoring high on most of the
parameters among its peer set, MindTree is trading at a
discount to them. We ascribe it P/E rating of 12x FY13E
FDEPS (which is at a significant discount to its average PE
of 18x since its listing), valuing it at a slight premium to
peers. We recommend BUY with March 2012 TP of Rs506.
Investment Argument
De-rating of the stock not sustainable
Soota’s resignation overplayed; opportune time to make an entry
The steep correction in March Qtr 2011 witnessed by the MindTree stock was triggered not by
fundamental reasons but by the resignation of founder and Chairman Mr. Ashok Soota. We
believe the potential impact of Mr. Soota’s exit has been overplayed. His exit was part of the
transition plan laid out in FY08 when Mr. K Natarajan was promoted as the CEO. The company has
said that Mr. Soota would sell his 11.1% stake in MindTree only in “due course of time” and that it
would be done in a way that wouldn’t jeopardize the company’s operations. We believe MindTree
has evolved over a decade and with nine of the ten founders still there, it should not be affected
by this change at the helm. Steep correction post Mr. Soota’s resignation provides an opportune
time for the investors to enter this stock. We believe the de-rating of the stock is a shorter term
phenomenon and is not sustainable. At 9.4x FY13E diluted earnings, the valuations look attractive
Over-penalized for taking some calculated risks
Though in hindsight, it was a strategic mistake to venture into the Smartphone business (called
Next in Wireless or NIW), the management clearly had a stop loss in mind. Upside on the other
hand was substantial if it had worked in MindTree’s favour as it would have added another nonlinear
revenue stream to its repertoire.
Company announced in Q3FY11 that restructuring cost for wireless business was only $3.7mn
versus $12-$14mn estimated earlier. Company had paid $6mn upfront payment to acquire
Kyocera’s Indian subsidiary. With $22mn of revenue since acquisition from this subsidiary, the
acquisition has yielded positive returns although it did dent confidence of investor community on
management’s foresight. We believe, rather than holding it against the management, they should
be given credit for realizing non-feasibility of the venture and exiting without inflicting a lot of
damage on shareholder’s wealth.
Exhibit 2: Key data regarding NIW venture
($mn)
Upfront Investment 6
Revenue from NIW 21.9
Restructuring Cost (3.7)
Tax Advantage (Approx) 0.4
Source: Company, Centrum Research
Core strength intact
Standalone business has performed well
We believe with the strategic mistake behind it and focus back on being a pure play IT services
company, its breadth of offerings and domain expertise in select verticals should help it grow at
least at par with the industry if not more. We think the growth would likely be superior to its midcap
peers.
MindTree’s standalone business has grown at a CQGR of 5% since Q1FY10 and 6% in the first three
quarter of FY11. The same numbers for Hexaware, Patni and Infosys are 2%/6%, 1%/2%, 5%/6%,
respectively. We have modeled revenue CAGR of 17% from FY11-FY13E which is at par with our
industry growth estimates.
Diversified portfolio mix
Unlike many of the mid-cap companies which have been focused on various niches, MindTree’s
revenues have been broad based from both a service line as well as vertical perspective. A
comparison with Infosys’ service offerings tells us that MindTree has positioned itself on the lines
of bigger diversified players. An expected uptick in discretionary spending in FY12 is going to
benefit MindTree because of its high exposure to it through application development work.
Application development has grown at a CQGR of 5% since Q1FY10. Other fast growing service
lines are consulting which has grown at 11% CQGR and IMS which has grown at 17% CQGR in the
same period. Among the verticals, Manufacturing and BFSI have led the growth since Q1FY10
growing at a CQGR of 8% each while R&D services has grown at a CQGR of 3% in the same period.
Fixed price project, Utilization are the key margin levers left
Fixed price project (FPP) proportion has steadily been increasing for MindTree allowing it to
improve realizations. FPP however is still lower than mid-cap diversified players like Patni and can
be utilized as a lever to counter margin pressure. Utilization level is also in early 70s and presents
another lever for the company.
Although MindTree’s relatively high offshore presence (88% offshore efforts) means no offshore
lever, it also tells us that MindTree does more offshore-able work than other mid-cap companies
and is therefore able to utilize the labor arbitrage present in India. It has a hybrid global delivery
model called Oneshore.
While it may seem that companies (especially mid-cap) with low offshore revenue mix can use it
as a lever to push their margins up, it is not always possible to move the work offshore if they are
involved in EAS product implementation which requires higher onsite presence. Satyam and
Hexaware are examples of this as they are focused on EAS implementation and therefore have
high onsite presence.
Diversified client base and better revenue visibility
MindTree has a much more diversified client base in comparison to other mid-cap companies. This
not only insulates it from untimely ramp down by any particular client resulting in revenue
volatility, it also signals management’s far-sightedness towards maintaining a healthy and
balanced growth.
Despite lower dependence on few clients, MindTree has a much higher repeat business. It gives a
better revenue visibility to MindTree and also signifies the customer centric approach that
MindTree adopts to retain and grow its diversified client base. This is reflected in the steady
revenue growth from its top clients.
High repeat business also speaks of client’s confidence on MindTree as a service provider. This is
going to be critical in today’s environment when vendor consolidation is hurting mid cap
companies. MindTree has been steadily adding $1mn plus clients in its portfolio.
A comparison with Hexaware reveals that MindTree has been able to mine its top clients better
. It has not only retained and increased its $1mn+ clients, it is also increasing
the wallet share of its clients on a consistent basis
Valuation
Re-rating imminent; Buy with TP of Rs506
We believe the stock has been beaten down on misplaced concerns. Strong financials and
improving prospects entail a re-rating of the stock. The current correction provides an attractive
entry point to investors.Despite scoring high on most of the parameters among its peer set (See
Exhibits 29 to 32), MindTree is trading at a discount to them. We believe it has a better business
than its peers like Persistent and Hexaware and should command a premium. We ascribe it a PE of
12x FY13 FDEPS (which is 33% lower than the average PE over the last 4 years (since listing), and
small premium to the target PE attributed to Persistent and Hexaware as we believe the business
quality is superior). We recommend a BUY with March 2012 target price of Rs506, an upside of
27% from current levels.
Risks
Key upside risks
�� We have not factored in any realization gains. Any uptick would translate into better margins
and higher earnings.
�� Increase in discretionary spending could result in potential upside as MindTree generates
substantial proportion of its revenue from application development.
�� Higher than expected PE re-rating would result in substantial upside from our target price.
Key downside risks
�� Any other strategic mis-steps could result in further loss of confidence for investors and could
pose downside risk to our rating.
�� ADM is a fairly commoditised service line and is susceptible to price pressures
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
A quality mid-cap at a good entry point
MindTree might have lost steam post some of its strategic
mis-calculations, but it still has strengths relative to its
peers in the Indian IT services mid-cap space which we
believe are not currently priced in. A diversified and fairly
de-risked portfolio of services and clients lends support to
likely better than peer revenue growth. In fact, we believe
its large exposure to Application development (46%) would
likely lead to higher than peer top line growth as
discretionary spending picks up in FY12. With investments
in smart phone venture behind it, margins are set to
improve. We believe the recent correction in stock price
based on concerns regarding Mr Soota’s exit and the likely
short term blips in growth that this might entail would be
good points for entry. We initiate coverage with a BUY
rating and a target price of Rs506.
�� Standalone business growing well: Although in-organic
growth strategy has not paid off, MindTree has been
growing well on a standalone basis. It had a revenue CQGR
of 5% since Q1FY10 and 6% in first three quarters of FY11.
The same numbers for Hexaware, Patni and Infosys are
2%/6%, 1%/2% and 5%/6%, respectively.
�� Focus on services will help improve profitability: With
no more investment required in smart phone business,
restructuring cost of $3.2mn behind it and focus back on
being a services company, MindTree’s EBITDA margin will
likely improve. We model a 160bps improvement in
margin till FY13E on a conservative basis. MindTree has
margin levers in utilization and fixed price component.
�� Revenues are de-risked to greater extent compared to
other mid caps; ROIC is relatively strong and FCF
generation to be good going forward: MindTree has a
repeat business of ~99% which renders stability to revenue
and shows client’s confidence in MindTree which would be
helpful in times when vendor consolidation is eating away
mid-cap companies’ market share. With client
concentration levels similar to Tier-1 companies, we
believe sharp downside risks to growth would be relatively
limited compared to other mid-cap companies. Company
has a healthy balance sheet. We expect FCFF generation to
improve going ahead.
�� Valuation attractive; BUY with TP of Rs506. We believe
the stock has been beaten down on misplaced concerns.
Strong financials and improving prospects entail a rerating
of the stock. Despite scoring high on most of the
parameters among its peer set, MindTree is trading at a
discount to them. We ascribe it P/E rating of 12x FY13E
FDEPS (which is at a significant discount to its average PE
of 18x since its listing), valuing it at a slight premium to
peers. We recommend BUY with March 2012 TP of Rs506.
Investment Argument
De-rating of the stock not sustainable
Soota’s resignation overplayed; opportune time to make an entry
The steep correction in March Qtr 2011 witnessed by the MindTree stock was triggered not by
fundamental reasons but by the resignation of founder and Chairman Mr. Ashok Soota. We
believe the potential impact of Mr. Soota’s exit has been overplayed. His exit was part of the
transition plan laid out in FY08 when Mr. K Natarajan was promoted as the CEO. The company has
said that Mr. Soota would sell his 11.1% stake in MindTree only in “due course of time” and that it
would be done in a way that wouldn’t jeopardize the company’s operations. We believe MindTree
has evolved over a decade and with nine of the ten founders still there, it should not be affected
by this change at the helm. Steep correction post Mr. Soota’s resignation provides an opportune
time for the investors to enter this stock. We believe the de-rating of the stock is a shorter term
phenomenon and is not sustainable. At 9.4x FY13E diluted earnings, the valuations look attractive
Over-penalized for taking some calculated risks
Though in hindsight, it was a strategic mistake to venture into the Smartphone business (called
Next in Wireless or NIW), the management clearly had a stop loss in mind. Upside on the other
hand was substantial if it had worked in MindTree’s favour as it would have added another nonlinear
revenue stream to its repertoire.
Company announced in Q3FY11 that restructuring cost for wireless business was only $3.7mn
versus $12-$14mn estimated earlier. Company had paid $6mn upfront payment to acquire
Kyocera’s Indian subsidiary. With $22mn of revenue since acquisition from this subsidiary, the
acquisition has yielded positive returns although it did dent confidence of investor community on
management’s foresight. We believe, rather than holding it against the management, they should
be given credit for realizing non-feasibility of the venture and exiting without inflicting a lot of
damage on shareholder’s wealth.
Exhibit 2: Key data regarding NIW venture
($mn)
Upfront Investment 6
Revenue from NIW 21.9
Restructuring Cost (3.7)
Tax Advantage (Approx) 0.4
Source: Company, Centrum Research
Core strength intact
Standalone business has performed well
We believe with the strategic mistake behind it and focus back on being a pure play IT services
company, its breadth of offerings and domain expertise in select verticals should help it grow at
least at par with the industry if not more. We think the growth would likely be superior to its midcap
peers.
MindTree’s standalone business has grown at a CQGR of 5% since Q1FY10 and 6% in the first three
quarter of FY11. The same numbers for Hexaware, Patni and Infosys are 2%/6%, 1%/2%, 5%/6%,
respectively. We have modeled revenue CAGR of 17% from FY11-FY13E which is at par with our
industry growth estimates.
Diversified portfolio mix
Unlike many of the mid-cap companies which have been focused on various niches, MindTree’s
revenues have been broad based from both a service line as well as vertical perspective. A
comparison with Infosys’ service offerings tells us that MindTree has positioned itself on the lines
of bigger diversified players. An expected uptick in discretionary spending in FY12 is going to
benefit MindTree because of its high exposure to it through application development work.
Application development has grown at a CQGR of 5% since Q1FY10. Other fast growing service
lines are consulting which has grown at 11% CQGR and IMS which has grown at 17% CQGR in the
same period. Among the verticals, Manufacturing and BFSI have led the growth since Q1FY10
growing at a CQGR of 8% each while R&D services has grown at a CQGR of 3% in the same period.
Fixed price project, Utilization are the key margin levers left
Fixed price project (FPP) proportion has steadily been increasing for MindTree allowing it to
improve realizations. FPP however is still lower than mid-cap diversified players like Patni and can
be utilized as a lever to counter margin pressure. Utilization level is also in early 70s and presents
another lever for the company.
Although MindTree’s relatively high offshore presence (88% offshore efforts) means no offshore
lever, it also tells us that MindTree does more offshore-able work than other mid-cap companies
and is therefore able to utilize the labor arbitrage present in India. It has a hybrid global delivery
model called Oneshore.
While it may seem that companies (especially mid-cap) with low offshore revenue mix can use it
as a lever to push their margins up, it is not always possible to move the work offshore if they are
involved in EAS product implementation which requires higher onsite presence. Satyam and
Hexaware are examples of this as they are focused on EAS implementation and therefore have
high onsite presence.
Diversified client base and better revenue visibility
MindTree has a much more diversified client base in comparison to other mid-cap companies. This
not only insulates it from untimely ramp down by any particular client resulting in revenue
volatility, it also signals management’s far-sightedness towards maintaining a healthy and
balanced growth.
Despite lower dependence on few clients, MindTree has a much higher repeat business. It gives a
better revenue visibility to MindTree and also signifies the customer centric approach that
MindTree adopts to retain and grow its diversified client base. This is reflected in the steady
revenue growth from its top clients.
High repeat business also speaks of client’s confidence on MindTree as a service provider. This is
going to be critical in today’s environment when vendor consolidation is hurting mid cap
companies. MindTree has been steadily adding $1mn plus clients in its portfolio.
A comparison with Hexaware reveals that MindTree has been able to mine its top clients better
. It has not only retained and increased its $1mn+ clients, it is also increasing
the wallet share of its clients on a consistent basis
Valuation
Re-rating imminent; Buy with TP of Rs506
We believe the stock has been beaten down on misplaced concerns. Strong financials and
improving prospects entail a re-rating of the stock. The current correction provides an attractive
entry point to investors.Despite scoring high on most of the parameters among its peer set (See
Exhibits 29 to 32), MindTree is trading at a discount to them. We believe it has a better business
than its peers like Persistent and Hexaware and should command a premium. We ascribe it a PE of
12x FY13 FDEPS (which is 33% lower than the average PE over the last 4 years (since listing), and
small premium to the target PE attributed to Persistent and Hexaware as we believe the business
quality is superior). We recommend a BUY with March 2012 target price of Rs506, an upside of
27% from current levels.
Risks
Key upside risks
�� We have not factored in any realization gains. Any uptick would translate into better margins
and higher earnings.
�� Increase in discretionary spending could result in potential upside as MindTree generates
substantial proportion of its revenue from application development.
�� Higher than expected PE re-rating would result in substantial upside from our target price.
Key downside risks
�� Any other strategic mis-steps could result in further loss of confidence for investors and could
pose downside risk to our rating.
�� ADM is a fairly commoditised service line and is susceptible to price pressures
No comments:
Post a Comment