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India Equity Research Reports, IPO and Stock News
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Discretionary spend to be key growth driver in FY12
Indian IT services companies generate ~30% of revenues from discretionary spend. Discretionary spend
environment is improving sharply as visible from both Oracle and SAP, recording yoy growth in new license
sale greater than 25%. Management commentary of technology bellwethers suggests a more buoyant discretionary
spend environment in North America and emerging economies than Europe. We believe increased spend on
discretionary projects is critical because these have better pricing when compared to maintenance projects.
Coupled with secular offshore shift to manage costs, the bounce back in discretionary spend augurs well for Indian IT
services companies.We remain positive on the sector and expect returns to be driven by robust earnings growth.
HCL Technologies: All positive priced in
HCL Technologies (HCLT) has been able to catch-up and even outperform its larger peers in revenue growth by
acquiring Axon and also by investing in Remote Infrastructure Management (RIM). However, the story is not same
when it comes to other metrics such a margins, cash generation and return ratios. Though HCLT’s revenue growth has
been impressive and would continue to be inline with larger peers, led by its RIM practice, our concern is on HCLT’s
margin owing to: aggressive pricing especially in RIM, lower than peer fresher recruits, increased contribution
from RIM business and relatively low SG&A spend. We do not share consensus optimism in HCLT improving
operating margins by 100bps in FY12. We do not expect HCLT’s P/E to bridge the gap with Tier-1 owing to relatively
weak financial metrics. Initiate coverage on HCLT with Reduce/Underperform rating with a price target of Rs. 465.
Tech Mahindra – Mahindra Satyam: Marriage on the cards
Management of Tech Mahindra (TECHM) have indicated time and again that TECHM and Mahindra Satyam (MSAT)
would be merged. With some of the obstacles out, we too believe a merger is realistic possibility in the next 12-18
months. In this context, TECHM and MSAT should not be looked at in isolation by investors in our opinion. On a
combined basis, we expect the duo to have a sales of US$ 2.5bn of revenues in FY12E making it the fifth largest
India listed IT services company. Moreover, the business would exhibit a diversified revenue profile, a luxury TECHM
hitherto did not enjoy.
We expect both companies to lag industry revenue growth – TECHM owing to a weak demand environment in the
telecom vertical; MSAT due to their inability to participate in large deals in the past 24 months. On the margins front,
TECHM would have a muted expansion, on the contrary we expect MSAT to expand operating margins by ~650bps
over next 24 months. At current prices, the combined entity is trading at a P/E of 12.2x FY12E EPS and 9.0x FY13E,
attractive in our view. Given the attractive valuation we believe investors should buy into both TECHM and MSAT in a
manner that would result in them having the same stake in both the companies. We prefer this approach as a protection
against the as-yet-uncertain swap ratio that would be used for the merger. Our target multiple for the combined entity is
12x 1 year forward EPS based on a 20% discount to HCLT target multiple of 15x. We believe the discount in
multiple is warranted given HCL Tech’s higher earnings growth and more diversified business.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Discretionary spend to be key growth driver in FY12
Indian IT services companies generate ~30% of revenues from discretionary spend. Discretionary spend
environment is improving sharply as visible from both Oracle and SAP, recording yoy growth in new license
sale greater than 25%. Management commentary of technology bellwethers suggests a more buoyant discretionary
spend environment in North America and emerging economies than Europe. We believe increased spend on
discretionary projects is critical because these have better pricing when compared to maintenance projects.
Coupled with secular offshore shift to manage costs, the bounce back in discretionary spend augurs well for Indian IT
services companies.We remain positive on the sector and expect returns to be driven by robust earnings growth.
HCL Technologies: All positive priced in
HCL Technologies (HCLT) has been able to catch-up and even outperform its larger peers in revenue growth by
acquiring Axon and also by investing in Remote Infrastructure Management (RIM). However, the story is not same
when it comes to other metrics such a margins, cash generation and return ratios. Though HCLT’s revenue growth has
been impressive and would continue to be inline with larger peers, led by its RIM practice, our concern is on HCLT’s
margin owing to: aggressive pricing especially in RIM, lower than peer fresher recruits, increased contribution
from RIM business and relatively low SG&A spend. We do not share consensus optimism in HCLT improving
operating margins by 100bps in FY12. We do not expect HCLT’s P/E to bridge the gap with Tier-1 owing to relatively
weak financial metrics. Initiate coverage on HCLT with Reduce/Underperform rating with a price target of Rs. 465.
Tech Mahindra – Mahindra Satyam: Marriage on the cards
Management of Tech Mahindra (TECHM) have indicated time and again that TECHM and Mahindra Satyam (MSAT)
would be merged. With some of the obstacles out, we too believe a merger is realistic possibility in the next 12-18
months. In this context, TECHM and MSAT should not be looked at in isolation by investors in our opinion. On a
combined basis, we expect the duo to have a sales of US$ 2.5bn of revenues in FY12E making it the fifth largest
India listed IT services company. Moreover, the business would exhibit a diversified revenue profile, a luxury TECHM
hitherto did not enjoy.
We expect both companies to lag industry revenue growth – TECHM owing to a weak demand environment in the
telecom vertical; MSAT due to their inability to participate in large deals in the past 24 months. On the margins front,
TECHM would have a muted expansion, on the contrary we expect MSAT to expand operating margins by ~650bps
over next 24 months. At current prices, the combined entity is trading at a P/E of 12.2x FY12E EPS and 9.0x FY13E,
attractive in our view. Given the attractive valuation we believe investors should buy into both TECHM and MSAT in a
manner that would result in them having the same stake in both the companies. We prefer this approach as a protection
against the as-yet-uncertain swap ratio that would be used for the merger. Our target multiple for the combined entity is
12x 1 year forward EPS based on a 20% discount to HCLT target multiple of 15x. We believe the discount in
multiple is warranted given HCL Tech’s higher earnings growth and more diversified business.
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