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MPHASIS BFL LTD
PRICE: RS.475 RECOMMENDATION: REDUCE
TARGET PRICE: RS.458 FY11E P/E: 12.4X
Await better price points to become positive
q Mphasis' 2QFY11 results were below expectations. Volumes grew by
2.6% only despite the low base of the previous quarter. In 1QFY11, the
company had faced lower billing days due to shut downs at HP and customer
sites, impacting revenues by 3.5% QoQ. Margins also came in
lower than estimates - impacted largely by currency and one off expenditure.
The company once again wrote back past provisions of about
Rs.540mn over and above the Rs.435mn written back in 1Q. To that extent,
reported PAT was higher than the actual number. According to the
management, these write backs have been happening but the company
has started reporting these recently. We find this surprising.
q Billing rates were steady during the quarter. The re-negotiations with HP
on the rate card should conclude by the end of 2Q and is an overhang.
While revenues from HP / HP channels fell marginally, the positive came
in the form of a 10.7% revenue growth in USD terms from non-HP channel.
Mphasis won a record 17 clients through independent channel. The
investments should yield further results in the quarters ahead.
q Thus, despite an encouraging macro scenario and expected growth in the
future quarters, we are cutting our FY11E EPS projections to Rs.38.4
(Rs.44.8) and price target to Rs.458 (Rs.509). Our DCF based price targets
leads us to a target FY11E PE of Rs.11.9x. We expect the stock to underperform
because of the lack of any triggers. We downgrade the stock to
REDUCE (ACCUMULATE) and will wait for better price points to turn positive
on the stock based on CY12 earnings. A potential buy-back offer /
de-listing from HP can provide upsides to the stock.
q A delayed recovery in user economies and a sharper-than-expected rupee
appreciation are key risks to our estimates.
Revenues - volume growth of 2.6% below expectations
n Revenues grew by about 1.9% QoQ. More importantly, volumes grew by 2.6%
only. This is despite the lower base of the previous quarter. In 1QFY11, the company
had faced lower billing days due to shut downs at HP and customer sites,
impacting revenues by 3.5% QoQ.
n Thus, we were expecting a much higher growth on this depleted base.
n While volumes grew by 2.6% and pricing / mix added another 1.8%, currency
fluctuations impacted the growth rate negatively by 2.5%.
n Revenues grew on the back of scale up in focus verticals like Banking / Capital
Markets and Insurance. These verticals reported a 7% QoQ growth. Mphasis has
been strongly focusing on these verticals.
n Mphasis has also been focusing hard on the emerging markets including India.
During the quarter, revenues from these markets grew by 8% QoQ. However,
EMEA reported a 4% de-growth in rupee revenues.
n In terms of clientele, HP and HP-led revenues witnessed a marginal de-growth
on a sequential basis. Within this, revenues from Enterprise Solutions business
reported a 0.8% de-growth. On the other hand, the remaining HP business witnessed
a 13.2% QoQ rise, according to the company.
n The Enterprise Solutions business has been witnessing stagnation / de-growth
and because of this, Mphasis has been trying to penetrate the other businesses
of HP namely professional Services and Technology services.
n During 2Q, Mphasis won a large deal along with the Professional Services division
of HP.
n On the other hand, business from independent channels grew by 8.6% in INR
terms and 10% in USD terms, which is encouraging.
n Mphasis has been focusing on the non-HP business over the past few quarters
and has indicated additional spends to garner more business from non-HP channels.
n In revenue terms, revenues from independent channels formed 33% of 2Q revenues
as against 31% in 1Q.
Billing rates stable
n Average realizations for the quarter were marginally higher. However, billing
rates on a like-to-like basis remained stable.
n The company was able to get new accounts at higher-than-average rates which
helped average realizations on a QoQ basis, apart from the mix change.
n But, the semi-annual re-negotiations with HP are currently on and are expected
to be concluded by the quarter end. If these result in another round of billing rate
cuts, it could be negative for Mphasis.
n On the other hand, Mphasis is also re-negotiating some parts of the rate card
with HP for possible upward revisions. We will carefully watch this data.
n Within the HP revenues, migration, internal work and go-to-market (third party)
business form approximately 30%, 15% and 55% of the company's total revenues,
respectively.
n Mphasis bills HP on either rate card basis (migration and internal work) and goto-
market basis (40% of revenues)
n During the fiscal, the rate card business, which was on a cost-plus basis, was
moved on to fixed rates, which will be reviewed periodically. Thus, the fixed
margin business will now see volatility in margins depending on the efficiencies
of the company and the external environment.
n On the other hand, in the go-to-market business, Mphasis is passed on the revenues
by HP, after charging a commission for the business transferred, we understand.
n We understand that, from 3QFY10, the amount received by Mphasis was relatively
lower. The remuneration to Mphasis also obviously changes depending on
the contract between HP and the client.
EBIDTA margins lower
n Headline numbers indicate that, EBIDTA margins fell QoQ by about 170bps. This
was largely due to the currency impact, which impacted revenue growth also to
the extent of 250bps.
n However, the quarter contained several one-time items. The company provided
for one-time expenditure towards large projects (Rs.30mn), customer claim
(Rs.80mn) and fixed priced project (Rs.156mn) totaling to Rs.266mn.
n On the other hand, the company wrote back provision of Rs.540mn during the
quarter. This was in addition to the write back of about Rs.435mn of provisions in
the previous quarter.
n In 1Q, the company had disclosed that, 4QFY10 also included a provision reversal
of about Rs.230mn in direct expenses.
n However, there was no indication that, there could be reversals of such large
provisions during 2Q. The management has indicated that, there have been such
reversals earlier also but the company has started reporting the same recently.
We believe that, if the reversals were large enough, they should have been disclosed
earlier also.
n Thus, the actual margins after negating the impact of these one-offs are at 17%
in 2QFY11 v/s 17.4% in 1QFY11.
n We have consequently reduced our margin assumptions for FY11E.
30 new clients added; focus on independent channel
n During the quarter, the company signed up 30 new accounts of which, a record
17 additions came from the independent efforts of Mphasis and 13 from HP.
n Thus, while HP continues to help Mphasis get into new accounts, Mphasis is now
increasingly focusing on reducing its dependence on HP for new business.
n At the same time, it sees bigger opportunities with HP but beyond the Enterprise
Solutions business, from which it is currently earning more than 95% of its HP
revenues.
n The company sees opportunities in the technology Services and Professional Services
businesses of HP.
n In a joint effort with Professional Services division of HP, Mphasis has a large
order in 2Q.
n Mphasis is focusing on the direct marketing channel for non-HP accounts and
plans to add to its sales force for the same.
n This may impact margins in the near term. However, we believe it will result in
reduced dependence on HP in the long term, which could be positive for the
company.
Future prospects
n We have made changes to our FY11 estimates.
n In FY11, we expect revenues to grow by about 7%. We have assumed the rupee
to average 45 to a USD in FY11.
n Margins are expected to be lower. While the billing rate cuts, expected rupee
appreciation, higher S&M spend and higher employee costs are expected to impact
the profitability, better resources utilization and higher value-added work
are expected to restrict the impact.
n With a higher tax rate of about 18.5% v/s 10% in FY10, earnings are expected
to fall by about 26% v/s FY10, leading to an EPS of Rs.38.4 for FY11.
Concerns
n A delayed recovery in major user economies may impact our projections.
n A sharp acceleration in rupee from the current levels may impact our earnings
estimates for the company.
n While strong parentage is a positive, uncertainty over future allocation of business
remains a concern for the market.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
MPHASIS BFL LTD
PRICE: RS.475 RECOMMENDATION: REDUCE
TARGET PRICE: RS.458 FY11E P/E: 12.4X
Await better price points to become positive
q Mphasis' 2QFY11 results were below expectations. Volumes grew by
2.6% only despite the low base of the previous quarter. In 1QFY11, the
company had faced lower billing days due to shut downs at HP and customer
sites, impacting revenues by 3.5% QoQ. Margins also came in
lower than estimates - impacted largely by currency and one off expenditure.
The company once again wrote back past provisions of about
Rs.540mn over and above the Rs.435mn written back in 1Q. To that extent,
reported PAT was higher than the actual number. According to the
management, these write backs have been happening but the company
has started reporting these recently. We find this surprising.
q Billing rates were steady during the quarter. The re-negotiations with HP
on the rate card should conclude by the end of 2Q and is an overhang.
While revenues from HP / HP channels fell marginally, the positive came
in the form of a 10.7% revenue growth in USD terms from non-HP channel.
Mphasis won a record 17 clients through independent channel. The
investments should yield further results in the quarters ahead.
q Thus, despite an encouraging macro scenario and expected growth in the
future quarters, we are cutting our FY11E EPS projections to Rs.38.4
(Rs.44.8) and price target to Rs.458 (Rs.509). Our DCF based price targets
leads us to a target FY11E PE of Rs.11.9x. We expect the stock to underperform
because of the lack of any triggers. We downgrade the stock to
REDUCE (ACCUMULATE) and will wait for better price points to turn positive
on the stock based on CY12 earnings. A potential buy-back offer /
de-listing from HP can provide upsides to the stock.
q A delayed recovery in user economies and a sharper-than-expected rupee
appreciation are key risks to our estimates.
Revenues - volume growth of 2.6% below expectations
n Revenues grew by about 1.9% QoQ. More importantly, volumes grew by 2.6%
only. This is despite the lower base of the previous quarter. In 1QFY11, the company
had faced lower billing days due to shut downs at HP and customer sites,
impacting revenues by 3.5% QoQ.
n Thus, we were expecting a much higher growth on this depleted base.
n While volumes grew by 2.6% and pricing / mix added another 1.8%, currency
fluctuations impacted the growth rate negatively by 2.5%.
n Revenues grew on the back of scale up in focus verticals like Banking / Capital
Markets and Insurance. These verticals reported a 7% QoQ growth. Mphasis has
been strongly focusing on these verticals.
n Mphasis has also been focusing hard on the emerging markets including India.
During the quarter, revenues from these markets grew by 8% QoQ. However,
EMEA reported a 4% de-growth in rupee revenues.
n In terms of clientele, HP and HP-led revenues witnessed a marginal de-growth
on a sequential basis. Within this, revenues from Enterprise Solutions business
reported a 0.8% de-growth. On the other hand, the remaining HP business witnessed
a 13.2% QoQ rise, according to the company.
n The Enterprise Solutions business has been witnessing stagnation / de-growth
and because of this, Mphasis has been trying to penetrate the other businesses
of HP namely professional Services and Technology services.
n During 2Q, Mphasis won a large deal along with the Professional Services division
of HP.
n On the other hand, business from independent channels grew by 8.6% in INR
terms and 10% in USD terms, which is encouraging.
n Mphasis has been focusing on the non-HP business over the past few quarters
and has indicated additional spends to garner more business from non-HP channels.
n In revenue terms, revenues from independent channels formed 33% of 2Q revenues
as against 31% in 1Q.
Billing rates stable
n Average realizations for the quarter were marginally higher. However, billing
rates on a like-to-like basis remained stable.
n The company was able to get new accounts at higher-than-average rates which
helped average realizations on a QoQ basis, apart from the mix change.
n But, the semi-annual re-negotiations with HP are currently on and are expected
to be concluded by the quarter end. If these result in another round of billing rate
cuts, it could be negative for Mphasis.
n On the other hand, Mphasis is also re-negotiating some parts of the rate card
with HP for possible upward revisions. We will carefully watch this data.
n Within the HP revenues, migration, internal work and go-to-market (third party)
business form approximately 30%, 15% and 55% of the company's total revenues,
respectively.
n Mphasis bills HP on either rate card basis (migration and internal work) and goto-
market basis (40% of revenues)
n During the fiscal, the rate card business, which was on a cost-plus basis, was
moved on to fixed rates, which will be reviewed periodically. Thus, the fixed
margin business will now see volatility in margins depending on the efficiencies
of the company and the external environment.
n On the other hand, in the go-to-market business, Mphasis is passed on the revenues
by HP, after charging a commission for the business transferred, we understand.
n We understand that, from 3QFY10, the amount received by Mphasis was relatively
lower. The remuneration to Mphasis also obviously changes depending on
the contract between HP and the client.
EBIDTA margins lower
n Headline numbers indicate that, EBIDTA margins fell QoQ by about 170bps. This
was largely due to the currency impact, which impacted revenue growth also to
the extent of 250bps.
n However, the quarter contained several one-time items. The company provided
for one-time expenditure towards large projects (Rs.30mn), customer claim
(Rs.80mn) and fixed priced project (Rs.156mn) totaling to Rs.266mn.
n On the other hand, the company wrote back provision of Rs.540mn during the
quarter. This was in addition to the write back of about Rs.435mn of provisions in
the previous quarter.
n In 1Q, the company had disclosed that, 4QFY10 also included a provision reversal
of about Rs.230mn in direct expenses.
n However, there was no indication that, there could be reversals of such large
provisions during 2Q. The management has indicated that, there have been such
reversals earlier also but the company has started reporting the same recently.
We believe that, if the reversals were large enough, they should have been disclosed
earlier also.
n Thus, the actual margins after negating the impact of these one-offs are at 17%
in 2QFY11 v/s 17.4% in 1QFY11.
n We have consequently reduced our margin assumptions for FY11E.
30 new clients added; focus on independent channel
n During the quarter, the company signed up 30 new accounts of which, a record
17 additions came from the independent efforts of Mphasis and 13 from HP.
n Thus, while HP continues to help Mphasis get into new accounts, Mphasis is now
increasingly focusing on reducing its dependence on HP for new business.
n At the same time, it sees bigger opportunities with HP but beyond the Enterprise
Solutions business, from which it is currently earning more than 95% of its HP
revenues.
n The company sees opportunities in the technology Services and Professional Services
businesses of HP.
n In a joint effort with Professional Services division of HP, Mphasis has a large
order in 2Q.
n Mphasis is focusing on the direct marketing channel for non-HP accounts and
plans to add to its sales force for the same.
n This may impact margins in the near term. However, we believe it will result in
reduced dependence on HP in the long term, which could be positive for the
company.
Future prospects
n We have made changes to our FY11 estimates.
n In FY11, we expect revenues to grow by about 7%. We have assumed the rupee
to average 45 to a USD in FY11.
n Margins are expected to be lower. While the billing rate cuts, expected rupee
appreciation, higher S&M spend and higher employee costs are expected to impact
the profitability, better resources utilization and higher value-added work
are expected to restrict the impact.
n With a higher tax rate of about 18.5% v/s 10% in FY10, earnings are expected
to fall by about 26% v/s FY10, leading to an EPS of Rs.38.4 for FY11.
Concerns
n A delayed recovery in major user economies may impact our projections.
n A sharp acceleration in rupee from the current levels may impact our earnings
estimates for the company.
n While strong parentage is a positive, uncertainty over future allocation of business
remains a concern for the market.
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