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Tech Mahindra and Mahindra Satyam hosted their annual analyst meet on
Friday, June 24, 2011. The essence of the meet was skewed towards how
management has improved margins for Satyam from 3% to 13% in two years and
how the companies, in a merged scenario, would synergise and are strongly
positioned to compete with tier-I Indian IT companies. Along with this, the
management and the heads of various SBUs such as telecom, BFSI,
manufacturing, enterprise business solution and BPO spoke about the trends and
opportunities they foresee.
Mahindra Satyam
In case of Mahindra Satyam, management sounded confident about growth and
indicated it to be in line with the industry (NASSCOM estimates for industry
growth in FY2012 are at 16–18% yoy). On the margin front as well, management
indicated that it will be in line with the industry’s range, i.e., 18–29% within one to
two years. The key margin levers for this are 1) strong volume growth,
2) employee pyramid resizing (current fresher ratio, i.e., 0–3 year experienced
employees, is at ~23%) and 3) better price realisation majorly by improving the
business mix. Management also indicated that it is open to inorganic growth and
is looking at potential companies in the BPO and BFSI space.
Service wise: The company has more than 35% of its revenue coming from
enterprise business solution (EBS). The company added 60 new logos in this
horizontal in FY2011, out of which 10 clients were those who left at the end of
FY2009. This horizontal had a run rate of ~US$750mn in FY2009, but due to the
heat from the scam that came out in January 2009, it declined to ~US$450mn in
FY2011. In fact, overall the highest attrition of clients was seen in the BFSI vertical,
as security issues are prominent in case of financial services entity. Management
also pointed that until six months back the company was not even invited for
many RFPs, but with increasing transparency and stability in its business it has
now started getting invitations for many RFPs. Though the TCVs are small,
typically US$10mn–20mn, management expects them to improve going forward.
Vertical wise: Mahindra Satyam currently generates ~18% of its revenue from the
BFSI vertical. The company is witnessing demand in this vertical from areas like
1) risk management (fraud, detection and security), 2) regulatory compliance
(Basel II, solvency II and IRFS) and 3) data analytics. The company has 70+ active
customers in its vertical, with the client portfolio comprising four of the top 10
retail brands and two of the top three in the cards.
Manufacturing is one of the major revenue generators for Mahindra Satyam,
contributing ~31% to its revenue. The company is seeing good demand coming
from subsectors like automotive, aerospace, defense and hi-tech. The company
expects engineering, product life cycle management and supply chain
management to be the top spend areas in manufacturing. The company has
130+ active customers in this vertical, of which 25 are in the list of Fortune 500
companies.
Tech Mahindra
In case of Tech Mahindra, the company is witnessing a pick-up in the deal pipeline
in the telecom vertical on the back of emerging opportunities for work related to
the external business of telecom service providers (TSPs), i.e., related to
end-consumers. This commentary was kind of contrary to tier-I IT companies
because of the fact that these companies are still focused on services related to the
internal usage of TSPs, which is kind of sluggish now; whereas, Tech Mahindra is
chasing the external part of TSPs, which is upbeat right now. Geographically, the
trend emerging is different in different regions. For instance, in case of North
America, the company is witnessing opportunities related to 1) fiber rollout,
2) upgrade plans and 3) Skype slashing rates. In western Europe, the company is
witnessing opportunities related to 1) superfast broadband, 2) radio spectrum sale,
3) 4G wireless technology and 4) telecom ventures and M&As, whereas in the
southern region, it is witnessing spend from 1) new operators setting up shops and
2) telecom partnership.
Merger on the cards but only in FY2013
On the merger of Tech Mahindra and Mahindra Satyam, management indicated
that it is in the process of translating its financial records in US GAAP and once it is
done it will initiate the process of the merger; the end-to-end merger can latest be
around May 2012 or may be later depending on approvals from SEC. On the
liability front, the company is behind most of the claims except for 1) Aberdeen
claim, which is US$69mn–70mn and 2) miscellaneous claims of `1,233cr, which
are irrational as per management.
Outlook and valuation
Going forward, we expect Mahindra Satyam to record better growth due to its
diversified business, which will, in turn, augur well for Tech Mahindra. In case of
Tech Mahindra, management is witnessing traces of demand revival from TSP
clients and foresees them to return back to spending only in 2HFY2012. We expect
the non-BT business of Tech Mahindra to grow at a CQGR of 3% and 5% in
FY2012 and FY2013, respectively, with BT expected to be flat at US$114mn
run-rate quarterly. Thus, we expect a 10.9% CAGR in revenue over FY2011–13E.
On the margin front, headwinds such as wage inflation and INR appreciation are
expected to pressurise EBITDA margins, so we expect EBITDA margins to settle at
19.2% and 18.3% for FY2012 and FY2013, respectively. However, PAT is expected
to be supported by the deep in-the-money hedges of £280mn and US$840mn
with participation rates at 1.7 USD/GBP and 49.0 INR/USD, boosting the forex
gains for the company.
We value Tech Mahindra on an SOTP basis, giving a standalone target multiple of
9.3x FY2013E PAT of `735cr (i.e., at a steep 55% discount to Infosys’ target due to
its undiversified business, resulting in underperformance) and further adding the
value of the company’s stake in Mahindra Satyam, with a holding discount of 25%
to the CMP. Thus, we recommend Accumulate rating on the stock with a target
price of `790.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Tech Mahindra and Mahindra Satyam hosted their annual analyst meet on
Friday, June 24, 2011. The essence of the meet was skewed towards how
management has improved margins for Satyam from 3% to 13% in two years and
how the companies, in a merged scenario, would synergise and are strongly
positioned to compete with tier-I Indian IT companies. Along with this, the
management and the heads of various SBUs such as telecom, BFSI,
manufacturing, enterprise business solution and BPO spoke about the trends and
opportunities they foresee.
Mahindra Satyam
In case of Mahindra Satyam, management sounded confident about growth and
indicated it to be in line with the industry (NASSCOM estimates for industry
growth in FY2012 are at 16–18% yoy). On the margin front as well, management
indicated that it will be in line with the industry’s range, i.e., 18–29% within one to
two years. The key margin levers for this are 1) strong volume growth,
2) employee pyramid resizing (current fresher ratio, i.e., 0–3 year experienced
employees, is at ~23%) and 3) better price realisation majorly by improving the
business mix. Management also indicated that it is open to inorganic growth and
is looking at potential companies in the BPO and BFSI space.
Service wise: The company has more than 35% of its revenue coming from
enterprise business solution (EBS). The company added 60 new logos in this
horizontal in FY2011, out of which 10 clients were those who left at the end of
FY2009. This horizontal had a run rate of ~US$750mn in FY2009, but due to the
heat from the scam that came out in January 2009, it declined to ~US$450mn in
FY2011. In fact, overall the highest attrition of clients was seen in the BFSI vertical,
as security issues are prominent in case of financial services entity. Management
also pointed that until six months back the company was not even invited for
many RFPs, but with increasing transparency and stability in its business it has
now started getting invitations for many RFPs. Though the TCVs are small,
typically US$10mn–20mn, management expects them to improve going forward.
Vertical wise: Mahindra Satyam currently generates ~18% of its revenue from the
BFSI vertical. The company is witnessing demand in this vertical from areas like
1) risk management (fraud, detection and security), 2) regulatory compliance
(Basel II, solvency II and IRFS) and 3) data analytics. The company has 70+ active
customers in its vertical, with the client portfolio comprising four of the top 10
retail brands and two of the top three in the cards.
Manufacturing is one of the major revenue generators for Mahindra Satyam,
contributing ~31% to its revenue. The company is seeing good demand coming
from subsectors like automotive, aerospace, defense and hi-tech. The company
expects engineering, product life cycle management and supply chain
management to be the top spend areas in manufacturing. The company has
130+ active customers in this vertical, of which 25 are in the list of Fortune 500
companies.
Tech Mahindra
In case of Tech Mahindra, the company is witnessing a pick-up in the deal pipeline
in the telecom vertical on the back of emerging opportunities for work related to
the external business of telecom service providers (TSPs), i.e., related to
end-consumers. This commentary was kind of contrary to tier-I IT companies
because of the fact that these companies are still focused on services related to the
internal usage of TSPs, which is kind of sluggish now; whereas, Tech Mahindra is
chasing the external part of TSPs, which is upbeat right now. Geographically, the
trend emerging is different in different regions. For instance, in case of North
America, the company is witnessing opportunities related to 1) fiber rollout,
2) upgrade plans and 3) Skype slashing rates. In western Europe, the company is
witnessing opportunities related to 1) superfast broadband, 2) radio spectrum sale,
3) 4G wireless technology and 4) telecom ventures and M&As, whereas in the
southern region, it is witnessing spend from 1) new operators setting up shops and
2) telecom partnership.
Merger on the cards but only in FY2013
On the merger of Tech Mahindra and Mahindra Satyam, management indicated
that it is in the process of translating its financial records in US GAAP and once it is
done it will initiate the process of the merger; the end-to-end merger can latest be
around May 2012 or may be later depending on approvals from SEC. On the
liability front, the company is behind most of the claims except for 1) Aberdeen
claim, which is US$69mn–70mn and 2) miscellaneous claims of `1,233cr, which
are irrational as per management.
Outlook and valuation
Going forward, we expect Mahindra Satyam to record better growth due to its
diversified business, which will, in turn, augur well for Tech Mahindra. In case of
Tech Mahindra, management is witnessing traces of demand revival from TSP
clients and foresees them to return back to spending only in 2HFY2012. We expect
the non-BT business of Tech Mahindra to grow at a CQGR of 3% and 5% in
FY2012 and FY2013, respectively, with BT expected to be flat at US$114mn
run-rate quarterly. Thus, we expect a 10.9% CAGR in revenue over FY2011–13E.
On the margin front, headwinds such as wage inflation and INR appreciation are
expected to pressurise EBITDA margins, so we expect EBITDA margins to settle at
19.2% and 18.3% for FY2012 and FY2013, respectively. However, PAT is expected
to be supported by the deep in-the-money hedges of £280mn and US$840mn
with participation rates at 1.7 USD/GBP and 49.0 INR/USD, boosting the forex
gains for the company.
We value Tech Mahindra on an SOTP basis, giving a standalone target multiple of
9.3x FY2013E PAT of `735cr (i.e., at a steep 55% discount to Infosys’ target due to
its undiversified business, resulting in underperformance) and further adding the
value of the company’s stake in Mahindra Satyam, with a holding discount of 25%
to the CMP. Thus, we recommend Accumulate rating on the stock with a target
price of `790.
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