IT - TechM, Mahindra Satyam merger gets going; sector update :: Edelweiss PDF link

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The board of directors of Tech Mahindra (TechM) and Mahindra Satyam (MSAT) today approved the merger proposal of the two companies and also the swap ratio of 2:17, i.e., two TechM shares for every 17 shares held in MSAT. The merger will create the sixth largest Indian IT services player with combined revenue of USD2.4bn, employee strength of 75,000 and 350 plus active client base. We expect the combined entity to become a formidable competition in the scale player league with complementary skill sets and a well balanced revenue mix. Despite the valuation (P/E) of the combined entity at 9.9x FY13E, we believe it will have to demonstrate stronger growth for upward re-rating.

Well balanced revenue mix; creation of treasury stock

The merger reduces client concentration—British Telecom (BT) now 18% from 35% earlier and telecom contribution reduced from 96% to 47%. Further, the geographic mix now is broad based with Americas at 42%, Europe at 35% and Emerging Markets at 23%. With the requisite size and scale, the combined entity will benefit from economies of scale and sourcing advantages. Upon integration, we also believe cross selling of enterprise solutions (MSAT strength) and mobility/SI (TechM strength) will gain momentum as operational hurdles dwindle. 

Creation of treasury stock: On a pro-forma basis, the Mahindra Group will own 26.3% in the combined entity, British Telecom 12.8%, 10.4% will be held as treasury stock, 34.4% will be held by public shareholders of MSAT and the balance 16.1% will be held by public shareholders of TechM.

Outlook and valuations: Growth acceleration to be gradual

TechM is trading at a P/E of 9.8x and MSAT at 9.8x FY13E consensus earnings. Based on the swap ratio, MSAT’s valuation stands at USD1.7bn and TechM’s at USD1.6bn. While the former’s business is much stronger than the latter’s due to diversified services and vertical mix, contingent liabilities have driven down part of the valuation. Going forward, we believe current valuation of the combined entity of P/E at 9.9x (in line with mid-tier peers) could see positive re-rating only when the company is able to demonstrate stronger revenue growth going forward. This, we believe, will take at least two-three quarters before any synergy benefits flow in.

IT - TechM, Mahindra Satyam merger gets going; sector update