MphasiS --HP continues to haunt, outlook hazy: Sunidhi

MphasiS’ US$ revenues have been declining for the last four quarters – primarily due to weak HP contribution. Management indicated discretionary budgets for clients remain under pressure, with longer decision cycles. We believe weak sentiment due to a declining headcount (4 quarters in Applications and ITO business) and a weak outlook on HP’s enterprise services business is likely to persist for some time. HP channel revenues declined 10.1% QoQ to US$138.6 mn, while direct channel revenues grew at 1.6% to US$113.4 mn.

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Quarter details. MphasiS reported a ~5.2% QoQ decline in USD revenues to US$252 mn. Reported EBITDA margin of 19.8% was up 10 bps QoQ on account of Rupee depreciation, mostly being offset by wage hikes and promotions during the quarter. Net headcount increase of 458, was on account of an increase of 1,409 employees in the BPO space. Applications and ITO space has seen a continuous decline since last 4 quarters. The total employee base stood at 37,637 – a number almost equivalent to 3QFY10, coming on the back of 4,560 combined reductions in Q3FY11-Q2FY12, does not paint a pretty picture in terms of demand. Management indicated that HP enterprise service revenues will remain weak, while it expects HP non-enterprise service revenues to grow. HP non-ES contribution to share of HP revenues increased to 8.9% in Q3 from 7.5% in Q2. HP (overall) business was down 6.2% QoQ in constant currency terms.
Other key points. HP’s contribution to revenue was lower by 300 bps QoQ at 55% this quarter. MphasiS added 24 clients this quarter (of which 20 are from the Direct channel). Net Cash & equivalents stand at `123/share (~33% of the MCap is in form of cash). DSO’s increased 5 days QoQ to 85 days this quarter. MphasiS has given wage hikes of ~8% and 3% for offshore/onsite employees respectively, which impacted margins by ~200bps QoQ in the quarter. Management expects to maintain margin QoQ, through multiple cost levers.
Valuation: Apart from Buyback, delisting and cash/share, Mphasis does not compare well versus some of the other mid-cap IT companies. Valuations, though being cheap compared to some of the performing mid-caps, the revenue growth story is weak, while risks to its margins are higher. MphasiS trades at single digit P/E multiples. We have modeled in 4.6% US$ revenue growth for FY13E and 3.4% YoY growth in EPS.