Tech Mahindra ACCUMULATE. Performance Highlights. CMP Target Price `659 `693. 3QFY2012 Result Update IT. Key financials (Consolidated, Indian GAAP)

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1 3QFY2012 Result Update IT February 9, 2012 Tech Mahindra Performance Highlights (` cr) 3QFY12 2QFY12 % chg (qoq) 3QFY11 % chg (yoy) Net revenue 1,445 1, , EBITDA (6.2) EBITDA margin (%) bp 20.6 (441)bp Adj. PAT* (5.0) ; Note:*exclude one-offs For 3QFY2012, Tech Mahindra reported subdued performance with revenue as well as profit coming in below ours as well as street s expectations. BT business was a major growth dampener, USD revenue of which declined by 7.8% qoq. Growth came from non-bt business yet again, which grew by 0.6% qoq. BT has started retendering its work; this poses risk to Tech Mahindra s revenue run rate. However, due to the company s stake in Mahindra Satyam, we maintain our Accumulate rating on the stock. ACCUMULATE CMP Target Price Investment Period Stock Info Sector Market Cap (` cr) Beta 52 Week High / Low Avg. Daily Volume Face Value (`) BSE Sensex Nifty Reuters Code Bloomberg Code `659 ` months IT 8, /524 41, ,831 5,412 TEML.BO TECHM.IN Result highlights: For 3QFY2012, Tech Mahindra reported USD revenue of US$288.7mn, down 2.5% qoq due to a 0.5% qoq decline in volume and ~2.0% qoq negative cross-currency impact. In INR terms, revenue came in at `1,445cr, up 8.4% qoq, largely aided by qoq INR depreciation. EBITDA margin of the company improved by 90bp qoq to 16.2% on the back of INR depreciation. Outlook and valuation: We expect the non-bt business to post a CQGR of 2.4% over 3QFY2012-4QFY2013, with BT s quarterly revenue expected to be flat from here. However, there is a caveat that BT s revenue may see a downside if the company loses out its market share in the retendering process initiated by BT. In fact, even if the company manages to hold the share or increase it, it can be margin dilutive as the client has initiated this retendering process as part of its cost-cutting drive with lower pricing expectation. Thus, we expect a 7.6% CAGR in USD revenue over FY E. The company s core EPS is expected to post a negative CAGR over FY E. The only potential upside is due to the company s stake in Mahindra Satyam, which is improving its overall profitability. We continue to value the company at 55% discount to Infosys target PE i.e., at 8x the company s consolidated EPS of `86.4 and maintain our Accumulate rating on the stock with a target price of `693. Key financials (Consolidated, Indian GAAP) Y/E March (` cr) FY2009 FY2010 FY2011 FY2012E FY2013E Net sales 4,465 4,625 5,140 5,520 6,153 % chg Reported net profit 1, ,061 1,140 % chg (30.9) (8.3) EBITDA margin (%) EPS (`) P/E (x) P/BV (x) RoE (%) RoCE (%) EV/Sales (x) EV/EBITDA (x) Shareholding Pattern (%) Promoters 70.9 MF / Banks / Indian Fls 15.2 FII / NRIs / OCBs 4.9 Indian Public / Others 9.0 Abs. (%) 3m 1yr 3yr Sensex (3.4) (4.6) 75.0 Tech Mahindra Ankita Somani Ext: 6819 ankita.somani@angelbroking.com Please refer to important disclosures at the end of this report 1

2 Exhibit 1: 3QFY2012 performance (Consolidated, Indian GAAP) (` cr) 3QFY12 2QFY12 % chg (qoq) 3QFY11 % chg (yoy) 9MFY12 9MFY11 % chg (yoy) Net revenue 1,445 1, , ,071 3, Cost of revenue ,747 2, Gross profit ,323 1, SG&A expense EBITDA (6.2) (7.0) Dep. and amortisation (23.1) EBIT (9.2) (11.0) Interest Other income PBT (1.4) 242 (27.2) (17.0) Income taxes (25.2) 36 (18.1) PAT (28.7) (22.3) Minority interest PAT after minority interest (29.7) (22.7) Profit from associates Exceptional item (143) Final PAT Adj. PAT (5.0) Diluted EPS (5.1) Gross margin (%) (23)bp 34.9 (316)bp (272)bp EBITDA margin (%) bp 20.6 (441)bp (371)bp EBIT margin (%) bp 17.8 (424)bp (381)bp PAT margin (%) (42)bp 17.0 (697)bp (484)bp Exhibit 2: 3QFY2012 Actual vs. Angel estimates (` cr) Actual Estimate Var. (%) Net revenue (4.4) EBITDA margin (%) (119)bp PAT* (21.5) ; Note: *Excludes share of profits from Mahindra Satyam Muted revenue growth For 3QFY2012, Tech Mahindra reported USD revenue of US$288.7mn, down 2.5% qoq due to a 0.5% qoq decline in volume and ~2.0% qoq negative cross-currency impact. This was because of a 7.8% qoq decline in USD revenue from BT account to US$101mn ( 64mn). USD revenue from non-bt business grew merely by 0.6% qoq to US$188mn. In INR terms, revenue came in at `1,445cr, up 8.4% qoq, largely aided by qoq INR depreciation. Going ahead, the company expects business from non-bt accounts to be its key growth driver. February 9,

3 Exhibit 3: Trend in revenue growth for non-bt accounts (US $mn) (%) QFY11 4QFY11 1QFY12 2QFY12 3QFY Non BT qoq growth Management indicated that BT business may continue to decline in the next few quarters, as BT is retendering its contracts. This may lead to Tech Mahindra losing its share in BT contracts, as clearly the client is looking out for a lower pricing opportunity as part of its cost-cutting drive. So, even if the company manages to hold or gain its share, it is expected to be operating margin dilutive. Exhibit 4: Revenue trend for BT account (US $mn) (3.5) (2) (%) (4) 105 (5.5) (6) QFY11 4QFY11 1QFY12 2QFY12 3QFY12 (7.8) (8) (10) BT qoq growth The company s revenue from telecom service providers (TSPs) (~78.6% to revenue) and telecom equipment manufacturers (TEMs) (~7.3% to revenue) grew by 4.5% and 31.5% qoq to `1,135cr and `106cr, respectively. The company s top 2-5 clients drove its growth in 3QFY2012, by registering whopping 0.6% qoq USD revenue growth. Revenue from the company s top 6-10 clients declined by 2.5% qoq during the quarter. February 9,

4 Exhibit 5: Trend in revenue growth of top clients (qoq) (%) (5) (10) (3.5) (2.5) (5.5) (7.8) 3QFY11 4QFY11 1QFY12 2QFY12 3QFY12 BT Next 4 accounts Next 5 accounts Utilization level improves During the quarter, the company s utilization level increased by 100bp qoq to 73% from 72% in 2QFY2012 as the hiring done by the company from 4QFY2011 to 2QFY2012 turned billable in 3QFY2012. The company s net technical employee base again showed reduction by 1,447 employees to 25,218. Again in this quarter, maximum addition was done in the BPO employee base of 544, taking its total employee base to 16,419. Exhibit 6: Trend in utilization rate Net addition no. 3,200 2,400 1, (800) (1,600) (2,400) 2,522 2, ,071 1,609 1, QFY11 4QFY11 1QFY12 2QFY12 3QFY12 (1,255) (1,447) S/w professionals BPO professionals Utilisation (%) (%) Margin improves In 3QFY2012, Tech Mahindra s EBITDA and EBIT margin increased by 90bp and 201bp qoq 16.2% and 13.5%, respectively, because of depreciating INR, which absorbed the negative impact of onsite wage hike given. February 9,

5 Exhibit 7: Margin trend (%) QFY11 4QFY11 1QFY12 2QFY12 3QFY12 Gross profit margin EBITDA margin EBIT margin Client pyramid Tech Mahindra s client pyramid witnessed slight improvement with one of its clients being added to the US$20mn-25mn bracket from lower revenue bracket. Also, US$1mn-2mn revenue bracket witnessed addition of three new clients. The active client base of the company increased to 130 in 3QFY2012 from 128 in 2QFY2012. Exhibit 8: Client metrics Particulars 3QFY11 4QFY11 1QFY12 2QFY12 3QFY12 US$1mn 2mn US$2mn 5mn US$5mn 10mn US$10mn 15mn US$15mn 20mn US$20mn 25mn US$25mn 50mn US$50mn Active clients Outlook and valuation Management is witnessing traces of demand revival from TSPs and foresees them to return to spending on 4G technology and cloud only in FY2012. We expect the non-bt business to post a CQGR of 2.4% over 3QFY2012-4QFY2013, with BT s quarterly revenue expected to be flat from here. However, there is a caveat that BT s revenue may see a downside if the company loses out its market share in the retendering process initiated by BT. In fact, even if the company manages to hold the share or increase it, it can be margin dilutive as the client has initiated this retendering process as part of its cost-cutting drive with lower pricing expectation. Thus, we expect a 7.6% CAGR in USD revenue over FY E. February 9,

6 PAT is expected to be supported by 1) the deep in-the-money hedges of 305mn and US$540mn with participation rates at 83 INR/GBP and 50 INR/USD, boosting forex gains for the company; and 2) declining interest expense due to quick repayments possible from Mahindra Satyam s strong earnings. Thus, the company s core EPS is expected to have a negative CAGR over FY E. The only potential upside is due to the company s stake in Mahindra Satyam, which is improving its overall profitability. Since, the company s core earnings are subdued and the huge contribution (~33%) to its consolidated earnings is due to Mahindra Satyam s profitability, we continue to value the company at 55% discount to Infosys target PE i.e., at 8x the company s consolidated EPS of `86.4 and maintain our Accumulate rating on the stock with a target price of `693. Exhibit 9: Key assumptions FY2012E FY2013E Revenue growth (US$) USD-INR rate (realized) Revenue growth (`) EBITDA margin (%) Tax rate (%) EPS growth (%) Exhibit 10: One-year forward PE (x) 2,200 1,900 1,600 1,300 (`) 1, Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Price Note: P/E includes share of profits from Mahindra Satyam 2QFY2011 onwards. February 9,

7 Exhibit 11: Recommendation summary Company Reco CMP Tgt Price Upside Target FY2013 FY2013E FY E FY2013E FY2013E (`) (`) (%) P/E (x) EBITDA (%) P/E (x) EPS CAGR (%) RoCE (%) RoE (%) HCL Tech Accumulate Hexaware Neutral Infosys Accumulate 2,807 3, Infotech Enterprises Neutral KPIT Cummins Neutral Mahindra Satyam Buy MindTree Accumulate Mphasis Neutral (3.1) NIIT^ Buy Persistent Neutral TCS Neutral 1, Tech Mahindra* Accumulate Wipro Neutral Note: ^Valued on SOTP basis,* EPS CAGR includes earnings from Mahindra Satyam February 9,

8 Profit and loss statement (Consolidated, Indian GAAP) Y/E March (` cr) FY2009 FY2010 FY2011 FY2012E FY2013E Net sales 4,465 4,625 5,140 5,520 6,153 Cost of revenues 2,638 2,871 3,403 3,702 4,094 Gross profit 1,827 1,754 1,737 1,818 2,059 % of net sales SG&A expenses ,009 % of net sales EBITDA 1,215 1,133 1, ,050 % of net sales Depreciation and amortization % of net sales EBIT 1, % of net sales Interest expense Other income, net of forex gain/(loss) (38) Profit before tax 1, Provision for tax % of PBT Recurring PAT Share from associates Exceptional item 67 (9) (143) - - Minority interest Profit after minority interest 1, ,061 1,140 Reported PAT ,061 1,140 Fully diluted EPS (`) February 9,

9 Balance sheet (Consolidated, Indian GAAP) Y/E March (` cr) FY2009 FY2010 FY2011 FY2012E FY2013E Equity capital Preference capital Share premium Profit and loss 1,401 1,783 2,365 3,351 4,411 Other reserves Net worth 1,943 2,887 3,351 4,338 5,397 Secured loans Unsecured loans - 1,385 1, Total debt - 2,135 1, Deferred revenue Minority interest Total capital employed 1,954 5,035 5,174 5,260 5,823 Gross block 908 1,131 1,273 1,433 1,588 Accumulated depreciation (410) (527) (670) (836) (1,011) Net block Capital WIP Total fixed assets Investments 435 3,015 2,908 2,872 2,870 Deferred tax asset, net Inventories Sundry debtors 902 1,042 1,247 1,225 1,357 Cash and cash equivalents Loans and advances ,015 Sundry creditors (469) (461) (510) (528) (573) Other liabilities (205) (129) (53) (65) (15) Provision (215) (277) (308) (331) (338) Working capital 848 1,068 1,474 1,579 2,141 Total capital deployed 1,954 5,035 5,174 5,260 5,823 February 9,

10 Cash flow statement (Consolidated, Indian GAAP) Y/E March (` cr) FY2009 FY2010 FY2011 FY2012E FY2013E Pre tax profit from operations 1, Depreciation Expenses (deferred)/written off/others - (9) (98) Pre tax cash from operations 1, ,241 1,418 Other income/prior period ad (38) Net cash from operations 1, ,400 1,530 Tax (118) (144) (132) (172) (214) Cash profits 1, ,228 1,315 (Inc)/dec in Sundry Debtors 194 (140) (205) 22 (132) Inventories Loans and advances 65 (377) (160) (51) (132) Sundry creditors (43) (8) Others 5 (14) (45) 35 (39) Net trade working capital 222 (539) (358) 24 (258) Cashflow from operating activities 1, ,252 1,057 (Inc)/dec in fixed assets (162) (407) 54 (175) (176) (Inc)/dec in investments (371) (2,580) (Inc)/dec in deferred tax asset, net (14) (8) (36) (11) (3) Cashflow from investing activities (547) (2,995) 125 (149) (177) Inc/(dec) in debt (30) 2,135 (912) (316) (500) Inc/(dec) in deferred revenue 584 (584) - Inc/(dec) in equity/premium 3 5 (0) - - Inc/(dec) in minority interest Addition to reserves on amalgamation (274) 288 (117) - - Dividends (57) (50) (61) (74) (80) Cashflow from financing activities (358) 2,381 (504) (974) (580) Cash generated/(utilized) 441 (320) Cash at start of the year Cash at end of the year February 9,

11 Key Ratios (Consolidated, Indian GAAP) Y/E March FY2009 FY2010 FY2011 FY2012E FY2013E Valuation ratio(x) P/E (on FDEPS) P/CEPS P/BVPS Dividend yield (%) EV/Sales EV/EBITDA EV/Total assets Per share data(`) EPS (Fully diluted) Cash EPS Dividend Book value Dupont analysis Tax retention ratio (PAT/PBT) Cost of debt (PBT/EBIT) EBIT margin (EBIT/Sales) Asset turnover ratio (Sales/Assets) Leverage ratio (Assets/Equity) Operating ROE (%) Return ratios (%) RoCE (pre-tax) Angel RoIC RoE Turnover ratios(x) Asset turnover (fixed assets) Receivables days Payable days February 9,

12 Research Team Tel: Website: DISCLAIMER This document is solely for the personal information of the recipient, and must not be singularly used as the basis of any investment decision. Nothing in this document should be construed as investment or financial advice. Each recipient of this document should make such investigations as they deem necessary to arrive at an independent evaluation of an investment in the securities of the companies referred to in this document (including the merits and risks involved), and should consult their own advisors to determine the merits and risks of such an investment. Angel Broking Limited, its affiliates, directors, its proprietary trading and investment businesses may, from time to time, make investment decisions that are inconsistent with or contradictory to the recommendations expressed herein. The views contained in this document are those of the analyst, and the company may or may not subscribe to all the views expressed within. Reports based on technical and derivative analysis center on studying charts of a stock's price movement, outstanding positions and trading volume, as opposed to focusing on a company's fundamentals and, as such, may not match with a report on a company's fundamentals. The information in this document has been printed on the basis of publicly available information, internal data and other reliable sources believed to be true, but we do not represent that it is accurate or complete and it should not be relied on as such, as this document is for general guidance only. Angel Broking Limited or any of its affiliates/ group companies shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. Angel Broking Limited has not independently verified all the information contained within this document. Accordingly, we cannot testify, nor make any representation or warranty, express or implied, to the accuracy, contents or data contained within this document. While Angel Broking Limited endeavours to update on a reasonable basis the information discussed in this material, there may be regulatory, compliance, or other reasons that prevent us from doing so. This document is being supplied to you solely for your information, and its contents, information or data may not be reproduced, redistributed or passed on, directly or indirectly. Angel Broking Limited and its affiliates may seek to provide or have engaged in providing corporate finance, investment banking or other advisory services in a merger or specific transaction to the companies referred to in this report, as on the date of this report or in the past. Neither Angel Broking Limited, nor its directors, employees or affiliates shall be liable for any loss or damage that may arise from or in connection with the use of this information. Note: Please refer to the important `Stock Holding Disclosure' report on the Angel website (Research Section). Also, please refer to the latest update on respective stocks for the disclosure status in respect of those stocks. Angel Broking Limited and its affiliates may have investment positions in the stocks recommended in this report. Disclosure of Interest Statement Tech Mahindra 1. Analyst ownership of the stock No 2. Angel and its Group companies ownership of the stock No 3. Angel and its Group companies' Directors ownership of the stock No 4. Broking relationship with company covered No Note: We have not considered any Exposure below ` 1 lakh for Angel, its Group companies and Directors Ratings (Returns): Buy (> 15%) Accumulate (5% to 15%) Neutral (-5 to 5%) Reduce (-5% to 15%) Sell (< -15%) February 9,