Mphasis BFL Ltd. Business. Struggling for growth. BSE Code NSE Code MPHASISBFL Bloomberg Code

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1 BSE Code NSE Code MPHASISBFL Bloomberg Code CMP Rs285 Market Cap Rs22bn 52week H/L Rs425/197 Face Value Rs1 Share Holding Pattern Shareholding pattern (%) Indian Institutional 8.5 Foreign (Institutional & NRI) 22.7 Public 12.8 Others (Body corporates) 56. Mphasis BFL Ltd Struggling for growth Background Mphasis is a global IT and BPO services provider to G2 companies situated around the globe. It assists its clients in innovating and streamlining their business processes by offering customized solutions for technology and operations outsourcing. Its management is led by its two main promoters, Jerry Rao (Chairman & CEO) and Jeroen Tas (Vice Chairman). Both are former Citibank executives, who possess immense knowledge in financial services domain and command technology leadership. The company s clientele includes big names like Citigroup, JP Morgan Chase, ING, BNP Paribas, Rabobank, ABN-Amro, Deutsche Bank, ICICI, AIG Inc, Charles Schwab, Compaq, NEC, Fedex, P&G, Johnson & Johnson, Singapore Airlines and many other Fortune 5 clients. It has 2 client relationship management & project delivery offices that are located across 4 continents and 11 countries. The company currently employs more than 7,5 people. It has a strong quality culture which is reflected in ISO 91, BS 7799 and SEI CMMi Level 5 certifications. Share Price Chart Business IT services Vertical focus Banking, Financial Services & Insurance (BFSI) Retail & Logistics Airlines Technology Service portfolio Architecture Application development & integration Application maintenance & support Testing & deployment The company s IT services business though contributes almost 65% of the revenues but employs ~3% of the total employee strength. The software processes of the company are certified at SEI CMMi Level-5 by the Software Engineering Institute. It has in all 6 offshore development centres (ODC s) with 5 located in India and 1 in China. Apart from above services, the company also provides software process consulting to other smaller IT companies and IT divisions of domestic and global corporations. December 27, 24 1

2 ITES/BPO services Vertical focus Retail, Banking & Credit cards Insurance Logistics Technology Tax & accounting Service portfolio Sales & service Account receivables Case handling Brokerage Utilities Content management Technical helpdesk The BPO operations employ about 7% of the company s employee strength whereas it contribute only ~35% of the company s revenues. The company s domestic contact centers are located in Bangalore and Pune. These centres offer English language support while its global center located in Tijuana, Mexico provide Spanish language solutions. The BPO cantres provide both voice and non-voice based services though the share of the latter is very low at present. The company also provides services relating to setting up and managing offshore processing centers of global corporations who are not willing to outsource their process to third party BPO companies. Subsidiaries The company has in all 15 direct and indirect subsidiaries, the details of which are given below. Subsidiaries % Holding Mphasis Corporation (Mphasis USA) 1 Mphasis Deutschland GmbH (Mphasis GmbH) 91 BFL Software Asia Pacific Pte Ltd (BFL APAC) 1 Mphasis Australia Pty Ltd (MphasiS Australia) 1 Mphasis Software and Services Ltd (Mphasis China) 1 Kshema Technologies Ltd (Kshema) 1 MbrokeR Inc. (MbrokeR) 1 MbrokeR (India) Private Ltd (MbrokeR India) 1 Mphasis Europe BV (Mphasis Europe) 1 Mphasis Pte Ltd (Mphasis Singapore) 1 Mphasis UK Ltd (Mphasis UK) 1 Mphasis Software and Services Pvt Ltd (Mphasis India) 1 Msource Holdings BV (Msource Netherlands) 1 Msource Mauritius Inc (Msource Mauritius) 1 Msource (India) Private Ltd (Msource India) 1 December 27, 24 2

3 Revenue growth... driven by BPO and inorganic initiatives 7, 6, 5, Revenue Growth Segmental Composition 4, , 3 2, 2 1, 1 FY2 FY3 FY4 H1 FY5 Revenues yoy growth FY2 FY3 FY4 H1 FY5 IT services BPO Over the last two fiscals, the topline of the company had increased from Rs3.1bn to Rs5.8bn representing a CAGR of 36.1%. In the first half of the current fiscal, the revenues have witnessed a growth of 35%. The growth momentum of the company has been led by robust growth witnessed by the BPO business (Msource). The BPO revenues have witnessed a CAGR of 182% over the last two years, growing from Rs236mn to Rs1,9bn. On the other side, the IT services revenues have increased from Rs2.9bn to Rs3.9bn, reflecting a CAGR of 16.5%. Due to huge discrepancy in the growth rate of the two segments, the business composition has been shifting in favour of BPO, which now contributes ~37% of the revenues. The growth in the BPO revenues is attributable to the management s emphasis on scaling-up operations to meet the ever increasing volumes. This has been ably supported by the consistency in billing rate near US12$ per hour. In the IT services segment, the growth was modest due to absence of significant volume growth with billing rates being relatively stable at US$61-62/hour for onsite and US$19-21/hour for offshore services. Due to the sluggish growth in the IT services, the company was compelled to pursue inorganic growth recently. It acquired Onida Infotech, a SAP implementation arm of MIRC Electronics in Q4 FY4 and Kshema Technologies, a company specializing in embedded software and systems, in Q1 FY5. December 27, 24 3

4 IT revenue mix...reflects domination 1% 8% 6% Vertical Mix % 2% % FY2 FY3 FY4 Q1 FY5 Q2 FY5 BFSI Retail & logistics Technology In the IT services segment, the company has been focusing on three key verticals; banking, financial services & insurance (BFSI), retail & logistics and technology. This is as per the strategy of the company to focus on few verticals so as to acquire deep domain knowledge and provide tailor made solutions to the clients. If one looks at the vertical mix of the IT services revenues, the domination of BFSI is apparent. One of the reasons behind this could be the expertise and experience of the promoters in this field due to their association with Citibank for years. However, this domination seems to be tapering off as the share of other services have been rising in the last two quarters. 1 Project Type Mix 8 Delivery Mix FY3 FY4 Q1 FY5 Q2 FY5 T&M FP/FT FY3 FY4 Q1 FY5 Q2 FY5 Onsite Offshore The time & material (T&M) contracts constitute majority of the revenues. In the last two quarters, their share has actually risen from 75% in FY4 to 82% in Q2 FY5. The lower contribution from the fixed price & fixed time contracts augurs well for the company as it involves the risk of cost overruns and completion delays thereby making it less preferable from the vendor s point of view. The onsite-offshore mix with onsite revenues forming 6+% and offshore revenues contributing less than 4% of the revenues. Recently, the mix has shifted marginally in favour of offshore. December 27, 24 4

5 BPO revenue mix... shifting for better 1 8 BPO Service Mix FY3 FY4 Q1 FY5 Q2 FY5 Voice Non-voice The BPO revenue mix is highly in favour of voice based services that consist of inbound and outbound call center services. Non-voice services mainly comprising transaction processing and back office operations have a miniscule share. The mix is gradually shifting towards non-voice with some initiatives from the company. The management has expressed intentions of increasing the share of non-voice services and as a step towards this, it has started providing tax & accounting and equity research services to its clients. Operational performance... managing by balancing SG&A & staff cost Cost Analysis Segmental EBIT Margin FY2 FY3 FY4 Q1 FY5 Q2 FY5 Staff Cost level Gross Margin FY2 FY3 FY4 Q1 FY5 Q2 FY5 SG&A level OPM IT services BPO The movement in the margins of the company has not been unidirectional but rather range bound. The staff cost has gone up in the last one year as the company undertook large-scale recruitment, especially for its BPO operations, and conducted regular salary revisions so as to retain its resources. The company conducted its yearly salary hike in April 24. The other direct cost increased in line with the sales, mainly led by sharp increase in telecom and infrastructure cost incurred for ramping up BPO operations. The gross margin arrived after deducting the above two cost, has gradually decreased from 41.8% in FY2 to 37.4% in Q2 FY5. December 27, 24 5

6 Between FY2 & FY4, the selling, general& administration expense (SG&A) as percentage of sales declined, reflecting the operating leverage derived by the company. Since then, the SG&A level have been on the rise mainly attributable to addition of cost relating to the recent acquisitions. The current OPM of 19.4% is at the higher end of the company s historic range. Though the segmental EBIT margins cannot be used (in the company s case) to judge the individual operating performance of the segments due to presence of huge unallocated cost, but it surely indicates lower margin earned in BPO vis-a-vis IT services. Net profit growth robust... but buoyed by non-operational gains recently 1,2 1, Net Profit Growth FY2 FY3 FY4 H1 FY5 Net profits yoy growth Profitability Ratios FY2 FY3 FY4 Net Margin ROCE RONW There has been a consistent growth in the net profits of the company but the drivers have been different. The net profit witnessed a CAGR of 55.4% in the last two years, rising from Rs48mn in FY2 to Rs986mn in FY4. The net profit growth has been consistently out performing the sales growth. The net profit growth in FY3 was totally operationally driven while that in FY4 was driven by huge forex gains of Rs147mn on hedged receivables (as the Rupee appreciated sharply) and lower tax outflow due to reinstatement of income tax holiday partially withdrawn in FY3. Further, the company enjoyed deferred tax asset in the range of Rs28-32mn in each of the first two quarters of current fiscal, arising from restructuring of its US operations. The net profit margin as improved steadily from 13% in FY2 to 17% in FY4. The return ratios (RONW & ROCE) have shot up in the last year. This is mainly due to reduction in net worth of the company rather than growth in net profits. In FY4, the company obtained an approval from the Karnataka High Court and Registrar of Companies to reduce the share premium account by Rs7.1bn. On the asset side, it was applied towards goodwill in Mphasis Corporation (USA) and Mphasis Deutschland (Germany). December 27, 24 6

7 Client Addition... satisfactory, Concentration... concern 5 Client Addition 35 Top Client contribution FY2 FY3 FY4 H1 FY5 IT services BPO FY3 FY4 Q1 FY5 Q2 FY5 IT BPO The client addition numbers has been decent with total client addition number being around 4 in each of the last two years. In HI FY5, the company has already added 28 clients representing an improvement over last year. The BPO client addition has been relatively lower but the revenue from this segment has been rising at a far superior pace then IT services. This implies that the company is having more number of large accounts in this segment and has been able to mine it successfully, which is not the case with IT services. The top client concentration of revenues is higher in both the segments, at 17% for IT services and 16% for BPO operations. Though the concentration has declined to an extent in both segments, even the present levels make the company highly vulnerable to the activities of the top client. Manpower addition... higher on the BPO side 25 Manpower Addition FY2 FY3 FY4 H1 FY5 IT services BPO The trend in manpower addition reflects the company s confidence and visibility of future business. The company s manpower addition has been strong in the last two fiscals and reflected a CAGR of 99%. Most of the recruitment in each year has been done for Msource (BPO operations) so as to meet its expanding scale of operations. December 27, 24 7

8 In FY3, the net additions in the IT services segment were almost nil (3). Since then, the additions in this segment have picked as the company is in the process of increasing its presence outside India, by expanding its global pool of resources. In H1 FY5, the company added net 99 people, less than 5% of total FY4 number. At the end of Q2 FY5, the total manpower strength stood at 7,268; 2,258 in IT services and 5,1 in BPO. Rise in share capital... attributable to company s generosity The share capital of the company has increased four-fold from Rs172mn in FY2 to Rs772mn at the end of H1 FY5. The main reason for this is declaration of bonus share in the ratio of 1:1 in two consecutive years, FY3 and FY4. Apart from this, exercise of ESOPs by employees and issuance of equity shares as a part consideration for acquiring Kshema (Q1 FY5) and minority interest in Msource Corporation (Q2 FY5) led to increase in share capital. In Q2 FY5, the company issued 2.3mn and 2.4mn equity shares to the shareholders in Kshema and the holders of minority interest in Msource Corporation respectively. The nominal share capital of the company has been increased from Rs4mn to Rs1bn in Q1 FY5. Addition to gross block... BPO more capital intensive than IT services The gross block of the company has almost doubled increasing from Rs976mn in FY2 to Rs2bn in FY4. A large part of the incremental capital expenditure has been utilized for expanding and developing BPO facilities of the company. In FY3, the company set up a call center in Mexico to provide BPO services in Spanish language. During the last two years, it also increased the number of seats in its domestic centres in Bangalore and Pune. On the IT services side of the company, a new overseas development center (ODC) was developed in Mumbai in FY3 and further expenditure was incurred on it and China ODC in FY4. December 27, 24 8

9 Working capital... improving, Liquidity... comfortable Liquidity & Cash position FY2 FY3 FY4 Working Capital (A) 1,475 1,867 2,773 A as % of sales Cash & cash equivalents (B) 1, 1,47 1,326 B as a % of WC Core WC (A-B) as a % of sales Cash per share Debtor days The company s working capital (WC) has been in the range of 44%-48% of sales in the last three years implying that its growth has been in line with that of the revenues. Further, if one excludes cash & cash equivalents (C&CE) from total WC, then the core working capital of the company stands lower at 24.9% of sales in FY4. After having a high debtors level in the end of FY4 at 99 days, the company worked towards it by implementing a stricter credit policy and improving efficiency in collections. This resulted into debtor level declining sharply to 54 days at the end of Q2 FY5. The company has been enjoying comfortable liquidity as reflected by the huge C&CE balance carried by it. Even after paying for the couple of acquisitions and minority interest holders (in Msource Corporation), the company has C&CE of Rs1bn at the end of Q2 FY5, which translates into cash per share of Rs13. The cash generated from operations during FY4 stood at Rs1.18bn, 2% of the years revenues. December 27, 24 9

10 Outlook Concerns The consistent growth of 35-36% achieved by the company stands a tad lower that the industry growth rate of 4%+ recorded by mid-size plain IT services companies. If one considers that a significant portion of the revenues come from BPO operations, which is a relatively high growth segment than IT services, the marginal underperformance gains further significance. The sequential growth in the last three quarters, which was in the range of 8-1% in IT services, is mainly attributable to the acquisitions (Onida Infotech & Kshema Technologies) done by the company in the respective periods. Excluding acquisitions, the organic sequential growth stands lower in the range of 3-4%. The growth in BPO business, which the company is banking upon, has slowed down, which is reflected in the declining sequential growth in the last three quarters. The company s narrow vertical focus can be a concern in a scenario where a broad based portfolio of services and larger vertical presence is required to mine existing clients and add new ones. The onsite-offshore mix of 63:37 stands unfavorable in relation to the industry standard of 55:45. The companies tend to earn higher margin from offshore revenues vis-à-vis onsite revenues. OPM at the lower band of the industry range. The main lever for OPM improvement will be the SG&A leverage but gains will be limited to a large extent by increase in staff cost and adverse forex movement. The profitability in the last two quarters has been aided by deferred tax asset arising on restructuring of company s US operations. The net profit will receive a set back once this benefit goes off. The top client (most probably Citibank) concentration stands higher. The company runs the risk of scaling down operations by this client as it has its own BPO operations in India. Slow down in employee addition in H1 FY5. This is at a time when other companies are at the peak of their recruitment cycle. Positives The company is banking on the BPO growth, where the margins have started to improve. Huge potential accompanied by company s intention to increase the share of nonvoice based services will work well for the company. Non-voice services are less commoditised and command the margins than Call center (voice based) services. High C&CE balance coupled with huge cash generation from operations will enable company in employing it towards growth initiatives both, organic and inorganic. The management has a track record of sharing company s progress with its shareholders. December 27, 24 1

11 Income statement Period FY2 FY3 FY4 (Rs mn) (12) (12) (12) Net Sales 3,133 4,293 5,86 Operating expenses (2,65) (3,392) (4,689) Operating profit ,117 Other income PBIDT ,33 Interest (1) (2) (1) Depreciation & Amortization (128) (147) (248) Profit before tax (PBT) ,54 Tax (9) (118) (69) Profit after tax (PAT) Minority interest (1) Extraordinary / prior period items (11) Adjusted profit after tax (APAT) Balance sheet Period FY2 FY3 FY4 (Rs mn) (12) (12) (12) Sources Share Capital Reserves 8,697 9,363 3,138 Net Worth 8,868 9,536 3,492 Employee stock option outstanding Minority interest Loan Funds Def Tax liability Total 9,2 9,915 3,98 Uses Gross Block 976 1,539 2,25 Accd Depreciation (665) (824) (1,86) Net Block Capital WIP Total Fixed Assets ,47 Goodwill 7,13 7,195 7 Investments Total Current Assets 1,889 2,488 3,453 Total Current Liabilities (414) (62) (681) Net Working Capital 1,475 1,867 2,773 Def employee stock compensation exp Def Tax assets Total 9,2 9,915 3,98 December 27, 24 11

12 Cash flow statement Year 3/3 3/4P (Rs mn) (12) (12) Cash from operating activities 796 1,182 Add/less working capital changes (449) (2) Net cash from operating activities 346 1,18 Net Cash from investing activities (652) 6,78 Net cash from financing activities 68 (7,9) Net increase in cash and cash equivalents (238) 797 Cash at start of the year Cash at end of the year Key ratios Period FY2 FY3 FY4 (12) (12) (12) Per share ratios EPS (Rs) Div per share Book value per share Valuation ratios P/E P/BV EV/sales EV/ PBIT EV/PBIDT Profitability ratios OPM (%) PAT (%) ROCE RONW Published in December 24. India Infoline Ltd India Infoline Ltd. All rights reserved.regd. Off: 24, Nirlon Complex, Off W E Highway, Goregaon(E) Mumbai Tel.: +(91 22) Fax: This report is for information purposes only and does not construe to be any investment, legal or taxation advice. It is not intended as an offer or solicitation for the purchase and sale of any financial instrument. Any action taken by you on the basis of the information contained herein is your responsibility alone and India Infoline Ltd (hereinafter referred as IIL) and its subsidiaries or its employees or directors, associates will not be liable in any manner for the consequences of such action taken by you. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, but do not represent that it is accurate or complete. IIL or any of its subsidiaries or associates or employees 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 publication. The recipients of this report should rely on their own investigations. IIL and/or its subsidiaries and/or directors, employees or associates may have interests or positions, financial or otherwise in the securities mentioned in this report. December 27, 24 12