Setting path for growth in Direct Channel, Retain Accumulate June 18, 2015 Shashi Bhusan shashibhusan@plindia.com +91 22 66322300 Hussain Kagzi hussainkagzi@plindia.com +91 22 66322242 Rating Accumulate Price Rs380 Target Price Rs480 Implied Upside 26.3% Sensex 26,833 Nifty 8,092 (Prices as on June 17, 2015) Trading data Market Cap. (Rs bn) 79.8 Shares o/s (m) 209.9 3M Avg. Daily value (Rs m) 83.2 Major shareholders Promoters 60.49% Foreign 24.34% Domestic Inst. 4.96% Public & Other 10.21% Stock Performance (%) 1M 6M 12M Absolute (0.3) 11.1 (15.6) Relative 1.5 10.7 (20.8) How we differ from Consensus EPS (Rs) PL Cons. % Diff. 2016 35.4 31.7 11.7 2017 39.3 34.9 12.7 Price Performance (RIC:MBFL.BO, BB:MPHL IN) (Rs) 500 400 300 200 100 0 Jun 14 Aug 14 Oct 14 Source: Bloomberg Dec 14 Feb 15 Apr 15 Jun 15 We attended the Analyst Meet of Mphasis yesterday. Management talked about increased deal wins in Direct International business especially in the area of GRC and Digital. Moreover, Management highlighted their strategies to become more relevant in the new ecosystem created disruptive technologies in uncertain demand environment. The company clearly stated their aspiration to grow ahead of NASSCOM growth outside HP channel. However, we see challenges in HP would restrict strong earnings growth. We retain our Accumulate rating. Deal wins in FY15 in GRC and Digital: According to Management, FY15 has been a successful year in terms of deal wins. The company bagged total TCV of US$270m (GRC: 56%, Digital:, Others: 34%) (BFSI: 33%, Others: 67%) in Direct International business. Management was confident of organically growing non HP business stronger than NASSCOM guidance in FY16. Acclimatizing to uncertainty due to both technological and economic changes: In the uncertain economic condition, the fast evolving technology has increased volatility in revenue. Management has made some key changes in the organization to address this new challenge 1) High Clock Speed: Decentralization of decision making, moving delivery leaders to clients location 2) Continuous Disruptive Innovation: Set up Mphasis Innovation lab 3) High value specialization: Building growth strategy in BFS, Increase numbers of domain experts in top accounts from 0.75 per client to 1.5 per client 4) Brand Building 5) Transformation Axis: Bring point of stability in revenue for transformation. We see these initiatives as step in right direction. Building start up ecosystem: Mphasis has set up innovation lab that has objective to roll out solutions/products in no more than 4 months and address at least one business challenges faced by Top 16 clients. The start up will get seed funding from Mphasis and will have independent board. Valuation and Recommendation Retain Accumulate with TP of Rs480: Mphasis initiatives will accelerate revenue in non HP channel business. We expect low to mid single digit of revenue growth in FY16. Retain Accumulate Key financials (Y/e March) 2014 2015 2016E 2017E Revenues (Rs m) 63,182 57,803 58,118 62,999 Growth (%) 7.0 (8.5) 0.5 8.4 EBITDA (Rs m) 11,482 8,555 9,158 10,214 PAT (Rs m) 7,265 6,746 7,436 8,266 EPS (Rs) 34.6 32.1 35.4 39.3 Growth (%) (2.3) (7.1) 10.2 11.2 Net DPS (Rs) 7.0 16.0 26.0 30.0 Profitability & Valuation 2014 2015 2016E 2017E EBITDA margin (%) 18.2 14.8 15.8 16.2 RoE (%) 14.5 12.8 13.4 14.4 RoCE (%) 13.0 11.6 12.2 13.1 EV / sales (x) 1.3 1.4 1.3 1.2 EV / EBITDA (x) 7.0 9.2 8.6 7.7 PE (x) 11.0 11.8 10.7 9.7 P / BV (x) 1.6 1.5 1.4 1.4 Net dividend yield (%) 1.8 4.2 6.8 7.9 Source: Company Data; PL Research Analyst Meet Update Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
3 years objectives 2016 18: Management has set FY16 18 objective for the company: 1) Grow Direct International revenue faster than the market. 2) Increase quality of revenue GRC, Digital, and Next Generation Services to constitute more than 50% of Direct International Revenue. 3) Optimize Service segments to conserve leadership bandwidth and enhance profitability. 4) Be known as a Path breaking, Progressive, Innovative, Next Generation Company. 5) Deliver 14 16% EBIT margin Digital Risk optimism continues: Management has taken initiatives to improve revenue visibility in Digital Risk. 1) Improved the scale of business leveraging Mphasis S&M and delivery team 2) Invested in Go To Market 3) Made portfolios of new logos and deeper penetration with clients 4) Only increased focus in the US geographies and does not want to expand Digital Risk geographical presence. Exhibit 1: Emerging Technology to lead growth Emerging Traditional Emerging Gr. Traditional Gr. USD bn 400 300 200 100 20% 20% 17% 17% 345 375 360 395 245 210 1% 180 150 4% 4% 5% 2015E 2016E 2017E 2018E 20% 15% 5% 0% 5% Growth (% YoY) Source: Forrester (June 15), Company Data, PL Research Exhibit 2: Banks top priorities Top publicly announced IT investment of 25 banks Digital 54% IT Infrastructure 16% Platforms Payments 11% 11% Others 8% 0% 20% 30% 40% 50% 60% Source: Gartner (2013 14), Company Data, PL Research June 18, 2015 2
Exhibit 3: Top priorities of Insurance companies Top publicly announced IT investment of largest Insurers Digital 47% Legacy Modernation Portals 13% Risk Management Channel Management 6% 6% Otehrs 18% 0% 20% 30% 40% 50% Source: Gartners (2013 14), Company Data, PL Research June 18, 2015 3
Income Statement (Rs m) Net Revenue 63,182 57,803 58,118 62,999 Raw Material Expenses 45,734 43,424 43,098 47,159 Gross Profit 17,448 14,379 15,019 15,840 Employee Cost Other Expenses 5,966 5,824 5,861 5,626 EBITDA 11,482 8,555 9,158 10,214 Depr. & Amortization 1,210 980 988 1,008 Net Interest Other Income (149) 1,833 2,016 2,117 Profit before Tax 10,123 9,408 10,187 11,323 Total Tax 2,858 2,630 2,750 3,058 Profit after Tax 7,265 6,778 7,436 8,266 Ex Od items / Min. Int. 32 Adj. PAT 7,265 6,746 7,436 8,266 Avg. Shares O/S (m) 210.1 210.1 210.1 210.1 EPS (Rs.) 34.6 32.1 35.4 39.3 Cash Flow Abstract (Rs m) C/F from Operations 1,888 7,225 7,966 8,445 C/F from Investing 2,201 (1,909) (2,067) (2,243) C/F from Financing (4,243) (2,352) (5,459) (6,299) Inc. / Dec. in Cash (153) 2,964 440 (97) Opening Cash 3,599 3,532 6,496 6,936 Closing Cash 3,532 6,496 6,936 6,839 FCFF 4,336 7,141 5,190 6,802 FCFE 4,189 7,141 5,190 6,802 Key Financial Metrics Growth Revenue (%) 7.0 (8.5) 0.5 8.4 EBITDA (%) 0.8 (25.5) 7.1 11.5 PAT (%) (2.3) (7.1) 10.2 11.2 EPS (%) (2.3) (7.1) 10.2 11.2 Profitability EBITDA Margin (%) 18.2 14.8 15.8 16.2 PAT Margin (%) 11.5 11.7 12.8 13.1 RoCE (%) 13.0 11.6 12.2 13.1 RoE (%) 14.5 12.8 13.4 14.4 Balance Sheet Net Debt : Equity Net Wrkng Cap. (days) Valuation PER (x) 11.0 11.8 10.7 9.7 P / B (x) 1.6 1.5 1.4 1.4 EV / EBITDA (x) 7.0 9.2 8.6 7.7 EV / Sales (x) 1.3 1.4 1.3 1.2 Earnings Quality Eff. Tax Rate 28.2 28.0 27.0 27.0 Other Inc / PBT (1.5) 19.5 19.8 18.7 Eff. Depr. Rate (%) 11.1 9.0 7.2 6.6 FCFE / PAT 57.7 105.8 69.8 82.3 Source: Company Data, PL Research. Balance Sheet Abstract (Rs m) Shareholder's Funds 51,150 54,568 56,545 58,512 Total Debt 5,396 5,396 5,396 5,396 Other Liabilities 159 159 159 159 Total Liabilities 56,705 60,123 62,100 64,067 Net Fixed Assets 2,240 2,667 3,145 3,780 Goodwill 21,865 22,465 23,065 23,665 Investments 18,154 18,154 18,154 18,154 Net Current Assets 13,478 15,870 16,768 17,500 Cash & Equivalents 4,670 6,496 6,936 6,839 Other Current Assets 21,852 20,934 21,048 22,813 Current Liabilities 13,044 11,561 11,216 12,152 Other Assets 968 968 968 968 Total Assets 56,705 60,123 62,100 64,067 Quarterly Financials (Rs m) Y/e March Q1FY15 Q2FY15 Q3FY15 Q4FY15 Net Revenue 14,961 14,591 14,082 14,169 EBITDA 2,573 2,088 2,040 2,064 % of revenue 17.2 14.3 14.5 14.6 Depr. & Amortization 263 247 238 232 Net Interest Other Income 220 406 462 745 Profit before Tax 2,530 2,247 2,264 2,577 Total Tax 742 645 613 630 Profit after Tax 1,788 1,602 1,651 1,947 Adj. PAT 1,788 1,602 1,651 1,947 Key Operating Metrics Application Serv 31,219 34,341 34,341 34,341 BPO Serv. 20,251 11,571 11,885 16,767 ITO Serv. 11,434 11,891 11,891 11,891 SW Devp. Cost (% of sales) 72.4 75.1 74.2 74.9 SG&A (% of sales) 11.0 11.4 11.8 10.5 Revenue (US$ m) 1,024 944 945 1,041 EBITDA Margin Expansion/(Erosion) (bps) (168) (1) (1) Tax Rate (%) 28.2 28.0 27.0 27.0 Source: Company Data, PL Research. June 18, 2015 4
Prabhudas Lilladher Pvt. Ltd. 3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai 400 018, India Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209 Rating Distribution of Research Coverage PL s Recommendation Nomenclature % of Total Coverage 50% 40% 30% 20% 0% 42.7% 39.6% 17.7% 0.0% BUY Accumulate Reduce Sell BUY : Over 15% Outperformance to Sensex over 12 months Accumulate : Outperformance to Sensex over 12 months Reduce : Underperformance to Sensex over 12 months Sell : Over 15% underperformance to Sensex over 12 months Trading Buy : Over absolute upside in 1 month Trading Sell : Over absolute decline in 1 month Not Rated (NR) : No specific call on the stock Under Review (UR) : Rating likely to change shortly DISCLAIMER/DISCLOSURES ANALYST CERTIFICATION We/I, Mr. Shashi Bhusan (BTech (IIT), MBA (IIM)), Mr. Hussain Kagzi (BMS), Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Terms & conditions and other disclosures: Prabhudas Lilladher Pvt. Ltd, Mumbai, India (hereinafter referred to as PL ) is engaged in the business of Stock Broking, Portfolio Manager, Depository Participant and distribution for third party financial products. PL is a subsidiary of Prabhudas Lilladher Advisory Services Pvt Ltd. which has its various subsidiaries engaged in business of commodity broking, investment banking, financial services (margin funding) and distribution of third party financial/other products, details in respect of which are available at www.plindia.com This document has been prepared by the Research Division of PL and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of PL. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, PL has not independently verified the accuracy or completeness of the same. Neither PL nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient's particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Either PL or its affiliates or its directors or its employees or its representatives or its clients or their relatives may have position(s), make market, act as principal or engage in transactions of securities of companies referred to in this report and they may have used the research material prior to publication. PL may from time to time solicit or perform investment banking or other services for any company mentioned in this document. PL is in the process of applying for certificate of registration as Research Analyst under Securities and Exchange Board of India (Research Analysts) Regulations, 2014 PL submits that no material disciplinary action has been taken on us by any Regulatory Authority impacting Equity Research Analysis activities. PL or its research analysts or its associates or his relatives do not have any financial interest in the subject company. PL or its research analysts or its associates or his relatives do not have actual/beneficial ownership of one per cent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report. PL or its research analysts or its associates or his relatives do not have any material conflict of interest at the time of publication of the research report. PL or its associates might have received compensation from the subject company in the past twelve months. PL or its associates might have managed or co managed public offering of securities for the subject company in the past twelve months or mandated by the subject company for any other assignment in the past twelve months. PL or its associates might have received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months. PL or its associates might have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months PL or its associates might have received any compensation or other benefits from the subject company or third party in connection with the research report. PL encourages independence in research report preparation and strives to minimize conflict in preparation of research report. PL or its analysts did not receive any compensation or other benefits from the subject Company or third party in connection with the preparation of the research report. PL or its Research Analysts do not have any material conflict of interest at the time of publication of this report. It is confirmed that Mr. Shashi Bhusan (BTech (IIT), MBA (IIM)), Mr. Hussain Kagzi (BMS), Research Analysts of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months Compensation of our Research Analysts is not based on any specific merchant banking, investment banking or brokerage service transactions. The Research analysts for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about the subject company or companies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report. The research analysts for this report has not served as an officer, director or employee of the subject company PL or its research analysts have not engaged in market making activity for the subject company Our sales people, traders, and other professionals or affiliates may provide oral or written market commentary or trading strategies to our clients that reflect opinions that are contrary to the opinions expressed herein, and our proprietary trading and investing businesses may make investment decisions that are inconsistent with the recommendations expressed herein. In reviewing these materials, you should be aware that any or all o the foregoing, among other things, may give rise to real or potential conflicts of interest. PL and its associates, their directors and employees may (a) from time to time, have a long or short position in, and buy or sell the securities of the subject company or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a market maker in the financial instruments of the subject company or act as an advisor or lender/borrower to the subject company or may have any other potential conflict of interests with respect to any recommendation and other related information and opinions. DISCLAIMER/DISCLOSURES (FOR US CLIENTS) ANALYST CERTIFICATION The research analysts, with respect to each issuer and its securities covered by them in this research report, certify that: All of the views expressed in this research report accurately reflect his or her or their personal views about all of the issuers and their securities; and No part of his or her or their compensation was, is or will be directly related to the specific recommendation or views expressed in this research report Terms & conditions and other disclosures: This research report is a product of Prabhudas Lilladher Pvt. Ltd., which is the employer of the research analyst(s) who has prepared the research report. The research analyst(s) preparing the research report is/are resident outside the United States (U.S.) and are not associated persons of any U.S. regulated broker dealer and therefore the analyst(s) is/are not subject to supervision by a U.S. broker dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account. This report is intended for distribution by Prabhudas Lilladher Pvt. Ltd. only to "Major Institutional Investors" as defined by Rule 15a 6(b)(4) of the U.S. Securities and Exchange Act, 1934 (the Exchange Act) and interpretations thereof by U.S. Securities and Exchange Commission (SEC) in reliance on Rule 15a 6(a)(2). If the recipient of this report is not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be copied, duplicated and/or transmitted onward to any U.S. person, which is not the Major Institutional Investor. In reliance on the exemption from registration provided by Rule 15a 6 of the Exchange Act and interpretations thereof by the SEC in order to conduct certain business with Major Institutional Investors, Prabhudas Lilladher Pvt. Ltd. has entered into an agreement with a U.S. registered broker dealer, Marco Polo Securities Inc. ("Marco Polo"). Transactions in securities discussed in this research report should be effected through Marco Polo or another U.S. registered broker dealer. June 18, 2015 5