3QFY2012 Result Update IT February 9, 2012 Tech Mahindra Performance Highlights (` cr) 3QFY12 2QFY12 % chg (qoq) 3QFY11 % chg (yoy) Net revenue 1,445 1,333 8.4 1,211 19.3 EBITDA 234 204 14.8 250 (6.2) EBITDA margin (%) 16.2 15.3 90bp 20.6 (441)bp Adj. PAT* 276 290 (5.0) 257 7.4 ; 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 `693 12 months IT 8,593 1.0 798/524 41,643 10 17,831 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 FY2011-13E. The company s core EPS is expected to post a negative CAGR over FY2011-13E. 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 18.6 3.6 11.1 7.4 11.5 Reported net profit 1,014 700 643 1,061 1,140 % chg (30.9) (8.3) 65.1 7.4 EBITDA margin (%) 27.2 24.5 19.5 16.9 17.1 EPS (`) 77.4 53.6 49.3 84.2 86.4 P/E (x) 8.5 12.3 13.4 7.8 7.6 P/BV (x) 4.4 3.0 2.6 2.0 1.6 RoE (%) 48.7 24.6 23.5 24.5 21.1 RoCE (%) 56.6 19.8 16.6 14.6 15.0 EV/Sales (x) 1.8 2.3 1.9 1.6 1.3 EV/EBITDA (x) 6.6 9.3 9.5 9.8 7.9 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 9.5 12.7 181.1 Ankita Somani +022 3935 7800 Ext: 6819 ankita.somani@angelbroking.com Please refer to important disclosures at the end of this report 1
Exhibit 1: 3QFY2012 performance (Consolidated, Indian GAAP) (` cr) 3QFY12 2QFY12 % chg (qoq) 3QFY11 % chg (yoy) 9MFY12 9MFY11 % chg (yoy) Net revenue 1,445 1,333 8.4 1,211 19.3 4,071 3,580 13.7 Cost of revenue 986 907 8.7 788 25.1 2,747 2,318 18.5 Gross profit 459 426 7.6 423 8.5 1,323 1,261 4.9 SG&A expense 225 222 1.0 173 29.7 643 530 21.3 EBITDA 234 204 14.8 250 (6.2) 680 731 (7.0) Dep. and amortisation 39 51 (23.1) 35 12.4 123 105 17.5 EBIT 195 153 27.3 215 (9.2) 557 626 (11.0) Interest 34 33 25 90 53 Other income 15 59 52 73 79 PBT 176 179 (1.4) 242 (27.2) 541 651 (17.0) Income taxes 29 39 (25.2) 36 (18.1) 120 109 9.8 PAT 147 139 5.3 206 (28.7) 421 542 (22.3) Minority interest 2 1 380.0 1 300.0 4 2 89.5 PAT after minority interest 144 139 4.0 205 (29.7) 418 541 (22.7) Profit from associates 132 102 52 329 158 Exceptional item - 50-50 (143) Final PAT 276 240 14.7 257 7.4 747 699 6.9 Adj. PAT 276 290 (5.0) 257 7.4 797 555 43.5 Diluted EPS 20.9 22.0 (5.1) 19.7 6.1 43 22.5 90.7 Gross margin (%) 31.8 32.0 (23)bp 34.9 (316)bp 32.5 35.2 (272)bp EBITDA margin (%) 16.2 15.3 90bp 20.6 (441)bp 16.7 20.4 (371)bp EBIT margin (%) 13.5 11.5 201bp 17.8 (424)bp 13.7 17.5 (381)bp PAT margin (%) 10.0 10.4 (42)bp 17.0 (697)bp 10.3 15.1 (484)bp Exhibit 2: 3QFY2012 Actual vs. Angel estimates (` cr) Actual Estimate Var. (%) Net revenue 1445 1511 (4.4) EBITDA margin (%) 16.2 17.4 (119)bp PAT* 144 184 (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, 2012 2
Exhibit 3: Trend in revenue growth for non-bt accounts 200 12 190 (US $mn) 180 170 160 150 140 151 164 9.1 174 5.8 187 188 7.3 8 4 (%) 130 120 0.7 3QFY11 4QFY11 1QFY12 2QFY12 3QFY12 0.6 0 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 120 3.0 4 (US $mn) 115 110 118 114 (3.5) 116 1.5 110 2 0 (2) (%) (4) 105 (5.5) (6) 100 101 3QFY11 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, 2012 3
Exhibit 5: Trend in revenue growth of top clients (qoq) (%) 15 10 5.3 5 3.0 1.7 0 13.6 9.3 7.3 3.6 4.1 4.1 1.5 0.6 (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 1,600 800 0 (800) (1,600) (2,400) 2,522 2,793 76 2,071 1,609 1,638 224 74 544 0 73 72 71 3QFY11 4QFY11 1QFY12 2QFY12 3QFY12 (1,255) (1,447) S/w professionals BPO professionals Utilisation (%) 78 76 74 72 70 68 (%) 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, 2012 4
Exhibit 7: Margin trend 40 35 34.9 36.7 33.9 32.0 31.8 30 (%) 25 20 15 10 20.6 20.5 18.7 15.3 16.2 17.8 17.5 16.1 11.5 13.5 3QFY11 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 14 18 20 19 22 US$2mn 5mn 19 16 13 14 13 US$5mn 10mn 5 6 8 13 13 US$10mn 15mn 7 7 9 6 6 US$15mn 20mn 2 1 1 2 2 US$20mn 25mn 1 3 2 2 3 US$25mn 50mn 2 1 1 2 2 US$50mn+ 3 3 3 2 2 Active clients 126 128 128 128 130 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 FY2011-13E. February 9, 2012 5
PAT is expected to be supported by 1) the deep in-the-money hedges of 305mn and US$540mn with participation rates at 83 INR/GBP and 50 INR/USD, boosting forex gains for the company; and 2) declining interest expense due to quick repayments possible from Mahindra Satyam s strong earnings. Thus, the company s core EPS is expected to have a negative CAGR over FY2011-13E. The only potential upside is due to the company s stake in Mahindra Satyam, which is improving its overall profitability. Since, the company s core earnings are subdued and the huge contribution (~33%) to its consolidated earnings is due to Mahindra Satyam s profitability, we continue to value the company at 55% discount to Infosys target PE i.e., at 8x the company s consolidated EPS of `86.4 and maintain our Accumulate rating on the stock with a target price of `693. Exhibit 9: Key assumptions FY2012E FY2013E Revenue growth (US$) 9.5 5.7 USD-INR rate (realized) 47.4 50.0 Revenue growth (`) 7.4 11.5 EBITDA margin (%) 16.9 17.1 Tax rate (%) 20.9 23.0 EPS growth (%) 70.9 2.6 Exhibit 10: One-year forward PE (x) 2,200 1,900 1,600 1,300 (`) 1,000 700 400 100 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Price 23 18 13 8 4. Note: P/E includes share of profits from Mahindra Satyam 2QFY2011 onwards. February 9, 2012 6
Exhibit 11: Recommendation summary Company Reco CMP Tgt Price Upside Target FY2013 FY2013E FY2011-13E FY2013E FY2013E (`) (`) (%) P/E (x) EBITDA (%) P/E (x) EPS CAGR (%) RoCE (%) RoE (%) HCL Tech Accumulate 465 520 11.9 13.0 17.5 11.6 22.1 20.9 23.1 Hexaware Neutral 106 - - 11.0 19.0 11.4 79.4 25.4 22.0 Infosys Accumulate 2,807 3,047 8.5 18.0 32.0 16.6 18.9 25.8 23.8 Infotech Enterprises Neutral 138 - - 8.5 16.0 8.8 11.9 16.1 13.0 KPIT Cummins Neutral 166 - - 10.0 15.4 10.2 19.9 19.5 16.9 Mahindra Satyam Buy 72 87 20.2 11.0 16.0 9.0 38.4 12.6 14.4 MindTree Accumulate 455 502 10.3 10.0 14.7 9.1 42.1 20.3 17.4 Mphasis Neutral 373 - - 11.5 16.6 10.1 (3.1) 14.0 14.2 NIIT^ Buy 45 55 22.8 6.9 16.3 5.6 19.3 11.0 15.6 Persistent Neutral 316 - - 9.0 23.0 9.0 0.1 19.4 14.3 TCS Neutral 1,227 - - 19.5 29.9 19.0 20.6 32.1 33.3 Tech Mahindra* Accumulate 659 693 5.2 8.0 17.1 7.6 32.3 15.0 21.1 Wipro Neutral 445 - - 15.3 19.7 16.0 13.1 15.3 20.5. Note: ^Valued on SOTP basis,* EPS CAGR includes earnings from Mahindra Satyam February 9, 2012 7
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 40.9 37.9 33.8 32.9 33.5 SG&A expenses 612 622 734 887 1,009 % of net sales 13.7 13.4 14.3 16.1 16.4 EBITDA 1,215 1,133 1,003 931 1,050 % of net sales 27.2 24.5 19.5 16.9 17.1 Depreciation and amortization 110 134 144 165 175 % of net sales 2.5 2.9 2.8 3.0 2.8 EBIT 1,106 999 860 766 875 % of net sales 24.8 21.6 16.7 13.9 14.2 Interest expense 3 218 100 115 54 Other income, net of forex gain/(loss) (38) 75 117 164 111 Profit before tax 1,065 856 877 814 932 Provision for tax 118 144 132 172 214 % of PBT 11.1 16.8 15.0 21.1 23.0 Recurring PAT 947 712 746 642 718 Share from associates 44 423 422 Exceptional item 67 (9) (143) - - Minority interest - 3 4 5 - Profit after minority interest 1,014 700 643 1,061 1,140 Reported PAT 947 709 786 1,061 1,140 Fully diluted EPS (`) 77.4 53.6 49.3 84.2 86.4 February 9, 2012 8
Balance sheet (Consolidated, Indian GAAP) Y/E March (` cr) FY2009 FY2010 FY2011 FY2012E FY2013E Equity capital 122 122 126 126 126 Preference capital - - - - - Share premium 233 237 233 233 233 Profit and loss 1,401 1,783 2,365 3,351 4,411 Other reserves 187 744 627 627 627 Net worth 1,943 2,887 3,351 4,338 5,397 Secured loans - 750 - - - Unsecured loans - 1,385 1,223 907 407 Total debt - 2,135 1,223 907 407 Deferred revenue 584 - - Minority interest 11 14 16 16 16 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 498 604 602 597 577 Capital WIP 154 321 125 140 160 Total fixed assets 652 925 727 737 737 Investments 435 3,015 2,908 2,872 2,870 Deferred tax asset, net 20 28 64 73 75 Inventories 1 1 - - - Sundry debtors 902 1,042 1,247 1,225 1,357 Cash and cash equivalents 538 219 267 395 696 Loans and advances 295 673 832 883 1,015 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, 2012 9
Cash flow statement (Consolidated, Indian GAAP) Y/E March (` cr) FY2009 FY2010 FY2011 FY2012E FY2013E Pre tax profit from operations 1,170 780 760 651 821 Depreciation 110 134 144 165 175 Expenses (deferred)/written off/others - (9) (98) 425 422 Pre tax cash from operations 1,280 906 805 1,241 1,418 Other income/prior period ad (38) 73 114 159 111 Net cash from operations 1,242 978 919 1,400 1,530 Tax (118) (144) (132) (172) (214) Cash profits 1,124 834 788 1,228 1,315 (Inc)/dec in Sundry Debtors 194 (140) (205) 22 (132) Inventories - - 1 - - Loans and advances 65 (377) (160) (51) (132) Sundry creditors (43) (8) 49 18 45 Others 5 (14) (45) 35 (39) Net trade working capital 222 (539) (358) 24 (258) Cashflow from operating activities 1,346 295 429 1,252 1,057 (Inc)/dec in fixed assets (162) (407) 54 (175) (176) (Inc)/dec in investments (371) (2,580) 107 36 2 (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 0 3 2 - - 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) 49 129 300 Cash at start of the year 98 538 219 267 395 Cash at end of the year 538 219 267 395 696 February 9, 2012 10
Key Ratios (Consolidated, Indian GAAP) Y/E March FY2009 FY2010 FY2011 FY2012E FY2013E Valuation ratio(x) P/E (on FDEPS) 8.5 12.3 13.4 7.8 7.6 P/CEPS 7.6 10.3 10.9 7.1 6.6 P/BVPS 4.4 3.0 2.6 2.0 1.6 Dividend yield (%) 0.6 0.5 0.6 0.6 0.6 EV/Sales 1.8 2.3 1.9 1.6 1.3 EV/EBITDA 6.6 9.3 9.5 9.8 7.9 EV/Total assets 12.4 11.4 13.1 12.4 11.3 Per share data(`) EPS (Fully diluted) 77.4 53.6 49.3 84.2 86.4 Cash EPS 86.2 64.0 60.3 93.0 99.7 Dividend 3.7 3.3 4.0 4.0 4.0 Book value 149.0 221.4 257.0 328.9 409.2 Dupont analysis Tax retention ratio (PAT/PBT) 0.9 0.8 0.9 1.3 1.2 Cost of debt (PBT/EBIT) 1.0 0.9 1.0 1.1 1.1 EBIT margin (EBIT/Sales) 0.2 0.2 0.2 0.1 0.1 Asset turnover ratio (Sales/Assets) 6.8 5.0 7.1 7.5 8.3 Leverage ratio (Assets/Equity) 0.3 0.3 0.2 0.2 0.1 Operating ROE (%) 48.7 24.7 22.3 24.5 21.1 Return ratios (%) RoCE (pre-tax) 56.6 19.8 16.6 14.6 15.0 Angel RoIC 87.6 22.2 18.0 16.2 17.6 RoE 48.7 24.6 23.5 24.5 21.1 Turnover ratios(x) Asset turnover (fixed assets) 6.8 5.0 7.1 7.5 8.3 Receivables days 82 77 81 81 81 Payable days 56 49 43 42 41 February 9, 2012 11
Research Team Tel: 022-3935 7800 E-mail: research@angelbroking.com Website: www.angelbroking.com 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, 2012 12