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3QFY2012 Result Update | IT

February 9, 2012

Tech Mahindra
Performance Highlights
(` cr) Net revenue EBITDA EBITDA margin (%) Adj. PAT* 3QFY12 1,445 234 16.2 276 2QFY12 1,333 204 15.3 290 % chg (qoq) 8.4 14.8 90bp (5.0) 3QFY11 1,211 250 20.6 257 % chg (yoy) 19.3 (6.2) (441)bp 7.4

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 IT 8,593 1.0 798/524 41,643 10 17,831 5,412 TEML.BO TECHM.IN

`659 `693
12 months

Source: Company, Angel Research; Note:*exclude one-offs

For 3QFY2012, Tech Mahindra reported subdued performance with revenue as well as profit coming in below ours as well as streets 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 Mahindras revenue run rate. However, due to the companys stake in Mahindra Satyam, we maintain our Accumulate rating on the stock. 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 BTs quarterly revenue expected to be flat from here. However, there is a caveat that BTs 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 companys core EPS is expected to post a negative CAGR over FY2011-13E. The only potential upside is due to the companys 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 companys consolidated EPS of `86.4 and maintain our Accumulate rating on the stock with a target price of `693.

Shareholding Pattern (%) Promoters MF / Banks / Indian Fls FII / NRIs / OCBs Indian Public / Others 70.9 15.2 4.9 9.0

Abs. (%) Sensex Tech Mahindra

3m

1yr

3yr 75.0 181.1

(3.4) (4.6) 9.5 12.7

Key financials (Consolidated, Indian GAAP)


Y/E March (` cr) Net sales % chg Reported net profit % chg EBITDA margin (%) EPS (`) P/E (x) P/BV (x) RoE (%) RoCE (%) EV/Sales (x) EV/EBITDA (x) FY2009 4,465 18.6 1,014 27.2 77.4 8.5 4.4 48.7 56.6 1.8 6.6 FY2010 4,625 3.6 700 (30.9) 24.5 53.6 12.3 3.0 24.6 19.8 2.3 9.3 FY2011 5,140 11.1 643 (8.3) 19.5 49.3 13.4 2.6 23.5 16.6 1.9 9.5 FY2012E 5,520 7.4 1,061 65.1 16.9 84.2 7.8 2.0 24.5 14.6 1.6 9.8 FY2013E 6,153 11.5 1,140 7.4 17.1 86.4 7.6 1.6 21.1 15.0 1.3 7.9

Ankita Somani
+022 3935 7800 Ext: 6819 ankita.somani@angelbroking.com

Source: Company, Angel Research

Please refer to important disclosures at the end of this report

Tech Mahindra | 3QFY2012 Result Update

Exhibit 1: 3QFY2012 performance (Consolidated, Indian GAAP)


(` cr) Net revenue Cost of revenue Gross profit SG&A expense EBITDA Dep. and amortisation EBIT Interest Other income PBT Income taxes PAT Minority interest PAT after minority interest Profit from associates Exceptional item Final PAT Adj. PAT Diluted EPS Gross margin (%) EBITDA margin (%) EBIT margin (%) 3QFY12 1,445 986 459 225 234 39 195 34 15 176 29 147 2 144 132 276 276 20.9 31.8 16.2 13.5 10.0 2QFY12 1,333 907 426 222 204 51 153 33 59 179 39 139 1 139 102 50 240 290 22.0 32.0 15.3 11.5 10.4 14.7 (5.0) (5.1) (23)bp 90bp 201bp (42)bp (1.4) (25.2) 5.3 380.0 4.0 % chg (qoq) 8.4 8.7 7.6 1.0 14.8 (23.1) 27.3 3QFY11 1,211 788 423 173 250 35 215 25 52 242 36 206 1 205 52 257 257 19.7 34.9 20.6 17.8 17.0 7.4 7.4 6.1 (316)bp (441)bp (424)bp (697)bp (27.2) (18.1) (28.7) 300.0 (29.7) % chg (yoy) 19.3 25.1 8.5 29.7 (6.2) 12.4 (9.2) 9MFY12 4,071 2,747 1,323 643 680 123 557 90 73 541 120 421 4 418 329 50 747 797 43 32.5 16.7 13.7 10.3 9MFY11 3,580 2,318 1,261 530 731 105 626 53 79 651 109 542 2 541 158 (143) 699 555 22.5 35.2 20.4 17.5 15.1 6.9 43.5 90.7 (272)bp (371)bp (381)bp (484)bp (17.0) 9.8 (22.3) 89.5 (22.7) % chg (yoy) 13.7 18.5 4.9 21.3 (7.0) 17.5 (11.0)

PAT margin (%)


Source: Company, Angel Research

Exhibit 2: 3QFY2012 Actual vs. Angel estimates


(` cr) Net revenue EBITDA margin (%) PAT* Actual 1445 16.2 144 Estimate 1511 17.4 184 Var. (%) (4.4) (119)bp (21.5)

Source: Company, Angel Research; 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

Tech Mahindra | 3QFY2012 Result Update

Exhibit 3: Trend in revenue growth for non-BT accounts


200 190 180
(US $mn)

12

9.1 174 164 151 5.8

187 7.3

188 8
(%)

170 160 150 140 130 120

0.7 3QFY11 4QFY11 Non BT 1QFY12 2QFY12 qoq growth

0.6 3QFY12

Source: Company, Angel Research

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 3.0 118 115
(US $mn)

4 1.5 2 0
(%)

116 114

110

(2) (3.5) 110 (5.5) (7.8) (4) (6) (8)

105

100 3QFY11 4QFY11 BT


Source: Company, Angel Research

101 1QFY12 2QFY12 qoq growth 3QFY12

(10)

The companys 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 companys top 2-5 clients drove its growth in 3QFY2012, by registering whopping 0.6% qoq USD revenue growth. Revenue from the companys top 6-10 clients declined by 2.5% qoq during the quarter.

February 9, 2012

Tech Mahindra | 3QFY2012 Result Update

Exhibit 5: Trend in revenue growth of top clients (qoq)


15 10 5.3 5
(%)

13.6 9.3 7.3 3.0 1.7 3.6 1.5 4.1 4.1 0.6 (2.5) (5.5) 1QFY12 2QFY12 Next 5 accounts (7.8) 3QFY12

0 (5) (10) 3QFY11 BT


Source: Company, Angel Research

(3.5)

4QFY11

Next 4 accounts

Utilization level improves


During the quarter, the companys 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 companys 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


3,200 2,400 1,600 76 2,522 1,609 74 0 71 3QFY11 4QFY11 1QFY12 2QFY12 (1,255) 3QFY12 (1,447) 68 S/w professionals
Source: Company, Angel Research

2,793 2,071 1,638 544 72 73

78 76

Net addition no.

800 0 (800) (1,600) (2,400)

224

72 70

BPO professionals

Utilisation (%)

Margin improves
In 3QFY2012, Tech Mahindras 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

(%)

74

Tech Mahindra | 3QFY2012 Result Update

Exhibit 7: Margin trend


40 34.9 35 30 36.7 33.9 32.0 31.8

(%)

25 20 15 10

20.6

20.5

18.7 15.3 16.2 13.5 3QFY12

17.8

17.5

16.1 1QFY12 EBITDA margin

11.5 2QFY12

3QFY11

4QFY11 Gross profit margin

EBIT margin

Source: Company, Angel Research

Client pyramid
Tech Mahindras 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 US$1mn2mn US$2mn5mn US$5mn10mn US$10mn15mn US$15mn20mn US$20mn25mn US$25mn50mn US$50mn+ Active clients 3QFY11 14 19 5 7 2 1 2 3 126 4QFY11 18 16 6 7 1 3 1 3 128 1QFY12 20 13 8 9 1 2 1 3 128 2QFY12 19 14 13 6 2 2 2 2 128 3QFY12 22 13 13 6 2 3 2 2 130

Source: Company, Angel Research

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 BTs quarterly revenue expected to be flat from here. However, there is a caveat that BTs 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

Tech Mahindra | 3QFY2012 Result Update

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 Satyams strong earnings. Thus, the companys core EPS is expected to have a negative CAGR over FY2011-13E. The only potential upside is due to the companys stake in Mahindra Satyam, which is improving its overall profitability. Since, the companys core earnings are subdued and the huge contribution (~33%) to its consolidated earnings is due to Mahindra Satyams profitability, we continue to value the company at 55% discount to Infosys target PE i.e., at 8x the companys consolidated EPS of `86.4 and maintain our Accumulate rating on the stock with a target price of `693.

Exhibit 9: Key assumptions


FY2012E Revenue growth (US$) USD-INR rate (realized) Revenue growth (`) EBITDA margin (%) Tax rate (%) EPS growth (%)
Source: Company, Angel Research

FY2013E 5.7 50.0 11.5 17.1 23.0 2.6

9.5 47.4 7.4 16.9 20.9 70.9

Exhibit 10: One-year forward PE (x)


2,200 1,900 1,600 1,300

(`)

1,000 700 400 100 Jan-08 Jul-08 Price Jan-09 23 Jul-09 Jan-10 18 Jul-10 13 Jan-11 8 Jul-11 Jan-12 4

Source: Company, Angel Research. Note: P/E includes share of profits from Mahindra Satyam 2QFY2011 onwards.

February 9, 2012

Tech Mahindra | 3QFY2012 Result Update

Exhibit 11: Recommendation summary


Company HCL Tech Hexaware Infosys Infotech Enterprises KPIT Cummins Mahindra Satyam MindTree Mphasis NIIT^ Persistent TCS Tech Mahindra* Wipro Reco Accumulate Neutral Accumulate Neutral Neutral Buy Accumulate Neutral Buy Neutral Neutral Accumulate Neutral CMP (`) 465 106 2,807 138 166 72 455 373 45 316 1,227 659 445 Tgt Price (`) 520 3,047 87 502 55 693 Upside (%) 11.9 8.5 20.2 10.3 22.8 5.2 Target P/E (x) 13.0 11.0 18.0 8.5 10.0 11.0 10.0 11.5 6.9 9.0 19.5 8.0 15.3 FY2013 EBITDA (%) 17.5 19.0 32.0 16.0 15.4 16.0 14.7 16.6 16.3 23.0 29.9 17.1 19.7 FY2013E P/E (x) 11.6 11.4 16.6 8.8 10.2 9.0 9.1 10.1 5.6 9.0 19.0 7.6 16.0 FY2011-13E EPS CAGR (%) 22.1 79.4 18.9 11.9 19.9 38.4 42.1 (3.1) 19.3 0.1 20.6 32.3 13.1 FY2013E RoCE (%) 20.9 25.4 25.8 16.1 19.5 12.6 20.3 14.0 11.0 19.4 32.1 15.0 15.3 FY2013E RoE (%) 23.1 22.0 23.8 13.0 16.9 14.4 17.4 14.2 15.6 14.3 33.3 21.1 20.5

Source: Company, Angel Research. Note: ^Valued on SOTP basis,* EPS CAGR includes earnings from Mahindra Satyam

February 9, 2012

Tech Mahindra | 3QFY2012 Result Update

Profit and loss statement (Consolidated, Indian GAAP)


Y/E March (` cr) Net sales Cost of revenues Gross profit % of net sales SG&A expenses % of net sales EBITDA % of net sales Depreciation and amortization % of net sales EBIT % of net sales Interest expense Other income, net of forex gain/(loss) Profit before tax Provision for tax % of PBT Recurring PAT Share from associates Exceptional item Minority interest Profit after minority interest Reported PAT Fully diluted EPS (`)
Source: Company, Angel Research

FY2009 FY2010 4,465 2,638 1,827 40.9 612 13.7 1,215 27.2 110 2.5 1,106 24.8 3 (38) 1,065 118 11.1 947 67 1,014 947 77.4 4,625 2,871 1,754 37.9 622 13.4 1,133 24.5 134 2.9 999 21.6 218 75 856 144 16.8 712 (9) 3 700 709 53.6

FY2011 5,140 3,403 1,737 33.8 734 14.3 1,003 19.5 144 2.8 860 16.7 100 117 877 132 15.0 746 44 (143) 4 643 786 49.3

FY2012E 5,520 3,702 1,818 32.9 887 16.1 931 16.9 165 3.0 766 13.9 115 164 814 172 21.1 642 423 5 1,061 1,061 84.2

FY2013E 6,153 4,094 2,059 33.5 1,009 16.4 1,050 17.1 175 2.8 875 14.2 54 111 932 214 23.0 718 422 1,140 1,140 86.4

February 9, 2012

Tech Mahindra | 3QFY2012 Result Update

Balance sheet (Consolidated, Indian GAAP)


Y/E March (` cr) Equity capital Preference capital Share premium Profit and loss Other reserves Net worth Secured loans Unsecured loans Total debt Deferred revenue Minority interest Total capital employed Gross block Accumulated depreciation Net block Capital WIP Total fixed assets Investments Deferred tax asset, net Inventories Sundry debtors Cash and cash equivalents Loans and advances Sundry creditors Other liabilities Provision Working capital Total capital deployed 11 1,954 908 (410) 498 154 652 435 20 1 902 538 295 (469) (205) (215) 848 1,954 14 5,035 1,131 (527) 604 321 925 3,015 28 1 1,042 219 673 (461) (129) (277) 1,068 5,035 FY2009 122 233 1,401 187 1,943 FY2010 122 237 1,783 744 2,887 750 1,385 2,135 FY2011 126 233 2,365 627 3,351 1,223 1,223 584 16 5,174 1,273 (670) 602 125 727 2,908 64 1,247 267 832 (510) (53) (308) 1,474 5,174 FY2012E 126 233 3,351 627 4,338 907 907 16 5,260 1,433 (836) 597 140 737 2,872 73 1,225 395 883 (528) (65) (331) 1,579 5,260 FY2013E 126 233 4,411 627 5,397 407 407 16 5,823 1,588 (1,011) 577 160 737 2,870 75 1,357 696 1,015 (573) (15) (338) 2,141 5,823

Source: Company, Angel Research

February 9, 2012

Tech Mahindra | 3QFY2012 Result Update

Cash flow statement (Consolidated, Indian GAAP)


Y/E March (` cr) Pre tax profit from operations Depreciation Expenses (deferred)/written off/others Pre tax cash from operations Other income/prior period ad Net cash from operations Tax Cash profits (Inc)/dec in Sundry Debtors Inventories Loans and advances Sundry creditors Others Net trade working capital Cashflow from operating activities (Inc)/dec in fixed assets (Inc)/dec in investments (Inc)/dec in deferred tax asset, net Cashflow from investing activities Inc/(dec) in debt Inc/(dec) in deferred revenue Inc/(dec) in equity/premium Inc/(dec) in minority interest Addition to reserves on amalgamation Dividends Cashflow from financing activities Cash generated/(utilized) Cash at start of the year Cash at end of the year
Source: Company, Angel Research

FY2009 FY2010 FY2011 FY2012E FY2013E 1,170 110 1,280 (38) 1,242 (118) 1,124 194 65 (43) 5 222 1,346 (162) (371) (14) (547) (30) 3 0 (274) (57) (358) 441 98 538 780 134 (9) 906 73 978 (144) 834 (140) (377) (8) (14) (539) 295 (407) (2,580) (8) (2,995) 2,135 5 3 288 (50) 2,381 (320) 538 219 760 144 (98) 805 114 919 (132) 788 (205) 1 (160) 49 (45) (358) 429 54 107 (36) 125 (912) 584 (0) 2 (117) (61) (504) 49 219 267 651 165 425 1,241 159 1,400 (172) 1,228 22 (51) 18 35 24 1,252 (175) 36 (11) (149) (316) (584) (74) (974) 129 267 395 821 175 422 1,418 111 1,530 (214) 1,315 (132) (132) 45 (39) (258) 1,057 (176) 2 (3) (177) (500) (80) (580) 300 395 696

February 9, 2012

10

Tech Mahindra | 3QFY2012 Result Update

Key Ratios (Consolidated, Indian GAAP)


Y/E March 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
Source: Company, Angel Research

FY2009 8.5 7.6 4.4 0.6 1.8 6.6 12.4 77.4 86.2 3.7 149.0 0.9 1.0 0.2 6.8 0.3 48.7 56.6 87.6 48.7 6.8 82 56

FY2010 12.3 10.3 3.0 0.5 2.3 9.3 11.4 53.6 64.0 3.3 221.4 0.8 0.9 0.2 5.0 0.3 24.7 19.8 22.2 24.6 5.0 77 49

FY2011 13.4 10.9 2.6 0.6 1.9 9.5 13.1 49.3 60.3 4.0 257.0 0.9 1.0 0.2 7.1 0.2 22.3 16.6 18.0 23.5 7.1 81 43

FY2012E 7.8 7.1 2.0 0.6 1.6 9.8 12.4 84.2 93.0 4.0 328.9 1.3 1.1 0.1 7.5 0.2 24.5 14.6 16.2 24.5 7.5 81 42

FY2013E 7.6 6.6 1.6 0.6 1.3 7.9 11.3 86.4 99.7 4.0 409.2 1.2 1.1 0.1 8.3 0.1 21.1 15.0 17.6 21.1 8.3 81 41

February 9, 2012

11

Tech Mahindra | 3QFY2012 Result Update


Research Team Tel: 022 - 3935 7800 E-mail: research@angelbroking.com Website: www.angelbroking.com

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Disclosure of Interest Statement 1. Analyst ownership of the stock 2. Angel and its Group companies ownership of the stock 3. Angel and its Group companies' Directors ownership of the stock 4. Broking relationship with company covered

Tech Mahindra No No No No

Note: We have not considered any Exposure below ` 1 lakh for Angel, its Group companies and Directors

Ratings (Returns):

Buy (> 15%) Reduce (-5% to 15%)

Accumulate (5% to 15%) Sell (< -15%)

Neutral (-5 to 5%)

February 9, 2012

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