Sunday, November 14, 2010

Buy Mphasis around 550 target 800 holding 1 year

Investors with a two-year horizon can buy the shares of Mphasis, a provider of software services.

An attractive service-mix, favourable offshore component and benefits of a strong deal pipeline accruing from the HP channel are key positives for the company. These apart, the company has also managed to grow inorganically through the acquisition of AIGSS in 2009 and Fortify Infrastructure Services this year. At Rs 580, the Mphasis share trades at 11 times its likely per share earnings for FY-11.

This is at a discount to peers such as Patni Computer and Tech Mahindra (not strictly comparable). Mphasis' net margin has been in the 20-21 per cent range, in line with what top-tier IT companies enjoy and a good 2-5 percentage points higher than peers.

Mphasis was acquired by EDS in 2006 and ,EDS, in turn, was taken over by HP in 2008. This has given access to the channels of HP and EDS, which have been well-utilised. Revenues from clients won through the HP channel accounts for over 70 per cent of overall revenues.

In FY-09 (it follows an October year-ending), the company reported revenues of Rs 4,263.8 crore, up 43.6 per cent compared to the previous fiscal while net profits stood at Rs 908.7 crore, an increase of 128.3 per cent. With the HP acquisition taking place, the numbers of FY-09 may not offer the best comparison for growth. For the nine months of FY-10 (a more comparable period), Mphasis' revenues grew 17.9 per cent to Rs 3691.1 crore compared with the corresponding previous period, while net profits expanded by 21.6 per cent to Rs 806.8 crore.

Healthy business mix

Mphasis offers application, BPO and infrastructure services. It derives around 65 per cent of revenues from application services, over 20 per cent from infrastructure outsourcing (ITO) and the rest largely through delivering BPO services.

With a bulk of its revenues coming from application development and maintenance and BPO, the company remains less susceptible to volatility in client spends and has a fairly stable revenue base. When HP acquired EDS (which bought Mphasis to its fold), the company managed to expand its capabilities into the fast growing infrastructure services, as clients outsource and go light on IT assets.

Also with over two-thirds of its revenues coming from the US and over 40 percent from the BFSI segment, Mphasis has benefited from the uptick in these segments over the last 3-4 quarters.

Cost optimisation

The company derives more than two-thirds of its revenues from services delivered offshore (mostly India). This has optimised cost for the company considerably.

In terms of manpower, in its various service segments, the offshore strength is 85-99 per cent, among the highest in the Indian IT space.

Billing in its BPO division has remained stable, while offshore billing rates for ITO services have increased. There has been billing pressure in the applications services offering, due to negotiations done with HP.

The management expects billing in this segment to be stable going forward. Any more pressure on the billing front could affect margins. But with robust volume growth and significant offshore proportion may provide some comfort.

Mphasis has also gained from the HP channel. By partnering the global IT major, the company has been able to compete for large-sized deals and win them as well. For instance, over the last one year, the number of clients with annual run-rate of $20 million has increased from 8 to13, with 10 of those coming from the HP channel.

The company's top ten clients have been stable and contribute around 45 per cent of revenues.

Inorganic growth

Mphasis acquired AIG Systems Solutions (AIGSS), a captive of AIG last year. AIGSS, with its offshore facilities based in India, offered twin advantages to Mphasis. One, it allowed for optimal cost structure by taking over readymade facilities and, second, it gave a chance to ramp-up on its applications offerings to the insurance industry along with being able to mine AIG for deals.

Another acquisition of Fortify Infrastructure done earlier this year, has enabled the company expand its ITO offerings. It has also managed a billing hike in its ITO segment based on this acquisition.

Fortify is likely to make annual contribution of close to Rs 100 crore to revenues. This would also position it well while pitching for deals from the HP channel.

Bought to you by

Ingenious Investor

Equity Research Division

Ravina Consulting

No.11 AG Plaza

3rd Cross Kamanahalli


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