MphasiS - Karvy

HP woes continue to haunt - Maintain "SELL"

The USD revenues of MphasiS have been declining for the last three quarters primarily due to weak HP contribution. Its Management has indicated that the discretionary budgets of the clients still remain under pressure with longer decision-making cycles. We believe weak sentiment due to declining headcount (4 quarters) and weak outlook on HP's enterprise services business is likely to persist for some more time. We raise our target price to Rs. 385 per share on account of lower top-client concentration risk, non-HP business growing faster-than-expected and Management's increased focus on profitability, notwithstanding a "SELL" recommendation.

- Quarter Details: The USD revenues of MphasiS declined ~1.8% QoQ to US$266 mn in Q2, while the Company's reported EBITDA margin rose 120 bps QoQ to 19.7% due to aggressive cost-cutting. Continuing the decline trend since last four quarters, the Company's net headcount dipped by 1,619 to 37,179 - a number almost equivalent to Q2FY10. Combined reduction in headcount (2,941) in Q3/Q4FY11/Q1FY12 does not paint a pretty picture in terms of demand. Its Management indicated that HP enterprise service revenues will remain weak, while it expects HP non-enterprise service revenues to grow to ~US$60 mn (up ~70% YoY) in FY12.

- Other Key Points: HP's contribution to revenue remained stable at 58% in Q2. MphasiS added 18 clients in Q2 out of which 14 were from direct channel. The Company's Net Cash & Equivalents stand at Rs. 111 per share - ~30% of the Mkt Cap is in form of cash. DSOs decreased by 8 days QoQ to 80 days in Q2. MphasiS has given wage hikes of ~8% and 3% for offshore/onsite employees respectively, which should impact margins by ~180 bps QoQ in Q3. However, the Management expects to maintain margin sequentially through multiple cost levers.

Outlook & Valuation

We maintain our FY12E and raise FY13E earnings estimates of MphasiS, by 4.1% to factor in the lower currency resets and higher margins. We raise our target to Rs. 385 per share (from Rs. 360 earlier), implying 10xOct'13 EPS (10xApr'13 earlier) owing to lower top-client concentration, likely ramp-up in non-HP business and Management's increased focus on profitability. Upside Risks: More-than-expected business from HP and potential delisting.

Source : Equity Bulls

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