Buy Tech Mahindra - BP Wealth Diwali Picks 2012

Tech Mahindra (along with Mahindra Satyam) is a 5th largest Indian IT company providing solutions and services to the telecommunications industry with a majority stake owned by Mahindra & Mahindra Limited. Tech Mahindra serves telecom service providers, equipment manufacturers, software vendors and systems integrators worldwide. Company's top client is BT and generates maximum revenues from Europe.

Investment Rationale

Improvement seen in the telecom market

Telecom has been one of the worst performing verticals for leading IT vendors over the past two years however now for the past two quarters we are seeing some improvement. Various factors such as geographical expansion of European IT operators, evolution of shared/managed services models, frequently changing pricing plans, bundling of services etc. are driving such demand for Telecom IT services. Tech Mahindra is the largest offshore telecom IT services provider and will be benefitted the most from such an improvement in the environment.

Acquisition of Hutch BPO business to boost revenues

Tech Mahindra has acquired 100% in Hutchison Global Services (HGS) for US$ 87mn, which has a top line of US$160 mn and has US$ 20 mn of Net cash, thus the net out flow is US$ 67 mn. Margins of HGS is in mid teens which is line with14-15% margins for International BPO's. The deal guarantees a business commitment of US$ 845 mn for 5 years affective from 4th Sep 12. HGS will contribute ~US$ 14 mn in Q2 FY12 and US$ 42.3 mn there after every quarter. The acquisition is EPS accretive and will be funded by a combination of debt and internal accruals (we have assumed 70% debt and 30% cash).

Improvement in deal flow and Non BT revenues

Management commentary on deal flows has improved over the past two quarters and remains encouraging. This has reflects in the recent deal wins, the company has won 2 large deals (KPN and large managed services deal from UK likely to ramp up in Q4 FY13) . Although decision cycles are longer in the current environment, the company's pipeline remains healthy and its managed services offerings is seeing good traction. The company sees no pricing pressure in the near term and competition remains stable in the current environment. Non BT revenue are growing strongly (grew 4.8% q-o-q in Q2 FY13)

51% acquisition of Comviva to be EPS accretive

Tech Mahindra acquired 51% stake in Mobile platform and VAS Solution company Comviva for Rs 2600 mn widening its presence in the telecom space and offerings in the booming VAS, MCommerce segment.

Cheap valuation as compared to peers

In view of improving demand environment , inorganic growth through acquisitions (Hutch BPO and Comviva), better performance by Mahindra Satyam, improving deal wins (Dutch telecom deal) and robust deal pipeline we maintain our positive view on Tech Mahindra. We have raise our revenue and PAT estimates for FY13E and FY14E. The stock currently trades at a P/E 9.2 FY13 earnings which we believe is cheap as compared to peers. We maintain our "BUY" rating on the stock and raise our target price to Rs 1,200.

Technical Outlook

Tech Mahindra has given breakout of a sideways channel after which it is expected to resume its previous upmove and head towards 1050-1100 in long term while support comes @880-850. The breakout has come with an increase in volume which increases the reliability of the pattern.

Source : Equity Bulls

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