Tech Mahindra Limited - Key concerns subsiding, upgrade to BUY - ANTIQUE

We reset estimates for Tech Mahindra Ltd. (TML) and Satyam Computer Services Ltd. (Satyam) and upgrade TML to a BUY. We believe revenue visibility post recent deal wins (such as KPN) have improved for TML and contribution from inorganic initiatives (Hutch Global Services/ Comviva) should help drive 12% EPS CAGR (FY12-15e) for TML standalone and 14% EPS CAGR for the combined entity. Satyam, TML's subsidiary, is seeing increasing deal participation levels with improving win ratios. Deal sizes too have improved, and we expect the company to achieve industry level revenue growth in FY14e.

Stock at 10x FY14e (combined earnings) is attractive and trades at 9.5x FY14e at a 25% discount to peers such as HCLT. Value TML at 12x and raise target prices to INR1,160, upside of 26%. Target price for Satyam at INR137 is at 12x FY12 and in line with implied target prices based on swap ratio of 17:2 announced for the merger.

Key highlights

Revenue concerns abating

While spends in telecom environment remains sluggish , we expect revenue growth for TML to improve over the next 1-2 years led by deal wins. Large deal win from KPN and contribution from Hutch Global Services acquisition (USD 850m over 5 years) should drive growth. AT&T, its second largest account, should see recovery from 1QFY14e post ramp down in one of the projects, and BT its top client potentially could stabilise given downside in revenues over 30% since peak levels in FY08 and retendering of contracts is already done with. Overall, we forecast revenues to grow at 15% CAGR (FY12-15e) in TML. Satyam is seeing increasing deal participation levels and improving win ratios. Deal sizes too have improved and checks indicate strong deal pipeline including two to three large USD100m plus deals. See triggers in large deal closures for Satyam.

Margins expansion sustainable

TML adjusted EBITDA margins stood at 18% (2Q FY13) and factors in impact of ramp down in top client BT. We believe current margin levels are sustainable given: 1) likely SG&A leverage from deal ramp ups; and 2) scope to improve margins in Hutch account. We expect margins to remain stable at ~17.5-18% for TML and around ~21% for Satyam. On proforma basis, the combined entity is likely to enjoy margins of 19%, on par with Tier-1 vendors.

Valuation and outlook

We value the company on basis of combined entity (proforma earnings). We forecast proforma EPS CAGR of 14% over FY13-15e leading to EPS of INR97 for FY14e and INR111 for FY15e. Stock trades at 9.5x FY14e and has scope to rerate to 12x led by increased revenue visibility and potential deal closures. Key risk: client concentration- ramp down amongst top 2-5 clients and appreciation of rupee. Upgrade TML to BUY with a TP of INR1,160.

Source : Equity Bulls

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