Tech Mahindra - Strong margin performance - Ambit

Results overview: Tech Mahindra's 3QFY13 revenue increased by 10% QoQ to US$329mn. In INR terms, the revenue increased by 9.8% QoQ to Rs17.9bn, 2% above consensus estimate. BT revenue declined by 3.4% QoQ to US$95mn, whilst non-BT revenue increased by 16.5% QoQ. Excluding the contribution from Comviva and Hutchison acquisitions, non-BT revenues increased by 2% QoQ. EBITDA margins increased by 31bps QoQ, 180bps ahead of consensus expectations, because lower employee benefit (down 104bps QoQ) and subcontracting costs (lower 59bps QoQ) were offset to some extent by higher other expenses (higher 127bps QoQ). Utilisation (including trainees) improved by 200bps, whilst the same excluding trainees declined by 100bps QoQ. Other income was at Rs300mn (including forex gain of Rs.121mn) in 3QFY13 as against a loss of Rs64mn (including forex loss of Rs.695mn) in 2QFY13. Higher revenue, EBITDA margin expansion and higher other income led to 36% QoQ growth in EPS (excluding share in Satyam's profits). The one-time loss of Rs1,254mn on account of the Aberdeen UK settlement led to a 7% QoQ decline in group net profit. Receivable days increased significantly by 9 days QoQ to 109 days. Customers are cautiously optimistic and decision making continues to be prolonged. However, the management was optimistic about the deal pipeline, indicating more than 5-6 large deals in the pipeline with a 6-8-month closing horizon.

The results showed that the Telecom vertical continues to reel under pressure, with discretionary spending remaining soft. Continued weakness in BT means organic growth will be soft, and the management will continue to look for inorganic opportunities to expand its top-line. Although the margin performance during the quarter was commendable (led by utilisation improvements), sustaining the same would be a challenge, given that utilisation is close to the management's upper target range and margin pressure increases as the deals ramp up. We believe that the merger completion with Satyam is a short-term trigger for the stock, with the long-term trigger being a successful integration of Satyam. Key takeaways for our existing coverage are that the Telecom vertical continues to be under pressure, owing to soft discretionary spending, as also highlighted by the companies that reported their results last month. Among the top-4 IT service companies, Wipro has the highest exposure to the Telecom vertical (~14%).

Key takeaways

- Europe business strong; US business rebounds: European business revenues increased by 9.8%. This was the third consecutive quarter of strong performance in the Europe business (revenues increased by 6.9% and 7.6%, respectively in 1QFY13 and 2QFY13). The management indicated that some large deals fructified in Europe. US business revenues increased by 3.1% QoQ, after declining by 0.9% in 2QFY13. Rest of world business revenues increased by 20% QoQ on the back of the 15.6% QoQ growth recorded in the previous quarter. Note that these growth rates also include some inorganic growth.

- BT's revenue share slipped below 30%: Revenue from the largest client, BT, declined by 3.4% QoQ to US$95mn, accounting for 29% of 3QFY13 revenues vs 33% in 2QFY13. Vendor consolidation is not yet over, and the management expects to see some more decline in the next two quarters.

- Telecom vertical continues to reel under pressure: The management indicated that the global Telecom market growth is likely to be flat over the next 2-3 years. Whilst discretionary spending remains weak, the management indicated that they are coming across transformation opportunities as Telecom companies look to cut cost.

- Recent acquisition update: Comviva generated revenues of US$6mn for 19 days. The management highlighted that 3Q and 4Q are seasonally strong quarters for Comviva. Comviva generated strong PAT margins of >40% (estimated based on minority interest) during the quarter. The management suggested that being a product business, margins would be lumpy. The Hutchison business generated revenues of ~US$37mn with mid-teen margins.

- KPN deal to start contributing from 4Q: Whilst the UK Telecom equipment manufacturer deal announced in the previous quarter has already been ramped up, the KPN deal will start contributing to revenues from 4Q. Tech Mahindra also signed a large-sized deal this quarter, which will be ramped up by 1QFY14. Transition costs for the two deals announced in the previous quarter were already absorbed during the quarter.

- BPO restructuring largely over: The management highlighted that with this quarters' headcount reduction, BPO restructuring is largely to be over. The management has closed down many unprofitable BPO accounts to improve the business' margins.

Source : Equity Bulls

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