MindTree - Fundamental Call - Consortium

Revenue growth to accelerate in FY14. We expect MindTree's USD revenues to grow ~12% in FY14 vs. an expectation of 8.2% growth in FY13. Our confidence is based on the following factors:

- Worst likely behind in Product Engineering Services (PES). MindTree's PES revenues have declined ~5% YoY in 9MFY13. However, we expect PES revenues to grow ~5% in FY14 as 1) rationalisation of long tail is largely behind and 2) ISV segment, which is 65% of MindTree's PES revenues (Microsoft is the biggest client), continues to be strong across OPD service vendors (like Persistent Systems). Further, the semiconductor segment, which dragged growth so far in FY13, seems to be stabilising, though the consumer electronics / communication segments continue to remain weak. PES contributes 30% to the total revenues of MindTree.

- Feedback from top 30 clients (~2/3rd of revenues) encouraging for CY13 budgets. Excluding one IT Services client, who is facing challenges in budgets and spends, the remaining of the top 30 clients have indicated higher budgets and spends with MindTree for FY14 versus that in FY13.

- Stronger order pipeline; company investing accordingly. Order pipeline exiting CY12 is significantly higher than that exiting CY11. MindTree has invested in a large deals team, which comprises seven members and is led by a senior recruit from industry consultancy, TPI. The company is currently engaged in eight large deals with size varying between USD20mn and USD100mn.

- Expected pickup in discretionary spends. Some of MindTree's clients are expanding their operations in emerging geographies, which is driving them to invest in transformational initiatives. This should lead to a pickup in implementation, consulting and IP led revenues. However, this would be a smaller driver unless development spends (around 26% of revenues) pick pace as well, as implementation, consulting and IP put together contributes just 8.6% to the company's revenues.

- Share gain in multi-sourcing situations. MindTree seems to be gaining share in instances where clients are looking at adding some vendors on the IT delivery side.

High conviction on constant currency margin management. MindTree has a significant opportunity to right size its employee pyramid. As an example, employees with less than three years of experience form just around 31% of MindTree's total employees as against around 38-40% for companies like Infosys and TCS. MindTree is focussing heavily on this aspect, with the company expected to extend offers to 2,000 freshers in FY14 (75-80% may join) vs. 800 in FY13. For perspective, MindTree has total employee base of just 10,952. Focus on managed services should also help manage margins through better productivity.

Valuations reasonable. MindTree is trading at just 8.7x our FY14 EPS estimate of Rs97.3, which is lower than its historical average of 10x. We expect EPS to grow at a CAGR of 11.4% over FY13-15.

Source : Equity Bulls

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