Tech Mahindra Limited - Improving revenue visibility, scale to drive re-rating - Antique

Tech Mahindra recently announced formal amalgamation of its subsidiary- Mahindra Satyam with itself. This follows court approval from Andhra Pradesh high court. Post merger company will emerge as the fifth largest listed Indian IT services company with revenues of USD2.6bn and employee strength of 84,000. We upgraded the stock to BUY early this year and believe stock has the potential to deliver 27% return from current levels.

Improving revenue visibility

Our BUY rating on Tech Mahindra (TML) is driven by our view that revenue visibility at TML has improved post recent deal wins such as KPN and acquisition of Hutch BPO division. We forecast revenues to grow at 13% CAGR FY13-15E and earnings to grow at CAGR of ~20%. At Satyam checks indicate improving deal pipeline in both manufacturing and BFSI and expect growth rate to be on par with industry by FY15E. Consequently earnings (including Satyam) likely to grow at CAGR of 15%, ahead of Tier one peers.

Merger should help address key concerns on the stock

The merger will help address some of the key concerns for Tech Mahindra. Historically Tech Mahindra valuations have been suppressed due to high client concentration (BT), single vertical exposure and skewed geographical mix. As highlighted in table 1 the merger should help improve client concentration, diversify vertical mix and improve geographical concentration.

While TML hedges stood at USD 700m covering nearly 70% of its net forex receivables, for Satyam hedge stood at USD250mn, covering ~40% of its net forex receivables. Consequently expect company to gain on net basis from rupee given lower hedges at Satyam. Also expect balance sheet to improve for the merged entity with net cash of INR 25bn, 11% of market capitalisation.

1Q -steady quarter

Tech Mahindra will announce consolidated results from 1Q. On proforma basis we expect revenue growth of 1.4% QoQ to USD722m, EBITDA margins expansion of 60bps to 20.6% leading to 8% QoQ EBITDA growth. PAT growth likely to be higher led by higher forex gains during the quarter. Our revenue assumption factors in flattish revenues for Tech Mahindra (impacted by BT) and 2.5%QoQ growth for Satyam led by consolidation of Complex IT (recent acquisition).

Attractive FCF yield, valuations

We tweak estimates to factor depreciating rupee. Expect earnings (including Satyam) to grow at CAGR of 15% over FY13-15E. Forecast EPS of INR96 for FY14E and INR112 for FY15E. Stock trades at 10x FY14E vs. 13-18x for Tier one vendors. Reiterate BUY with target price of INR1270 (~11x FY15E). FCF generation remains healthy for both Tech Mahindra/ Satyam. FCF yield is at ~8% vs historical average of 4-5% for the sector.

Source : Equity Bulls

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