Tech Mahindra - Not the real McCoy - Sell - Ambit

Tech Mahindra's share price has increased by 90% since the merger announcement with Satyam in March 2012 thanks to currency benefits and anticipated merger synergies that remain elusive. With a structurally weak Telecom vertical still half the business, the growth onus remains on the Enterprise business, which continues to struggle to break into large deals. With anaemic organic growth and low visibility on future growth drivers, shares appear pricy at 11.2x FY15 EPS. We initiate coverage with a SELL stance and a TP of Rs. 1,222.

Synergies still out of sight

Even after 1.5 years of the merger announcement, there appear few material signs of potential synergies. Indeed, our analysis indicates significant client overlap (particularly in larger accounts) between Tech Mahindra and the erstwhile Satyam. The erstwhile Satyam business continues to struggle to win large deals and seems to have lost the improved deal win momentum displayed in 2HFY13. We have pencilled in 10.8% organic revenue CAGR over FY13-16 for the Satyam part of the business.

Telecom - Historical success does not guarantee a brighter future

Given Tech Mahindra's presence in most large accounts and intense vendor competition, the long-term growth visibility remains low, whilst BT continues to be a drag. Tech Mahindra lacks distinct competitive advantages to maintain the historical (15-20%) growth in managed services offerings. We expect 9.5% organic revenue CAGR in the Telecom vertical ex-BT (4% including BT) over FY13-16, led by managed services offerings and the promising KPN account.

Enterprise business remains sub-par

Tech Mahindra's enterprise business (the erstwhile Satyam) continues to be subscale in most verticals outside of manufacturing that makes it harder to participate in overall sector growth. Our client analysis with help of a custom customer database indicates weak momentum in client revenues and poor account farming credentials. Finally, this business remains exposed to softness in discretionary spending in enterprise application services.

Valuation: Too close for comfort

Tech Mahindra currently trades at a slight premium to its historical valuations and close to the multiples of the better-placed peer, HCL Tech. Lack of material improvement in business fundamentals and low visibility on long-term growth do not justify current multiples. Our DCF model TP of Rs. 1,222 implies 10x FY15 P/E and 5.4x FY15 EV/EBITDA. We initiate coverage with a SELL stance.

Source : Equity Bulls

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