Tech Mahindra - Initiating Coverage - Synergy from recent acquisitions to power near-term - Centrum

Rating: Buy; Target Price: Rs2,090; CMP: Rs1,670; Upside: 25.1%

Synergy from recent acquisitions to power near-term

TechM is a Tier-1 equivalent in Telecom and Enterprise Svcs and has strengthened its position with strategic acquisitions over FY13 (vCustomer, Hutch Global Services, Comviva and Complex IT). In verticals where it lags Tier-1 providers, TechM can target IT-Outsourcing contracts with mid-market clients while maintaining relationships with top-tier clients through niche services. We expect price realization to decline slightly over 2HFY13 as BT restructuring fees run out but bounce back as deals in transition currently move to billing. We initiate TechM with a Buy Rating and a price target of Rs 2,090 (13x 1-year Fwd EPS in Sep'14).

Tier-1 level capabilities in Telecom and Enterprise Services, niche in others: We think TechM's management has a pragmatic approach - focusing on areas of strength such as Telecom and Enterprise Svcs where their capabilities match that of bigger Tier-1 peers. It has supported this strategy with carefully chosen acquisitions (which we expect to see results of over FY15). For other verticals such as BFSI, the strategy is to use chosen niches such as enterprise mobility to maintain relevance to Tier-1 clients while exploring larger deals for IT outsourcing with mid-sized firms that will want to be given high mindshare by their vendor.

Strategy to support increasing wallet-share with Telecom customers: The six pillar strategy in Telecom (IT, Networks, Infrastructure, BSG - Business Svcs Group, VAS and Security) will yield results as Telecom Service Providers are under increasing pressure to lower cost of operations as they invest in network upgrades. Acquisitions of Comviva and Hutch Global Services have also been towards supporting this strategy. The managed services deal with BASE in Belgium is an example of this strategy at work and we expect to see deal traction pick up over FY15 for Managed N/w Svcs and BSG both - with Customer Support in particular seeing very good growth.

Deftly positioning itself differently even for mainstream services: TechM's focus strategy enables it to match Tier-1 investments thereby avoiding the disadvantages of lower scale - especially in Europe where its scale comes closer to Tier-1 peers. Its strength in Enterprise Svcs is maintained with investments in internal IP even as acquisitions such as Complex IT (in Brazil) increase its addressable market. In commoditized services such as Testing, TechM has chosen to differentiate with a focus on niche services, open-source tools and outcome-linked pricing.

Valuation and key risks: TechM's EPS is understated as 24Mn of its shares (~10.4% of shareholding) are under the TML Benefit Trust. Even without adjusting for this, TechM is trading at an attractive valuation of 12.3x 1-year forward EPS. While there are near-term margin headwinds as BT's contract restructuring fee for Barcelona and Andes contracts run out in 4QFY14, we expect this to be not as dilutive as many others view it. We assign a Buy rating, with a TP of Rs 2,090 based on 13x 1-year Fwd EPS at Sep'14. A key risk is the potential loss of some contracts from BT as these are up for renewal. Other major risks come from the exposure to the global economy and the concentration of revenue in Telecom (47%) and Manufacturing (19%) verticals.

Source : Equity Bulls

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