Tech Mahindra - All set to join the Big league - PhillipCapital

Formidable force post Satyam integration; superior return profile

Post integration with Satyam, Tech Mahindra (TechM) has transformed into a full range IT service provider, with significant presence in all key geographies and verticals. We expect the combined entity to benefit from TechM's expertise in Telecom and Satyam's presence in manufacturing and BFSI space. The combined entity has a strong presence in Europe, which we expect to be the next frontier for the Indian IT Services sector.

Overall, we expect TechM to report topline CAGR of 17% over FY13-15 and maintaining average EBITDA margins of ~22% over the period. The PAT is expected to grow by 31% over this period, enabling the company to deliver average ROE of ~25%.

Strong presence in Europe to boost growth, as it opens up to outsourcing

Our analysis of the top 80 companies (by capex spend) in Europe, in each of the four sectors (telecom, manufacturing, BFSI and retail) reveals that 21 of those have never outsourced and another 35 have outsourced, but not offshored their IT development work. That, in our opinion, is a testimony to the potential that the region represents, for the Indian IT companies.

TechM has been one of the most active Indian IT vendor in the European region, with over 33% of its revenues coming from EU. Its growth over the last six quarters too, has been much ahead of peers. We expect the trend to continue, and the company to benefit immensely from more companies opening up to outsourcing, on the back of cost pressures and regulatory changes.

Domain expertise in Telecom to drive growth momentum

TechM has always had strong expertise in the Telecom domain. Today, it is one of the preferred IT vendors for telecom companies. It has also been able to add key clients (eg AT&T, Verizon) to its portfolio. The division has grown by CQGR of 8.9% (excl BT) over the last six quarters. We expect higher momentum of deals in the telecom space, driven by regulatory changes and advent of new technology (smartphone, mobility, social media) and TechM to grab larger part of the same.

Multiple avenues for margin expansion

TechM has a significantly lower blended pricing level for services provided as compared with the peer average of $38/hr. Along with utilization levels (currently at 77%), we see the company with significant headroom for margin expansion over the next few years.

Bundled services to support growth in other verticals

In order to enrich its portfolio, TechM has been bundling its Communications & Networking services with Enterprise Solutions – an expertise gained from Satyam. The company intends to target multiple CXOs of an organisation and boost business from strong client mining. We expect the strategy to payoff, as it has for HCL Tech.

Attractive valuations – definite case for FURTHER re-rating

On our current estimates, the stock is trading at 15x FY14 and 13x FY15 earnings. While the stock has run up significantly over the last six months (6m 77%, 12m 90%), we believe the stock still trades at a significant discount to its peers (top 4).

As stated before, post integration with Satyam, TechM has transformed into a full range IT service provider, with significant presence in all key geographies and verticals and reduced client concentration. Hence we believe it should get a multiple in-line with the top 4, especially Wipro and HCL Tech.

We value the company at 14x avg FY15-16 earnings (30% premium to its historical average, but in-line with our multiple for Wipro and HCL Tech). That gives us a price target of Rs2150, representing 18% upside from current level. We initiate with BUY.

Source : Equity Bulls

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