Sell Mphasis for target of Rs 560 - Elara Capital

• Rating : Sell
• Target Price : INR560
• Downside : 7%
• CMP : INR603 (as on 17 June 2010)

Rotating the pain around

In our interaction with the Mphasis CFO Ganesh Murthy, we are not convinced that the direct channel revenue and margin levers available to Mphasis will make up for the repeated realignment of billing rates in the near term. We also feel that an adjustment of the 'go to market' commission rates payable to HP, could be in the offing in this calendar year.

Applications business set to get the chop

It is clear that the restructuring related pricing hit on 'rate cards' is poised to come down on the applications business for Mphasis from Q3 onwards. Recall that price cuts in offshore BPO and ITO had taken place in Q1 of FY10. We note that the applications business comprises 69% of Mphasis revenues. The management has, however, not quantified the quantum of the Q3 price cuts taken. This relates to HP's captive and migration work (~28% of Mphasis revenue).

Few more levers to absorb the shock

The management has pointed out that the different licenses and tools that Mphasis had to buy from EDS will now be given by HP, free of cost. These costs relate to the applications business hence, it will absorb some impact of the price cuts. The management has also outlined savings in G&A and facilities rationalization (moving to Tier-2 locations) as other levers. The impact of the license cost should not be more than 30% (of the total margin impact due to price cuts in the applications business). We, however, think that these levers will only manage to make a rather marginal impact in the short term.

Incorporating Q3 cuts in apps billing rates into estimates

While we were already on the lower side of Street estimates (previous to the Q2 results and the announcement of the pricing restructuring) for FY10, we are adjusting the estimates by incorporating price cuts in the apps business now. Our FY10 EPS now stands at INR48 while our FY11 EPS stands at INR50.

Maintain Sell, Target Price

While the management commentary did not explicitly indicate anything on that front, we expect the second round of revisions to target different lines of business again from Nov 10. This will act as a hangover on stocks for some time. We maintain our target price at INR560 based on DCF valuation.

Source : Equity Bulls

Keywords