CMP Rs955, Target Rs1,100, Upside 15.2%
Tech Mahindra reported an inline dollar revenue performance for Q2 FY13. The company registered dollar revenues of US$299.6mn a growth of 6.5% qoq boosted by the consolidation of the Hutchison Global (HGS) acquisition (1- month contribution of US$13.3mn). On an organic basis, Tech M dollar revenues grew 1.8% qoq on the back of better than expected growth of 4% in the Non BT clientele. In rupee terms, revenues grew by 5.7% qoq to Rs16.3bn
The BT business, against our expectation of zero growth, declined 2.4% qoq in GBP terms. Management alluded that the freeze in certain project development work due to London Olympics and continued rationalization of IT business were the key reasons for the de-growth. This is expected to continue further for a few quarters before it stabilizes. Non BT clients on the other hand grew better than expected (+4% qoq) offsetting the de-growth in the BT account.
Growth in the top clients (excluding the Top client BT) was strong partly supported by the integration of HGS. While top5/top10 clients' growth was 4%/5% qoq, the growth excluding top client was much stronger. For instance top2-5/top6-10 clients grew 9%/18% qoq. Among geographies, growth was led by RoW and Europe which grew 12% and 9% respectively on a sequential basis. The strong growth in client metrics as well as geographies was both due to HGS integration as well as traction from managed services as well as cost efficiency services in the non BT clientele.
Due to addition of ~12000 employees (gross) post the integration of HGS, the total employee base growth was nearly 25% over Q1 FY13. The employee strength is now divided equally between IT services and BPO. Despite the strong gross additions, the net additions were lower at 9849 employees due to ongoing rationalization exercise as well as weakness in certain clients esp. BT. On the positive side, the reported attrition for the company came down appreciably to 16% (19% in last quarter).
Due to the on-going rationalization exercise (as evident in the correction in organic employee base), the OPM for Q2 FY13 came better than expected at 20.7%. The operating margin corrected only 69bps against our expectation of 180 bps due to salary hikes as well as integration impact of lower margin HGS business. The salary hikes (6% offshore and 2% onsite) impacted the OPM by 150bps and the HGS integration impacted nearly 30bps. These headwinds were largely offset by the rationalization exercise and absence of visa costs. Going forward, transition costs of large deals, integration of lower margin HGS and Comviva (integrated in our FY13 estimates) are near term margin headwinds. While the other income was largely in line with expectation, the tax outflow was significantly lower (ETR 12.4% versus 23.7% in Q1 FY13) due to certain one-off tax refund. Both the better than expected OPM as well as lower tax outflow resulted in better than expected PAT at Rs2.96bn (Satyam contribution of Rs1.19bn).
On the whole, we liked the Q2 FY13 results due to the strong traction on non BT clients, decent deals wins (won 2 large deals in Q2 FY13) and robust OPM performance. While the continued weakness in BT account came as a negative surprise we have now factored further correction in the same. We remain enthused by the sustained traction as well as strong OPM performance for both Tech M and Mahindra Satyam. Post incorporation of HGS and Comviva, we now dollar revenues/rupee earnings to witness 11%/9% CAGR over FY12-14E. We maintain BUY with 9-month TP of Rs1,100.