Tech Mahindra (TechM) was initially incorporated as a joint venture between Mahindra & Mahindra and British Telecom plc in 1986 under the name of ‘Mahindra British Telecom’. The company has, over the years, developed a niche in the telecom vertical by providing end-to-end services to telecom OEMs and service providers. It has filled gaps in its service offerings in the telecom space through acquisitions of Comviva Technologies (a mobile VAS provider) and Hutchison Global Services (a customer services BPO). Tech Mahindra has entered into the enterprise solutions space through its acquisition of erstwhile Satyam and has now diversified its exposure to other verticals like BFSI and Manufacturing. With ~121,000 employees and FY21 revenue of ~US$5.1bn, Tech Mahindra is the fifth largest Indian IT services company.

Investment Rationale
Margin improvement still has legs: Despite a 360bps EBIT margin improvement since FY21, TechM continues to see further room for improvement in margins, driven by improving operational metrics like offshoring, employee pyramid rationalisation and utilisation, combined with focus on yield management, portfolio synergies and changing business mix. We see upside risk to our forecasts of stable EBIT margins over FY21-24ii.

Rise in Telecom revenue: 5G-related revenues hit a US$500mn annual run-rate in 2QFY22 vs. US$110mn in FY21, leading to a 16% YoY growth in the Telecom vertical. Management expects 5G investments to accelerate going forward, leading to spurt in growth.

Outlook & Valuation:
TechM has restructured its large-deal team which has led to a 3x increase in the average quarterly deal-win TCV since FY18. TECHM is improving operational metrics like utilisation, offshoring and employee pyramid rationalisation, along with improving portfolio companies’ margins, have led to 360bps EBIT margin improvement from FY20 to 2QFY22. Management is confident of exceeding its FY22 guidance of double-digit organic revenue growth and sees room for further margin improvement. Thus, we recommend a buy with a target of ₹1,850 for a 12-month period.