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MphasiS BFL: Managing risks

Feb 23, 2005

One mid sized Indian software company that has shown strong growth in the past and seems to be moving in the right direction as far as focus is concerned in MphasiS BFL. Despite being a mid-sized player, MphasiS has a broad range of service offerings, which includes IT consulting, architecting solution, development & maintenance of applications, transformation of legacy systems, application life cycle maintenance (ALCM), enterprise application integration (EAI) and testing. In this article, we take a look at how the company has performed in the past and what challenges lie ahead of it. Performance over the years

As can be seen from the table below, MphasiS' sales and profits have been growing at a very healthy rate. The company has been focusing on its BPO business in a big way, as can be seen in the segmental break-up below. There is, however, a lot of scope for the company to grow its IT services business, which has not been showing any decent growth since the past 8 quarters. Going forward, given the company's BPO focus, and scope for growth in other verticals serviced by it, we believe that providing increased value-added services on the BPO side, such as transaction processing, insurance claims processing, and also financial research and analytics, will be the main drivers of growth. Verticals such as financial services and technology will also drive growth in future, with the company having recently increased its focus on its flagging IT services business through a series of acquisitions.

(Rs m) FY02 FY03 Change FY04 Change 9mFY05 CAGR (%)
Net sales 3,133 4,293 37.0% 5,806 35.2% 5,606 36%
Operating profit (EBDITA) 344 753 118.9% 869 15.4% 752 59%
EBDITA margin (%) 11.0% 17.5% 15.0% 13.4%
Profit after tax/(loss) 408 669 64.0% 986 47.4% 937 55%
Net profit margin (%) 13.0% 15.6% 17.0% 16.7%
No. of shares (m) 16.8 17.7 36.6 78.0
Diluted earnings per share (Rs)* 24.3 37.8 26.9 16.0
(* annualised)

Now, despite a decent track record of good performances in the past, there are three major risks that the company faces, mainly on account of its small size and non-derisked business model. These are -

  1. Client concentration - MphasiS is highly dependent on its largest client, with the contribution from the same in FY02, FY03 and FY04 being 14%, 13% and 13% respectively. Any event that results in the relationship with this client turning adverse has the risk of MphasiS getting significantly impacted. The company already has a large proportion of its revenues coming from project-based contracts. This is to say that when a project gets over, unless there is some other project to fill in the gap, the company gets hit on the utilisation front that consequently impacts revenues and profitability.

  2. Regional concentration - MphasiS is highly dependent on the US market for its revenues. In FY02, FY03 and FY04, the company earned 66%, 72% and 78% of its revenues respectively from the US markets. Thus, any slowdown or adverse developments in this market would affect the company's business. The company is making sustained efforts to diversify into other markets. A case in point is the recent acquisition of Princeton Consulting in the UK, which shows the efforts the company is taking towards expanding its base, particularly in the European market.

  3. Vertical concentration - MphasiS has divided its business into 4 major segments or verticals: financial services, retail, logistics & transportation, technology and IT enabled services (BPO).

(Rs m) FY02 FY03 Change FY04 Change
Financial Services
Net Sales 1,411 1,785 26.5% 2,100 17.6%
EBIT 691 882 27.6% NA NA
EBIT margin (%) 49.0% 49.4% - -
Retail, Logistics & Transportation
Net Sales 843 945 12.1% 1,214 28.5%
EBIT 357 417 16.8% NA NA
EBIT margin (%) 42.3% 44.1% - -
Technology
Net Sales 646 626 -3% 622 -1%
EBIT 302 299 -1.0% NA NA
EBIT margin (%) 46.7% 47.8% - -
IT Enabled
Net Sales 234 936 300% 1,870 100%
EBIT 55 285 418.2% NA NA
EBIT margin (%) 23.5% 30.4% - -

As can be seen from the above table, the financial services vertical contributes the maximum revenue to the company. In FY02, FY03 and FY04, the company earned 45%, 42% and 36% of its revenues respectively from the financial services vertical. Therefore, any slowdown in this sector, and subsequent reduction in technology spending by clients in this sector would adversely affect the company's profitability. There is a risk to that extent. In order to mitigate this risk, the company has been increasing its focus on other verticals, apart from its BPO business.

What to expect?

MphasiS has shown an impressive past performance, with net sales, operating profits and net profits during FY02 to FY04 growing at CAGRs of 36%, 59% and 55% respectively. The execution skills that it has acquired will stand it in good stead going forward, with the company increasingly moving its operations offshore. However, given its small size and the resource constraints that it has faced in the past, we expect the spending towards employees and sales and marketing initiatives to continue aggressively in the future.

As regards valuations, the stock, at its current price of Rs 254, is trading at 15.9 times annualised 9mFY05 earnings. While these valuations are at the higher end of the spectrum when one considers the short term, we believe that, given the company's good growth prospects, the risk-reward equation favours investors with a 2 to 3 year time horizon.

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