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MphasiS FY06 results: Our view - Views on News from Equitymaster
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MphasiS FY06 results: Our view
Apr 12, 2006

Performance summary
MphasiS BFL announced its full-year FY06 results late yesterday evening. The company has reported a decent growth in its topline, driven mainly by the IT services business. However, the BPO business was subdued. Due to savings in selling, general and administrative (SG&A) expenses, the company witnessed a strong margin expansion in FY06. However, mainly due to considerably higher taxes, the bottomline performance under-performed the growth in operating profit.

Financial performance (Consolidated): A snapshot…
(Rs m) 3QFY06 4QFY06 Change FY05 FY06 Change
Sales 2,424 2,505 3.3% 7,657 9,401 22.8%
Expenditure 1,863 1,992 7.0% 6,245 7,420 18.8%
Operating profit (EBDIT)* 562 513 -8.8% 1,412 1,981 40.3%
Operating profit margin (%) 23.2% 20.5%   18.4% 21.1%  
Other income (16) 22   113 94 -16.7%
Depreciation 138 140 1.5% 396 518 30.9%
Profit before tax 408 394 -3.3% 1,129 1,557 37.9%
Tax (1) 43   (117) 58  
Profit after tax/(loss) 408 352 -13.9% 1,246 1,499 20.3%
Net profit margin (%) 16.8% 14.0%   16.3% 15.9%  
No. of shares (m) 160.5 161.0   78.6 161.0  
Diluted earnings per share (Rs)       7.7 9.3  
P/E ratio (x)         22.3  
* Includes amortisation of ESOPs            

What is the company’s business?
MphasiS is a mid-sized player in the Indian software sector. However, despite its small size, the company has carved a niche due to its broad range of quality offerings, particularly in the BFSI segment. The company has a special focus on the BPO segment, which contributes to nearly 32% of the total revenues. In recent times, MphasiS has been relying heavily on acquisitions for growth and has acquired companies in areas such as platform-based healthcare BPO (Eldorado Computing) and consulting (Princeton Consulting). During the period between FY01 and FY06, MphasiS’ revenues and net profits have grown at compounded rates of 28% and 32% respectively.

What has driven performance in FY06?
IT services drive the topline: MphasiS’ IT services business has been the main driver of the topline growth during FY06. This business, driven mainly due to volume growth and acquisitions made in the earlier part of the year, has shown a strong 33% YoY growth during the fiscal. It can be recalled that the company had acquired Princeton Consulting and Eldorado Computing towards the end of FY05 in order to boost this business, which was struggling to grow on an organic basis. However, post these acquisitions, the business has seen decent growth, on a sequential as well as yearly bases. A notable shift towards offshore revenues was noticed this year, with the contribution of offshore revenues rising to 41% from 37% in FY05. Billing rates witnessed a slight up-tick, both onsite as well as offshore. Volume growth was around 23% YoY onsite and 41% YoY offshore. The total number of employees in this business stood at 3,533 at the end of FY06, as compared to 2,741 at the end of FY05. The total number of clients now stands at 295 in this business.

However, as regards the BPO business, this showed a slow growth of 5% YoY. This was mainly due to a ramping up of headcount in order to implement a few order wins during the last quarter, particularly for the domestic BPO business (notably the Bharti order). As reported by the company, volume discounts also led to a drop in average billing rates from US$ 12 an hour to US$ 10 an hour. To give a perspective, volume growth seen in the BPO business was over 25% YoY, while overall revenues grew by under 5% YoY, a clear reflection of the pressure on billing rates. MphasiS ended the year with 7,881 people in the BPO business, as compared to 5,609 people at the end of FY05, taking the total employee strength to 11,414 people (including IT services). The total number of clients in the BPO business now stands at 32.

Lower costs send margins soaring: Operating margins in FY06 rose by an impressive 263 basis points. This was mainly due to savings in SG&A expenses. As a percentage of revenues, these reduced from 17.6% in FY05 to 15.3% this year. The total cost of sales was also nearly constant at 69.0% of revenues. Apart from the cost-side leverage, the company’s margins have been buoyed by the offshore shift witnessed during the fiscal.

Higher taxes dent profit growth: The higher margins resulted in PBT growing at a strong pace of 38% YoY, despite lower other income and considerably higher depreciation charges. However, this was not reflected in the bottomline, which grew at just over 20% YoY. The major reason for this was the taxes paid. In FY05, MphasiS BFL got tax credits (Rs 116.9 m) due to losses in its US operations. This year, however, due to that business reporting profitability, the deferred tax credits got reversed, resulting in a tax outgo of Rs 58.2 m. The company also incurred fringe benefits tax to the tune of Rs 26.8 m.

Performance in the recent past…
  1QFY06 2QFY06 3QFY06 4QFY06
Sales growth (%, QoQ) 7.1 3.5 6.6 3.3
Cost of sales (% of sales) 71.4 67.9 67.9 69.5
Selling expenses (% of sales) 7.0 6.0 5.6 6.4
G&A expenses (% of sales) 8.9 9.7 8.8 9.3
EBDIT margins (%) 17.8 21.8 23.2 20.5
Profits growth (%, QoQ) 8.8 19.2 1.7 (13.9)
Employees (Nos.) 8,173 9,512 10,871 11,414

What to expect?
At the current price of Rs 208, the stock is trading at a price to earnings multiple of 22.3 times its FY06 earnings, and 13.0 times our estimated FY08 earnings. The board of directors has recommended a final dividend of Rs 3 per share for FY06 (dividend yield of 1.4%).

MphasiS has marginally under-performed our FY06 revenue estimates by 1.7%, mainly due to the under-performance of the BPO business by nearly 5% as compared to our estimates. However, the IT services business’ performance has been just about what we had estimated for the year. The company has reported a decent operating performance this year, witnessing impressive margin expansion, which has exceeded our estimates. While we had estimated EBIDTA margins of 20.5% in FY06, the company has registered a 21.1% margin. However, due to the considerably higher taxes, the bottomline has seen a 4.9% under-performance relative to our estimates.

With the EDS deal in the background, we believe that any action on this front will be a strong positive for MphasiS. EDS’ vast global network of over 50 countries, as well as a strong client base, will enable MphasiS to broaden its service offerings and leverage the former’s global network to sell to its large clients. Given EDS’ urgent need to strengthen its offshore presence, MphasiS could also witness stronger volume growth, as the possibility of the former offshoring a part of its work with existing clients as well as recent large deals won is strong.

Given better traction in its IT services business and ramping up of the domestic BPO business in order to service orders like the Bharti deal, revenue visibility in the medium term is good. The possibility of EDS acquiring a majority stake in the company can also not be ruled out, in which case, the company will certainly get a big boost.

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