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MindTree Consulting: Conference call excerpts - Views on News from Equitymaster
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MindTree Consulting: Conference call excerpts
Jun 14, 2007

We had a conference call with the management of MindTree Consulting yesterday, with an aim to discuss on the company’s future growth strategies as also to identify the trends in offshoring. Here are the key excerpts from the call. Company background
Mindtree Consulting was incorporated in 1999. It is currently a mid-size IT and R&D services company. The company has two business units that focus on software development – IT Services and R&D Services. Around 75% of the revenues come from IT services and the balance 25% come from R&D services. It has offices in the US, UK, Germany, Switzerland, UAE, India, Singapore, Australia and Japan. MindTree’s IT services business comprises of IT strategic consulting, application development, data warehousing and business intelligence, application maintenance, package implementation and application product engineering. The R&D services division is organised into two sub-divisions:

  1. Engineering, which provides services to technology and product firms including product architecture, product design, product re-engineering and product assurance. This contributes 95% of the company’s R&D revenues.

  2. Research, which conceives and develops intellectual property in wireless communication segment, licenses and customises those intellectual property for the clients.

Mindtree has recorded strong growth in revenues and net profits over the past few years. While revenues grew at a CAGR of 65% during FY04 to FY07, the compounded annual growth in net profits stood at 292%. Also, the company has consistently improved its operating margins, from 3.0% in FY04 to just under 19% in FY07, which is commendable.

Excerpts from the conference call
On operating margins: MindTree has improved its operating margins considerably from 3% in FY04 to almost 19% in FY07. Operating margins for the company are in the middle of the peer group range at 19% for FY07. However, margins have moved upward sharply over the years; the company was loss making at the EBITDA level four years ago (in FY03). Going forward, we expect MindTree to maintain a healthy margin profile, as benefits of higher investments pay off. As per the management, the medium-term margins for the company would be at the upper end of the peer group. However, it might still be lower than the large players, given higher bargaining power and scale advantage of the latter.

On pricing power: Across the industry and including some mid-sized players, some lost pricing power seems to be coming back. The newer clients are coming in with a 2% to 3% increase in billing rates. As a matter of fact, every 1% price hike positively impacts operating margins by 60 basis points (0.6%). Even a small pricing success of the order of 2% can help margins substantially. This should help MindTree to absorb supply side pressures as the offshore wages increase by 10% to 15% annually. Over the last year, MindTree has succeeded in many operational areas including maintaining a healthy volume growth and lowest attrition rates in the industry.

On R&D capabilities: Like Wipro, from where its promoters belong, MindTree also has a strong R&D team that provides product realisation services to technology and product firms including product architecture, product design, product re-engineering, testing, validation and technical support. This division creates and develops intellectual property in wireless communication segment, licenses and customises those intellectual property for the clients thus creating opportunities to cross sell R&D services and supplementing IT services. R&D services generally command higher billing rates than generic IT services, as the technology skill-set requirements are relatively higher for the former.

On manpower management: At the end of FY07, MindTree’s attrition rate was at 16%, much lower than that recorded by its mid-size peers like Mphasis and Tech Mahindra. In fact, the company has been ranked amongst the best companies to work for in India, as is seen from some of the awards that it has won over the past few years. Managing people in terms of attracting and retaining the right kind of talent is key to growth of IT services business. We have seen in the past that some Indian IT services companies have lost businesses on account of non-availability of (right) people to be deployed on projects. The situation is especially serious for mid-size players who do not have deep pockets like their bigger counterparts to attract and retain high quality talent. As such, having a low attrition rate despite intensive competition from talents from domestic and international companies speaks volumes of the managerial capabilities of MindTree.

On global offshoring momentum: Although there are indications that the IT sector in India will be impacted due to any downturn in the US economy and reduction in global IT spending, the company maintains that they are very confident of their sourcing agreements with their clients and maintains that as of now there have not been any incident which could make them think otherwise. The company is also seeing good traction in the banking, financial services and insurance (BFSI) space. We believe that in the short term this may not be a constraint but if there is a gradual decline in IT spending, then mid-size firms like MindTree will be impacted.

On industry risks: The technology services sector is highly competitive and the company keeps facing competition from Indian and International technology services firm and captive offshore centers of large corporation. Secondly, with more than 90% of revenues coming from export of services and 80% of revenue being billed in US Dollars, the exchange rate risk cannot be ignored, as has been indicated by the management. The company has a current hedge of US$ 26 m (around 18% of FY07 revenues).

What to expect?
At the current price of Rs 780, the stock is trading at a multiple of 28.2 times its FY07 earnings. While we are positive on the company’s business model as also its management strength, the fact that R&D services are the first to get impacted in case of a slowdown in global technology spending (as was seen in the first 2 years of this decade) is one of the biggest risks for the company. Also, while it has scored high in terms of talent retention in the past, with competition intensifying by the day and wages rising across the board, the company might have a tough task on its hand. We shall soon initiate our research coverage on the company.

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