Mphasis BFL: Mixed performance

Mphasis BFL has reported of a 7% growth in consolidated revenues and a 4% growth in net profits for 1QFY03, on a sequential (QoQ) basis. Compared to corresponding quarter (1QFY02), the topline and bottomline have grown by 23% and 188% respectively. While the numbers on the first glance look impressive, delving deeper we see signs of strain.

The company’s revenues from software services business have shown a marginal decline during the quarter. Thus, Mphasis’ major revenue stream, which accounted for 84% of total revenues, is finding it difficult to grow. The growth in topline is due to the steep growth in revenues from Mphasis’ call centre subsidiary, MsourcE. The swift growth has increased MsourcE’s contribution to the total revenues from 10% in 4QFY02 to 16% in 1QFY03.

Highlight of the performance is the fact that the consolidated entity (MsourcE and Mphasis) has managed to improve operating margins. This has been possible due to MsourcE, which turned profitable and added to the operating margins. The operating margins of the software business (Mphasis) showed a marginal decline. However, the topline growth and the improvement in operating margins (for the consolidated entity) are not reflected in net profit growth due to a steep rise in taxation. The rise is due to the imposition of taxes from 1 April 2002 on export profits of the Indian units as per Union Budget.

Mphasis saw a significant growth in revenues from onsite projects. Consequently, the contribution to revenues from onsite revenues increased from 55% in 4QFY02 to 59% in 1QFY03 and the contribution of offshore revenues declined from 45% in 4QFY02 to 41% in 1QFY02. The gross margins were adversely impacted by change in the onsite offshore mix. However, the company managed to offset the decline by aggressively cutting other cost heads. The company managed to negotiate a billing rate hike for onsite projects, while the billing rates for offshore projects continued to decline.

For the software services business the revenue and the geographic mix remained almost the same compared to 4QFY02. There was a decline in business from the financial services vertical. Consequently, the share of the technology vertical increased from 19% in 4QFY02 to 21% in 1QFY02 and that for the financial services declined from 53% to 51%. US continued to dominate the geographic mix with a 67% share. While the revenues from Europe decline steeply, this was offset by increase in revenues from Japan. Europe’s contribution to the revenues was 12% and Japan contributed another 9%.

MsourceE continues to grow at a break neck speed. The company’s revenues from the call centre subsidiary grew by 68% sequentially. The growth was 274% on a YoY basis. The number of employees has grown from 705 in 4QFY02 to 1,096 in 1QFY03 a growth of 55%. The company earns 97% of its revenues from the US and 5 clients accounted for 87% of the revenues. 89% of the revenues were from the banking vertical and the remaining came from insurance (6%) and retail (5%) verticals. Undoubtedly the company has managed growth very well. However, the risk element in terms of client concentration and exposure to a single geography is significant.

During the quarter MsourcE added one new client, while Mphasis added 14 new clients. These include a large international financial institution, Emirates Bank, Sony Corporation and a large insurance company in India. Nine of the clients added, are from the financial services vertical.

Thus, while the numbers look quite impressive on a consolidated basis, the fact remains that the company’s major revenue stream, Mphasis, is going through a tough time and the call centre subsidiary is in its nascent stage. For that matter the whole of IT enabled services industry is in its initial stage. As the segment grows at swift there could be some surprises on the way. At the current market price of Rs 535, the stock is trading at a P/E multiple 17x 1QFY03 annualised earnings.