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Tech Mahindra: Haunted by debt - Views on News from Equitymaster
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Tech Mahindra: Haunted by debt
Jul 23, 2009

Performance summary
  • Topline grows by 6% QoQ in 1QFY10 on account of improved volumes across business segments.
  • Operating margins contract by 1.8% QoQ despite cost containment measures and due to high base effect as margins had improved significantly in the last quarter on the back of some policy change pertaining to employee costs.
  • Bottomline declines by 43% QoQ during the quarter, dented by high interest cost of Rs 571 m as against Rs 23 m in 4QFY09. This was the interest outlay on debt of Rs 24 bn raised for funding the acquisition of Satyam. There was also an impact of unfavorable currency movements.
  • Adds 510 employees during the quarter thereby taking the total strength to 25,482 at the end of June 2009.

Consolidated Financial Snapshot
(Rs m) 4QFY09 1QFY10 Change
Sales 10,513 11,130 5.9%
Expenditure 7,671 8,325 8.5%
Operating profit (EBITDA) 2,842 2,805 -1.3%
Operating Profit Margin (%) 27.0% 25.2%  
Other income 78 (261)  
Interest 23 571  
Depreciation 286 296 3.3%
Profit before tax 2,610 1,677 -35.8%
Tax 306 268 -12.5%
Minority interest (1) (8)  
Extraordinary income/(expense) - (85)  
Profit after tax/(loss) 2,303 1,316 -42.9%
Net profit margin (%) 21.9% 11.8%  
No of shares (m)   121.9  
Diluted earnings per shares*#   72.8  
P/E ratio#   10.8  
# On a trailing 12-months earnings basis

What has driven performance in 1QFY10?
  • Tech Mahindra recorded a 6% QoQ growth in topline during 1QFY10. This was driven by decent performance from its telecom service provider (TSP) and BPO segments. The TSP business (86% of total revenue) contributed maximum to the growth as sales here grew by 7% QoQ during the quarter. BPO services (6% of total revenue) also recorded a healthy growth of almost 26% QoQ during the quarter. The third business segment of telecom equipment manufacturing (TEM) declined by 8% QoQ during the quarter.

    Segment-wise revenue breakup
    Revenues (Rs m) 4QFY09 1QFY10 Change
    Telecom service provider(TSP) 8,928 9,514 6.6%
    Telecom equipment manufacturer (TEM) 720 662 -8.1%
    BPO service 537 677 26.0%
    Others 327 278 -15.1%
    Total 10,512 11,130 5.9%

  • The company derived 29%, 61% and 10% of its revenues in 1QFY10 from the US, Europe and ROW (rest of the world) regions respectively. Though the performance in the European market remained muted, the company saw a lot of traction from the Middle-East, US and Indian markets. It entered into a number of deals centered on mobile number portability, greenfield GSM operations and digital city projects in the Middle-East.

    Geography - wise revenue breakup
    Revenues (Rs mn) 4QFY09 1QFY10 Change
    US 2,103 3,228 53.5%
    Europe 7,885 6,789 -13.9%
    Rest of the world 526 1,113 111.7%

  • Tech Mahindra’s operating margins contracted by nearly 1.8% QoQ during 1QFY10. The margins declined to 25.2% from the 27% levels seen in 4QFY09, despite the cost containment measure, and better utilisation levels on account of increased employee cost. This QoQ increase in cost was due to the base effect resulting from lower employee costs in 4QFY10 on account on some HR policy changes.

  • Tech Mahindra’s bottomline declined drastically by 43% QoQ. This was primarily because of huge interest costs incurred in the quarter for the debt borrowed to fund Satyam’s acquisition. Net profits were also impacted by a large negative other income component arising from hedging losses due to appreciation of rupee against the British pound. The company also created a provision of Rs 85 m for writing off its investments in a UK based company, Servista, which closed down its operation.

What to expect?
At the current price of Rs 784.55 , the stock is trading at a multiple of 10.8 times our estimated FY10 earnings. The management has indicated that though they see first signs of revival in the business sentiment, they continue to maintain a cautious view with regard to the ongoing economic slowdown. Investors need to take into account the fact that the company is exposed to risk of single client (British Telecom or BT) dependency, which could be seen in the quarter in terms of significant pricing pressure from BT. Nevertheless, the company is confident of its growth in the emerging economies particularly Middle-East and India, placing it as a leading player in the telecom vertical.

The company has been aggressive in its approach towards growth, which is evident from its acquisition of 42.7% stake in Satyam (now Mahindra Satyam) through a net borrowing of Rs 24 bn. It is important to note that the management intends to prepay this debt as soon as possible based on the availability of surplus cash. The management is upbeat about the synergies that can be drawn from Mahindra Satyam on account of broadening of the IT services portfolio in terms of offerings, industry verticals and geographies.

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