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MphasiS: A recap…

Oct 7, 2003

One of the first companies from the software sector to announce its results for the September quarter is MphasiS. And before it does so, let us take stock of the company’s performance in the previous few quarters and see where it seems to be moving in the future.

As seen from the graphs above, the performance of MphasiS has been under pressure in the past few quarters, mainly on the operating margins front. On the topline growth front, while the company has moved in tandem with its peers, the fact that its small size is still a deterrent for the company to garner large size orders has led to its revenue growth be subdued in the past. Also, when compared to its large size peers, the small size of its orders has kept the pressure relatively lesser on MphasiS’ billing rates. Going forward, as the company scales up its operations and bigger contracts flow in, a greater pressure on the pricing front is expected. However, higher volume growth is likely to compensate for this pressure in pricing.

On the margins front, MphasiS has suffered on account of its high investments in human resource and infrastructure development. On the human resource front, the company is ramping up fast as seen by the additions of 533 and 463 people to MsourcE (the BPO subsidiary), during 4QFY03 and 1QFY04, respectively. This has taken the total staff strength for MsourcE to 3,120 employees by the end of 1QFY04. Going forward, MphasiS is likely to add around 1,000 more employees to MsourcE to take the level to the planned 4,000 employees by the end of FY04. This seems to be a sign of the company’s expectations of strong growth in outsourcing business going forward.

On the infrastructure front the company has recently invested in new development centres in Mumbai and Shanghai and a call centre in Mexico. Also, continued investments are being carried out in order to perk up the company’s selling and distribution network. Going forward, as the company realizes benefits of these investments, pressure on margins is likely to reduce owing to lessened incremental expenditure.

A look at valuations...
(P/E) 30-Jun-03 7-Oct-03
Digital 14 15
MphasiS 16 23
Satyam 19 16
Hughes 19 21
Infosys 23 27
Wipro 27 31

The above table indicates comparative valuations of Indian software majors before the June and September quarter results. The P/E ratio has been calculated on the EPS guidance given by respective managements. As seen from the table above, the valuation of MphasiS seems stretched as compared to its peers. While, for FY04, MphasiS’ management has projected a 30%-35% growth in total revenue (100% growth in ITES revenue) and 40%-45% growth in bottomline, we believe that the company will have to perform exceedingly well in the next two quarters to justify its management’s projections. Despite the fact that the company’s investments in human resource and infrastructure is yet to bear fruit in terms of volume growth, the risk for the stock seems to be on a higher side (MphasiS would have to justify these investments with strong growth in volumes). Investors thus need to exercise caution.

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