MphasiS: And miles to go… - Views on News from Equitymaster

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MphasiS: And miles to go…

Dec 29, 2003

MphasiS BFL is one Indian software company that has been the cynosure of eyes for investors in the last one year. Point-to-point, the stock has gained over 98% since the beginning of 2003. Apart of the benefiting from the overall optimism in the Indian stock markets, MphasiS has been rewarded by investors for the improved performance that the company has turned out over the last twelve months.
Returns are calculated on Rs 100 invested on Dec 31 2002

Starting off as an off-the-block software services company, MphasiS has seen a swift move towards IT-enabled services (ITES) that now contributes to around 31% of the company’s total revenues (23% during 3QFY03). This move towards ITES cost the company on operational fronts, as was witnessed in the decline in operating margins during the earlier period of the year. Apart from pressure on billing rates, continued investments in physical and human infrastructure affected the company’s bottomline. The company has specifically seen much activity on the hiring front. For the nine months ending September 2004, MsourcE (MphasiS’ BPO arm) has already added over 1,000 people, taking its total tally to around 3,100 employees. While the pressure on operating margins has reduced in the last two quarters, MsourcE’s plans to take its human resource tally to 4,000 by the end of FY04 is likely to put further strain on overall margins.

MphasiS’ proactive management is one of the key reasons for the growth witnessed in the recent past. And the rapid move towards catering to the high-potential ITES market is an example in this regard. According to industry estimates, the ITES market globally was of the order of US$ 14 bn (Rs 662 bn) during 2000 and is expected to grow to US$ 142 bn (Rs 7,000 bn) by 2008. As per NASSCOM-McKinsey report 1999, the ITES industry can attain revenues of US$ 17 bn by 2008 and capture 12% of the market. The company’s revenues from the call centre business (MsourcE) have shown rapid growth in the last two years (see the graph above) and the potential going forward seems huge enough.

At the current price of Rs 708, the stock trades at a P/E multiple of 24.7x our FY04E earnings. While the company’s valuations are relatively less stretched than its peers in the software sector, investors need to give heed to the small-size disadvantage that MphasiS suffers from. Larger companies have better logistics and resources in place to counter difficult times like these and size plays a very key role in helping companies garner large-size contracts. Besides, though ITES is a fast-growing area, it has to be remembered that, in terms of value-addition, it is not as significant when compared with high-end software services provided by the major players. To that extent, valuations need to reflect the quality of earnings.

While it would still take some more time before MphasiS gains in size and establish its credibility as a strong player in the software services market, the potential in the form of fast growing ITES market provides the company with the right area to deploy its resources that it seems accumulating at preset.

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