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Tech Mahindra: Good times to roll - Outside View by Luke Verghese
 
 
Tech Mahindra: Good times to roll

The company is finally coming into its own after the total disengagement of its British principals who held a whip hand on its functioning, and, following the now fortuitous acquisition of Satyam Computer Services

End of an era

This is the last annual report of Tech Mahindra (TML) as we know it. For one its erstwhile joint promoters British Telecom have pulled out all their dimes in the company, and, for another, the financials of the current year running will incorporate the working results of Satyam Computer Services -which is larger than the parent -and is being merged into the parent. (All credit to the new management for sorting out the vast bulk of the convoluted mess in Satyam and that too in double quick time-given the manner in which legal meanderings are played out in our country. I for one was of the opinion that it would probably take forever).

For the year ended March 31, 2013 Tech Mahindra had only a 42.63% holding in Satyam Computers and that too through Venturbay Consultants, which in turn is a wholly owned subsidiary of Tech Mahindra. (The largest shareholder of TML is Mahindra and Mahindra which holds 47.3% of the capital base). However, the consolidated working results include the financials of 23 siblings and/or step down siblings. The siblings, most of whom are 100% owned stretch across the United States, Germany, Singapore, Thailand, Indonesia, Malaysia, China, Brazil, Nigeria, Bahrain, UAE, South Africa and our very own Bharat. It makes for quite an impressive geographical spread.

The revenue flows

The standalone company generated 'revenues from services' of Rs 60 bn in 2012-13 against Rs 52.4 bn previously while recording negative 'other income' of Rs 952 m against positive receipt of other income of Rs 677 m previously. The group consolidated 'revenues from services' amounted to Rs 68.7 bn against Rs 54.9 bn previously along with negative other income of Rs 747 m against positive other income of Rs 982 m previously. Thus the consolidated group value addition in 'revenues from operations' in 2012-13 as compared to the standalone entity amounted to Rs 8.7 bn against a much lower rise of Rs 2.5 bn previously. The profit after tax of the standalone company amounted to Rs 6.5 bn against Rs 4.6 bn previously. The corresponding figures of the consolidated entity are 12.8 bn and Rs 10.9 bn respectively.

Growing in all directions

The company is growing in all directions including through acquisitions and joint ventures and has the financial muscle to do so. Its finances I may add are in superb shape and that is the end product of a well managed company. During the year the company bought into three independent entities. It acquired a 100% stake in Hutchison Global Services. This entity is one of India's 'largest' international telecom BPOs. It also acquired a 51% stake in Comviva a Bharti Group company The latter is a 'global leader' in providing mobile value added services and mobile money payment solutions. It has since been renamed as Mahindra Comviva, and the parent is now working on making it a 100% subsidiary by buying out the minority shareholders. TML also entered into a JV with Falcorp Technologies and has in the process purchased a 51% stake in Next Level Technologies Proprietary Ltd. This sibling has also affected a name change to Tech Mahindra South Africa Pvt Ltd. TML boasts a massive investment portfolio under the head 'Non-current investments' and amounting to a book value of Rs 38 bn plus. I may add here that the 42.6% stake in Satyam Computer Services alone is valued in the books at Rs 30.46 bn at an exercise price of Rs 1,000 per share on a face value of Rs 10 per share. This investment will however make an exit during the year as Satyam Computer Services gets absorbed into TML. (And what do you know TML even availed of inter corporate deposits of Rs 2.5 bn during the year from this former lackey). The two other investments of some significance are the outlay of Rs 4.8 bn in Hutchison Global at a price of Rs 97,460 per share of Rs 10 each, and the investment of Rs 1.8 bn in Comviva Tech at Rs 152 per share of Rs 10 each. There were also quite some inter-se revenue transactions between the parent and the many siblings and associates during the year.

The way the dice is loaded the company generated 'revenues from services' of Rs 60 bn -up 14.4% over that of the preceding year. The two largest revenue expenses by far -employee costs, and subcontracting expenses - rose by 11% and 24% respectively to Rs 25.1 bn and Rs 15.5 bn. The other expenditure of reckoning -operating and other expenses-fell quite some to Rs 7.5 bn from Rs 8.9 bn previously. So we had the peculiar situation of employee costs going up as it should given the increase in sales on the one hand, but on the other hand it was also accompanied by a sharp increase in subcontracting expenses. IT companies work conversely to other industrial segments. The health of IT companies is mainly judged by the additional number of employees on the payroll at year end. (The annual report proudly proclaims that the global headcount of the company as on the last day of the accounting year amounted to 47,498 against 40,763 employees previously, or a growth of 16.5%). What one is supposed to infer from this data though is not very clear. In other industrial sectors the emphasis is on limiting the growth in employee numbers-while generating productivity increases. Ironically enough, an industry which seeks to add value through software solutions achieves its objective through additional human labour. The two are complementary to one another.

Outsourcing software development

The company apparently saw value in outsourcing software development expenses. The subcontracting costs to its eight siblings in this subcontracting total amounted to Rs 11.2 bn against Rs 8.7 bn previously. Thus 72% of all such subcontracting costs were parcelled out to its siblings. The biggest contributor to such outsourcing costs among the siblings was Tech Mahindra (Americas) with billings of Rs 8.67 bn, followed by CanvasM Technologies with billings of Rs 1.18 bn. Did parcelling out such large contracts to its American sibling have the effect of raising subcontracting costs by 24% or was there some other factor at play? Satyam Computer also benefited to the extent of Rs 270 m through subcontracts. It would also appear that the siblings come in handy to complete the big picture.

Anyways, the pre-tax profit before exceptional items grew 26.5% to Rs 8.17 bn. Thus the increase in pre-tax profit was larger than the increase in revenues inspite of the inordinate increase in subcontracting costs. To be noted here is that it recorded negative 'other income' of Rs 952 m against a positive 'other income' of Rs 677 m previously or a negative turnaround of Rs 1.63 bn in this department. That is a large sum of money. The negative other income was a factor of a large forex loss that the company booked during the year against a gain in forex transactions that it recorded previously.

Sizeable gross block

The company boasted a sizeable gross block of Rs 15.8 bn at year end. Thus it was able to post revenues equivalent to 3.8 times the gross block. It would appear that the company has fixed assets which are disproportionate to the revenues that it can register. The biggest investments by far are in buildings, followed by plant and equipments, and computers at third place. At year end the company had also contracted total debt of Rs 14 bn against Rs 11.2 bn previously. The increase in debt was due to exceptional circumstances. The cash flow of Rs 6.4 bn that it generated from operations was more than enough to pay for new fixed assets, but not quite enough to pony up for new investments of Rs 6.1 bn. The extra cash requirement was also financed by the sale of liquid instruments to the tune of Rs 1.2 bn. Then there was the dividend outflow of Rs 593 m to be taken care of. To be mentioned here is that the company also possessed a cash hoard of Rs 2.7 bn at year end.

It must also be noted that the company did not receive a dime as income from its long term investments in both the years. As I had stated earlier the long term investments amounted to a humungous sum of Rs 38 bn at year end against a slightly lower Rs 31.3 bn previously. That would amount to a big shortfall in its ability to generate cash flow through the revenue account route. But as I also stated earlier the vast bulk of these investments is locked into Satyam Computer Services, and this investment gets to be extinguished from the books of the parent in the current year running. The total interest cost on the debt amounted to Rs 1 bn, the same as previously and more importantly, the interest payout on the aggregated debt of the two years roughly amounted to 8.6% on an annualised basis.

But for this 'blot' the company's finances are in fine fettle. It is a professionally run company in the true sense of the term. The trade receivables amounted to 83 days revenues, and since the company does not have trade purchases in the conventional sense of the term, the trade payables of Rs 5.6 bn at year end cannot be quite compared to the trade receivables of Rs 13.7 bn. Still, the current liabilities at year end were higher than the current assets thus reducing working capital costs on the one hand, and also showcase the ability of its accountants to steer the company through a negative current assets scenario on the other.

The siblings

Given the extent of the investment in its siblings and associates it would be in order to take a peek at their financials. Venturbay Consultants Pvt Ltd the wholly owned sibling which holds the shares in Satyam has an equity base of Rs 305 m but boasts reserves of Rs 29.4 bn and has no revenues and expenses. The reserves may well reflect the market value of its portfolio. The company with the biggest revenues is Tech Mahindra (Americas). It posted revenues of Rs 8.9 bn and a profit before tax of Rs 488 m. It achieved this performance on a pidgin capital base of Rs 20 m -- which is nothing short of showcasing money management skills of the highest order. It would appear that almost the entire revenues were generated care-of the goodwill of the parent. Following close behind is the India based sibling Hutchison Global Services which on a capital base of Rs 0.50 m and reserves of Rs 2.6 bn generated revenues of Rs 8.3 bn. Just to round out the picture it turned in a pre-tax profit of Rs 1.1 bn. To achieve such creditable results on an almost non-existent capital base is indeed a remarkable achievement. One hopes that this company will share the secret of its success with other budding entrepreneurs too. This company was followed by Comviva Technologies Ltd which on a capital base of Rs 219 m and reserves of Rs 2.2 bn, ponied up revenues of Rs 5 bn and registered a pre-tax profit of Rs 642 m. This company in turn has four siblings based out of the US, Nigeria, Singapore and the UAE.

The point to note here is that barring Venturbay all the other companies of any significance are recording both revenues and profits, which is indeed a revelation as India Inc is in the habit of procreating siblings purely as some sort of a catch me if you can mind games. Of course it is another matter that none of the siblings made do with any dividend tithes to the parent - a decision taken entirely by the parent. Also to be noted is that none of the siblings is sponging off the parent barring a minor loan of Rs 109 m to the Nigerian sibling and some tidbit advances to related parties.

The future

With Satyam Computers on the mend and soon to be merged with the mother hen and bringing with it a mix of software technologies on offer, and with British Telecom now off its back, and with its finances in top gear, it would appear that the company is poised to reap the whirlwind as long as the 'BPO' lodestar continues to shine on the IT industry.

P.S. Page 29 of the annual report states that C.P.Gurnani, the CEO, holds 336,564 shares in the company. But in the accompanying notice to the 26th annual general meeting Gurnani is shown as holding 458,245 shares in the company. Which figure is the correct one?

Disclosure: I hold 359 shares in the company

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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