July 2, 2007 |Information technology

Initiating coverage
CurrentPotential
price upsideTarget
13% price
Rs 515 Rs 519
WIPRO (WIPRO) Potential upside Time frame
NA NA
Time frame 12 months
HOLD
Volume growth to continue
ƒ Business momentum to continue with strong volume growth
Nitin Padmanabhan
Wipro is likely to see strong volume growth across business lines. The nitin.padmanabhan@icicidirect.com
company acquired a number of firms in FY07 to add domain expertise
across a number of verticals. We expect the benefits of these acquisitions
to accrue going forward, aiding volume growth and pricing power. The
company is also planning a big-ticket acquisition in the current fiscal, Sales & EPS trend
which could give a further fillip to the stock.
30000 30.0
ƒ Appreciating rupee could severely impact margins … 20000 20.0
The company will be impacted by the current strength in the rupee, which
10000 10.0
is evident from our EPS estimates derived from a rupee-dollar rate of Rs
40 in FY09E. Margins could fall by 445bps in FY08E and by 155bps in 0 0.0
FY06 FY07 FY08E FY09E
FY09E with the company’s current state of operations.
Sales (LHS) EPS (Rs) (RHS)

ƒ … the company has, however, several aces that mute the impact
We believe it is too early to ring the alarm bells as several factors could
help reduce the impact of a strong Rupee. The major ones are: (1) a Stock metrics
reduction in average employee costs by employing more freshers (14,000 Promoters holding 79.58%
campus offers for FY08 as compared to around 6,505 in FY07); (2) Market Cap Rs 76,598 crore
increasing utilization; (3) deriving synergies of the acquisitions made in 52 Week H/L 690 / 422
the previous year to boost growth and profitability; (4) a growing non- Sensex 14,499
ADM (non-Application Development & Maintenance) business portfolio Average volume 8,000
with higher margins; and (5) maturing BPO practice building strong
domain specific, platform based solutions that would drive increasing
realizations. Comparative return metrics
Stock return 3M 6M 12M
Valuations Infosys -8% -10% 34%
We believe Wipro has a number of aces that could spring positive TCS -12% 0% 40%
surprises going forward. At the current market price, the stock trades at Satyam 1% 1% 42%
23.2x FY09E EPS of Rs 23.2, which factors the impact of a strong Rupee. Wipro -12% -7% 19%
We rate the stock a ‘Hold’ at its current price as we would like to wait for a
few quarters to see how the company uses the various margin levers
illustrated above before we re-rate the stock.
Key Financials
Absolute sell
Year to March 31 FY06 FY07 FY08E FY09E
Net Profit 2067.4 2942.1 2829.7 3292.4
Shares in issue (crore) 142.6 145.9 145.9 145.9 Target price
EPS (Rs) 14.5 20.2 19.4 22.6
% Growth - 39.1 (3.8) 16.4 Absolute buy
P/E (x) 35.5 25.5 26.6 22.8
Price/Book (x) 11.1 7.8 7.0 6.2
EV/EBIDTA 27.0 19.8 18.8 16.0
RoNW (%) 30.8 30.3 26.1 27.1
RoCE (%) 35.6 33.2 29.5 30.7
ICICIdirect | Equity Research Source: ICICIdirect Research

2|Page
Company Background
Share holding pattern
Wipro Ltd, incorporated in 1945 and headquartered in
Shareholder Percentage holding (%)
Bangalore has a diverse range of businesses, which include
Promoters 79.58
IT services, BPO, FMCG, medical equipment and hydraulics Institutional investors 7.14
among others. However, 74% of its revenues and 88.5% of Other investors 5.69
its EBIDTA is derived from IT services and BPO business. General public 7.58
With IT services revenues of $2.57 billion in FY07 the
company is the third largest information technology
company in India. The company has differentiated itself by
Promoter & Institutional holding trend
its unique strength in R&D services, which it refers to as the
product engineering vertical. 100 81.09 80.94 80.65 79.58
80
60

(%)
40
20 6.47 6.75 7.13 7.14
0
Q1FY07 Q2FY07 Q3FY07 Q4FY07

Promoter Holding (%) Institutional holding (%)

Wipro

Wipro Technologies Wipro Infotech Wipro Consumer Care Others

74% of revenues 16% of revenues 5% of revenues 5% of revenues

88.5% of EBIDTA 7% of EBIDTA 3% of EBIDTA 1.5% of EBIDTA

2|Page
Investment Rationale

Business momentum to continue

The estimated opportunity for off-shore IT and BPO services is at around $320
billion globally and with revenues of about $48 billion in FY07, Indian players
have barely scratched the surface with a 15% market share. Wipro ranks
amongst the top three Indian players with a strong differentiator in R&D
services and is likely to enjoy strong tailwinds from this large untapped
opportunity.

ƒ Strong growth across verticals

The company recorded strong volume growth across verticals in FY07. The
most notable was the financial services vertical, which came of age
recording revenues of around $600 million with a y-o-y growth of 50%. The
R&D services vertical (also called the product engineering vertical) employs
over 14,000 engineers and is a strong differentiator for the company.
Growth in this vertical was impacted in FY07 by (1) M&A in telecom
equipment customers and (2) a transition in the General Motors account.
Wipro expressed confidence in resuming healthy growth in this vertical
over the next two quarters as its customers gradually ramp up business.

Robust growth across verticals

FY07 Revenues
Verticals
y-o-y growth% FY07 FY06
Product engineering services 31% 3072 2342
Telecom service providers 16% 744 643
Technology business 29% 3838 2985
Financial services 51% 2514 1666
Retail 48% 1053 710
Increasing presence in the large
Energy and utilities 29% 1036 801 financial services segment coupled
Manufacturing 30% 1017 786 with growth across verticals to drive
Technology media and transportation services 36% 1277 938 volume growth
Healthcare Lifesciences and others 104% 352 172
Enterprise solutions 39% 4739 3407
Source: ICICIdirect Research

ƒ Recent acquisitions to boost growth

Wipro made a number of small acquisitions in FY07 in the banking, financial
services & insurance (BFSI) space, and retail, manufacturing and embedded
technology verticals spaces in order to quickly bring in domain expertise.
We believe the benefits of these acquisitions would begin to show in FY08
and FY09 as the company derives increasing synergies from them.

ƒ A ‘big-ticket’ acquisition in FY08 could catapult revenue growth

The company has expressed its intent to make a large acquisition in Europe
during the current financial year of around $100-200 million. This would
increase the company’s presence in the under-penetrated European market
and give a booster to revenues.

3|Page
Strong rupee could severely impact margins
The rupee recorded its steepest rise during the decade (appreciated by almost
9% since January 2007). We have based our estimates on an average rupee-
dollar rate of Rs 41.3 to a dollar in FY08E and Rs 40 to a dollar in FY09E. This
gives us a -323bps margin impact in FY08E and a -214bps impact in FY09E.

Sensitivity analysis
EBIDTA% EPS
Average Rupee-Dollar rate
FY08E FY09E FY08E FY09E
Rs 40 19.6% 18.9% 17.7 22.6
Rs 41 20.7% 20.1% 19.0 24.2
Rs 42 21.8% 21.2% 20.3 25.9
Source: ICICIdirect Research

However, tweaking of multiple operational levers could mute impact

Wipro has a number of operational levers, which could be harnessed to mute
any adverse impact on margins.
1) A reduction in average employee costs by employing more freshers
2) Increasing utilization
3) Deriving synergies of the acquisitions made in the previous year to boost
growth and profitability
4) A growing non-Application Development & Maintenance business portfolio
with higher margins

ƒ Reducing average employee costs by employing more rookies

Wipro plans to reduce average employee costs by employing more rookies
(campus recruits). Rookies are almost 40% cheaper than laterals and could
reduce average employee costs over time. The company made the highest
ever number of campus offers for FY08 recruitments.

Rapid ramp-up of campus recruits for FY08

Massive campus recruitments for

FY08

Source: ICICIdirect Research

ƒ Increasing utilization
Wipro plans to go all out to hike utilization levels during the current year.
Although the massive campus recruits could see a dip in utilization, the
company believes a higher utilization of the strategic bench coupled with
accelerated training mechanisms could push utilization levels. A 1%
increase in utilization could push margins by 80bps.

4|Page
 Source: Company,
80%

72%
71%
70%
70% 69%

60%
FY06 FY07 FY08E FY09E

Utilization (excluding trainees)

Source: ICICIdirect Research

ƒ Higher synergies from acquisitions

The company is likely to derive higher synergies from acquisitions made in
FY06 and FY07. This would see an increase in margins coupled with robust
volume growth. We believe the acquisitions have brought in considerable
domain expertise and surprises could be expected in the form of large deals
materializing over the next few quarters.

Acquisitions add significant capabilities

Company Focus Cost Key gains
Newlogic Bluetooth, wireless Rs 115 crore and Rs IP’s in the semiconductor space
2.6crore earnout
Nerve wire Banking and Finance $18.7 million Client base & consulting skills
CMango Infrastructure $20 million Business services management
management
MPower Payment Services $28 million JV with master card
Enabler Retail Solutions $53 million Domain specialist in consulting Acquisitions to enable rapid scale up
and implementation of retail of domain expertise across business
solutions lines
Quantech Mechanical $10 million and Engineering services to
engineering and additional payout Fortune500 Automotive and
design Aerospace clients
Saraware Wireless, RF $25 million Telecom & R&D
Source: Company, ICICIdirect Research

ƒ A growing non-ADM business portfolio to aid margin growth

Application Development and Maintenance (ADM) offers lower margins as
compared to services like testing, infrastructure management, package
implementation and consulting. Wipro’s non-ADM business lines have grown
at around 58% in FY07. We believe this is a continuing trend with business
lines like testing infrastructure management and package implementation
continuing to grow at a frantic pace. This would trickle down to higher average
realized billing rates and EBIDTA margins.

Growth across business lines

Business lines FY07 Growth %
ADM 30%
Technology infrastructure services 78%
Testing services 66%
Package implementation 41% Non-ADM portfolio on a high
Consulting 14% trajectory
BPO 21%

Source: ICICIdirect Research

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Financials

ƒ Margins under pressure

Margins are likely to be under pressure in FY08E and FY09Eon account of the
strong rupee and increasing wage costs.

30.0
26.3 25.4
25.0 24.7
20.3
20.0
18.7
15.0

10.0

5.0

0.0
FY05 FY06 FY07 FY08E FY09E

EBIDTA %
Source: ICICIdirect Research

ƒ Return on net worth to decline

The company is likely to see its return on net worth decline over the next two
years if it is unable to use the various margin levers in its favour. We believe
there would be a dip in RoNW, however a large number of margin levers are
not quantifiable hence not factored in our model. These could playout
positively and see a lower dip in RoNW.

32.0
30.8
31.0
30.3
30.0
29.0
28.0
27.0 26.0 27.1
26.0
25.0
24.0
23.0
FY06 FY07E FY08E FY09E

RoNW (%)

Source: Company, ICICIdirect Research

6|Page
Valuation

Wipro is likely to see strong volume growth with dollar revenues growing by
over 35% in FY08E and by over 31% in FY09E. However, the recent rise in the
Rupee is likely to impact rupee revenue growth and margins. The stock
currently trades at 22.8x its FY09E EPS of Rs22.6 which we believe fairly
discounts the current rupee appreciation. With EBIDTA margins on a decline
RoNW also expected to trend downwards a P/E contraction cannot be ruled
out. The stock has already seen a downward P/E correction post the sharp
Rupee appreciation. However, we believe the company has a number of levers
that could help reduce the impact on margins and would wait for a few
quarters to see how the company uses these levers before we re-rate the
stock.

P/E band (1 year forward rolling)

32x
28x
24x

20x

Source: Company, ICICIdirect Research

7|Page
Profit & Loss Account

Year to March 31 FY06 FY07E FY08E FY09E Sales expected to grow at a

Sales 10602.92 14998.20 18363.61 23163.98 CAGR of 24% between FY07
% Growth 41.45 22.44 26.14 and FY09. Lower growth on
Total expenses 8065.50 11585.40 14972.15 19124.40 account of rupee impact.
Other Income 153.55 296.30 332.49 299.24
Operating profit 2690.98 3709.10 3723.96 4338.83
% Growth 37.83 0.40 16.51
Interest 3.49 12.40 12.40 12.40
EBDT 2687.49 3696.70 3711.56 4326.43
%Growth 37.55 0.40 16.57
Depreciation 309.64 397.90 459.95 522.00
Profit Before Tax (PBT) 2377.85 3298.80 3251.60 3804.42
% Growth 38.73 -1.43 17.00
Taxation 339.09 386.80 463.35 542.13
Tax as % of PBT 14.26 11.73 14.25 14.25
Extraordinary/Minority interest 28.65 30.10 30.10 30.10
Net Profit 2067.41 2942.10 2818.35 3292.39
% Growth 42.31 -4.21 16.82
Shares O/S 142.58 145.90 145.90 145.90
EPS (Rs) 14.50 20.17 19.32 22.57

Balance Sheet

Year to March 31 FY06 FY07E FY08E FY09E

Sources of funds
Share capital 285.15 291.80 291.80 291.80
Reserves & surplus 6327.70 9307.70 10435.04 11752.00
Secured loans 45.10 148.90 148.90 148.90
Unsecured loans 30.70 233.80 233.80 233.80
Current liabilities & provisions 3121.47 4172.90 6131.74 6708.87
Total 9810 14155 17241 19135
Net Block 2168.23 3796.20 2846.70 2854.72
Investments 3081.23 3324.90 3324.90 3324.90 Cash pile to help feed
Cash 885.74 1982.20 5414.01 6265.43 acquisitions
Trade receivables 2127.15 2939.10 3600.71 4541.96
Loans & advances 1281.80 1638.70 1638.70 1638.70
Inventory 206.46 415.00 357.27 450.66
Deferred tax asset 59.40 59.00 59.00 59.00
Total 9810 14155 17241 19135

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Cash Flow Statement
Year to March 31 FY06 FY07E FY08E FY09E
Pre tax profit from operations 2224.3 3002.5 2919.1 3505.2
Depreciation 309.6 397.9 460.0 522.0
Expenses (deffered)/others (36.0) 3.0 0.0 0.0
Pre tax cash from operations 2497.9 3403.4 3379.1 4027.2
Other income/prior period ad 182.2 326.4 362.6 329.3
Net cash from operations 2680.1 3729.8 3741.7 4356.5
Tax (339.1) (386.8) (463.4) (542.1)
Cash profits 2341.0 3343.0 3278.3 3814.4

Increase in current liabilities (8.6) 3.6 2.2 2.4

(Increase) in current assets (607.1) (1020.5) (603.9) (1034.6)

(Increase) in fixed assets (556.4) (2025.9) 489.6 (530.0)

(Increase) in investments (730.7) (243.7) 0.0 0.0
(Increase) in loans & advances (725.5) (356.9) 0.0 0.0

Cash flow from financing activities (723.4) 351.5 (1691.0) (1975.4)

Opening cash balance 571.4 885.7 1982.2 5414.0

Closing cash balance 885.7 1982.2 5414.0 6265.4

Ratios
Year to March 31 FY06 FY07E FY08E FY09E
EPS 14.5 20.2 19.3 22.6
Book value per share 46.4 65.8 73.5 82.5
Enterprise value 72616.2 73539.0 70107.2 69255.8
EV/EBIDTA 27.0 19.8 18.8 16.0
Employee exp / Sales (%) 66% 66% 70% 72%
Earnings per employee (Rs) 1499240 1635367 1541959 1569340
Market cap/Sales 6.9 5.0 4.1 3.2
Price/Book value 11.1 7.8 7.0 6.2
Operating margins expected
Operating margin (%) 25% 24.7% 20.3% 19% to decline
Return on Net-worth 30.8 30.3 26.0 27.1
Return on capital employed 35.6 33.2 29.4 30.7
Debt/equity 0.01 0.04 0.04 0.03
Fixed assets turnover ratio 4.9 4.0 6.5 8.1
Debtors turnover ratio 5.0 5.1 5.1 5.1

9|Page
RATING RATIONALE
ICICIDirect endeavours to provide objective opinions and recommendations. ICICIdirect assigns ratings to its
stocks according to their notional target price vs current market price and then categorises them as
Outperformer, Performer, Hold, and Underperformer. The performance horizon is 2 years unless specified and
the notional target price is defined as the analysts' valuation for a stock.

Outperformer: 20% or more;

Performer: Between 10% and 20%;
Hold: +10% return;
Underperformer: -10% or more.

Harendra Kumar Head - Research & Advisory harendra.kumar@icicidirect.com

ICICIdirect Research Desk,

ICICI Securities Limited,
2nd Floor, Stanrose House,
Appasaheb Marathe Marg,
Prabhadevi, Mumbai – 400 025

research@icicidirect.com

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