Equity Research

May 30, 2011 BSE Sensex: 18266

INDIA

Tech Mahindra
Thanks to Mahindra Satyam
Reason for report: Recommendation change and earnings revision

BUY
Upgrade from HOLD

Rs657

Technology
Target price Rs775 Earnings revision
(%) Sales EBITDA EPS FY12E 3.0 0.2 7.2 FY13E 3.8 4.9 10.7

Target price revision

Rs775 from Rs690

We upgrade Tech Mahindra (TechM) to BUY mainly led by significant upgrade (Rs85/share of TechM) in Mahindra Satyam and improving demand scenario in telecom vertical. The management expects the demand to improve especially in the US and the emerging markets compared to FY11. Couple of large deal wins and addition of 4,125 employees in Q4FY11 (versus mere 684 employees in M9FY11) lend significant revenue visibility over the coming quarters. While BT is expected to remain flat in the near term, its contribution would come down from current 40% to ~36% in FY12E and ~16% in FY13E post impending merger with Mahindra Satyam. While Mahindra Satyam has moved up 25% over the past three months, TechM with 42.7% stake in Mahindra Satyam is flat over the same period. We increase FY12-13E EPS by 7-11% owing to better performance of Mahindra Satyam and raise our sum-of-the parts target price to Rs775. Q4FY11 revenue grew 3.6% QoQ to US$278.5mn (I-Sec: US$277mn) led by nonBT clients, which grew 9% QoQ. BT revenue declined 3.5% QoQ. Overall volume growth was 2.5%. EBITDA margin was flat QoQ at 20.5% (I-Sec: 21%). PAT before share of Mahindra Satyam came in at Rs2.06bn (I-Sec: Rs2.06bn). Merger with Mahindra Satyam over next 12-15 months. Though TechM has begun utilising synergies from Mahindra Satyam, any material benefit is still a while away. The merged entity would be worth US$2.9bn by FY13E with 43% of the revenue from telecom vertical and ~16% share of BT. Hence, we believe the stock is likely to re-rate over the next 12-15 months. BPO is expected to gain traction with the Africa operations of Bharti Airtel (~2,000 employees deployed, with another ~700 employees expected to be added). Billing for the same is expected from Q1FY12. Two significant new deals in Q4FY11. TechM won a US$150mn+ Vodafone Australia deal executable over five years replacing four incumbents. It won another ~US$50mn Vodafone Qatar deal executable over three years. AT&T is expected to add two new services from TechM resulting in continued growth momentum. Margins to remain in narrow band. While BPO deal and initial transition cost of two large deals won in Q4FY11 will hit Q1FY12 margins, wage inflation will hit Q2FY12 margins. TechM expects to add 4,000 freshers in FY12E to reduce average cost per employee. Further, utilisation is expected to remain high in ~75% range.
Market Cap Rs82.7bn/US$1.8bn 125.9 851/477 28.3 2.9 7,770 2.3 2.5 2.5 Year to March Revenue (Rs mn) Adj. Net Income (Rs mn) Adj. diluted EPS (Rs) % Chg YoY P/E on Adj. EPS (x) Adj. CEPS (Rs) Adj EV/E (x) * Dividend Yield (%) RoCE (%) FY10 46,254 6,488 49.4 (29.7) 13.3 63.3 6.2 0.5 23.8 23.2 FY11 51,402 7,844 59.7 20.9 11.0 71.9 7.1 0.4 14.3 20.7 FY12E 55,663 7,708 58.7 (1.7) 11.2 72.7 6.2 0.5 12.8 18.9 FY13E 63,228 9,297 70.8 20.6 9.3 85.8 5.0 0.7 13.5 20.5 Reuters/Bloomberg TEML.NS/TECHM.IN Shares Outstanding (mn) 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%)

Shareholding pattern
Promoters Institutional investors 16.9 17.1 MFs/UTI/FIs 10.6 10.8 Insurance Cos. 4.6 4.6 FIIs 1.7 1.7 Others 10.3 10.1 Source: www.nseindia.com Sep 10 72.8 Dec 10 72.8 Mar 11 71.7 18.1 10.6 4.6 2.9 10.2

Price chart
850 800 750 700 650 600 550 500 May-10 Jul-10 Sep-10 Oct-10 Dec-10 Feb-11 Mar-11 May-11

Krupal Maniar, CFA

krupal.maniar@icicisecurities.com +9122 6637 7254

Varun Sharma
varun.sharma@icicisecurities.com

+91 22 6637 7180

(Rs)

Sensex Return 12m (%) 8.3 RoE (%) * Excluding Satyam from calculation of EV and based on adjusted EBITDA

Please refer to important disclosures at the end of this report

Tech Mahindra, May 30, 2011 Table 1: Q4FY11 earnings review

(Rs mn, year ending March 31) Q4FY11 Net Sales Cost of Services Operating Expenses Total Expenses EBITDA Depreciation Interest Expense Other Income Recurring pre-tax income Taxation Minority Interest Reported Net Income * 12,615 7,987 2,038 10,025 2,590 387 213 317 2,307 226 (16) 2,065 Q3FY11 12,111 7,882 1,731 9,613 2,498 347 252 521 2,420 359 (6) 2,055 Q4FY10 11,833 7,373 1,672 9,045 2,788 400 311 740 2,817 542 (6) 2,270 % chg (QoQ) 4.2 1.3 17.7 4.3 3.7 11.5 (15.5) (39.2) (4.7) (37.0) 0.5

ICICI Securities

% chg (YoY) 6.6 8.3 21.9 10.8 (7.1) (3.1) (31.5) (57.1) (18.1) (58.3) (9.0)

I-Sec estimates 12,517 8,080 1,777 9,857 2,659 357 240 395 2,458 393 (6) 2,059 21.2 18.4 16.4

% Variance 0.8 (1.1) 14.7 1.7 (2.6) 8.5 (11.2) (19.8) (6.2) (42.5) 0.3

Ratios (%) EBITDA margins 20.5 20.6 23.6 EBIT margins 17.5 17.8 20.2 Recurring Net profit margins 16.4 17.0 19.2 *Excluding Mahindra Satyam, Source: Company data, I-Sec Research

Chart 1: Revenues and margins

Dollar revenues grew 3.5% QoQ driven by 2.5% volume growth. EBITDA margin remained flat QoQ due to higher SG&A and lower manpower cost.
Revenues 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 EBITDA Margin (RHS) Adjusted PAT Margin (RHS) 30.0 25.0 20.0 15.0 10.0 5.0 0.0 (%)

Source: Company data, I-Sec Research

(Rs mn)

Tech Mahindra, May 30, 2011 Table 2: Segmental performance

(%) Segmental revenue Telecom Service Providers QoQ growth % to revenues TEM QoQ growth % to revenues BPO QoQ growth % to revenues Others QoQ growth % to revenues Total revenue growth (QoQ) Q2FY10 Q3FY10 Q4FY10 Q1FY11 2.8 85.6 4.9 86.4 (0.7) 86.1 (2.9) 87.3

ICICI Securities

Q2FY11* Q3FY11# 34.7 89.0 (20.7) 87.2

Q4FY11 0.0 83.8

TSP revenue remained flat QoQ during Q4FY11 while TEM revenues showed a sharp increase. BPO grew 31% QoQ and is expected to increase owing to ramp-up in Bharti deal for its African operations.

5.7 6.1

(17.1) 4.9

21.4 5.9

(17.0) 5.1

17.3 4.5

(14.8) 4.8

33.7 6.2

(0.4) 5.9

(7.0) 5.3

8.8 5.8

(2.0) 5.9

5.3 5.0

(0.6) 6.3

31.4 8.0

(4.2) 2.3 2.6

53.5 3.4 4.0

(36.9) 2.2 (0.3)

(26.9) 1.7 (4.2)

2.2 1.3 32.1

1.1 1.6 (19.1)

34.2 2.1 4.2

Segmental gross margins (%) Telecom Service Providers 38.5 36.6 37.6 33.9 29.3 35.2 36.1 TEM 35.5 32.7 34.1 32.5 34.3 24.9 39.4 BPO 49.2 46.0 42.4 41.3 43.6 43.1 45.6 Others 34.9 29.7 37.1 28.1 27.4 19.5 19.3 *Q2FY11 revenues include Rs2,989.5mn pass-through revenues from a domestic customer, largely relating to supply of third-party hardware and software; # growth rate impacted by pass-through revenues in Q2FY11 Source: Company data, I-Sec Research

Table 3: Client contribution to revenues (QoQ growth percentage in US dollar)

Revenues from the top client, BT, declined 3.5% in line with the companys focus to diversify its revenue base.
Top client Non-BT Top 2-5 clients Top 5 Top 6-10 clients Top 10 Others -- Non Top 10 Q3FY10 (1.3) 15.9 24.5 7.3 (16.5) 4.8 20.7 Q4FY10 1.9 1.9 (8.6) (2.2) 31.0 0.6 7.6 Q1FY11 (6.1) (0.2) 10.2 (0.2) (13.7) (1.7) (8.0) Q2FY11 2.8 53.1* 86.1 36.0 14.4 33.9 16.2 Q3FY11# 3.0 (29.4) (45.4) (23.4) 5.3 (21.0) (2.7) Q4FY11 (3.5) 9.1 7.2 0.7 3.5 1.0 14.4

$1 million clients 49 48 52 52 53 55 $2 million clients 30 33 36 39 39 37 $5 million clients 18 18 20 21 20 21 $10 million clients 9 11 13 14 15 15 $15 million clients 8 8 8 8 8 8 $20 million clients 5 5 6 7 6 7 $25 million clients 4 4 4 5 5 4 $50 million clients 2 2 2 3 3 3 *Q2FY11 revenues include Rs2,989.5mn pass-through revenues from a domestic customer, largely relating to supply of third-party hardware and software; # growth rate impacted by pass-through revenues in Q2FY11 Source: Company data, I-Sec Research

Emerging markets (especially India) are showing increased traction with 18.3% QoQ growth in Q4FY11.

Table 4: Geography-wise revenues (QoQ growth percentage)

(%) Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 North America 1.9 3.6 2.1 4.9 3.5 Europe 3.7 (6.3) 2.2 2.9 (0.3) Rest of World (RHS) (5.4) (2.9) 221.7* (64.2)# 18.3 Total 1.9 (2.9) 30.7 (18.1) 3.5 *Q2FY11 revenues include Rs2,989.5mn pass-through revenue from a domestic customer, largely relating to supply of third party hardware and software; # growth rate impacted by pass-through revenues in Q2FY11 Source: Company data, I-Sec Research

Tech Mahindra, May 30, 2011

ICICI Securities

Valuation methodology and key risks

We upgrade TechM to BUY from HOLD with a revised target price of Rs775 based on sum of the parts: i) Rs432 for TechM (ex- Mahindra Satyam) on target EV/E of ~7.4xFY13E and ii) Rs343/TechM share through Mahindra Satyam on target FY13E EV/E of ~8.5x and P/E of 14x. Key risks: i) lower growth of the telecom vertical ii) any adverse swap ratio in expected merger with Satyam.

Tech Mahindra, May 30, 2011

ICICI Securities
Table 7: Cashflow statement
(Rs mn, year ending March 31) FY10 FY11 FY12E FY13E Operating Cash flow before W Cap changes 11,315 8,071 9,633 12,813 Working Capital Inflow / (Outflow) (4,489) (7,930) (3,097) (2,118) Capex (4,106) 540 (1,800) (2,100) Free Cash flow 2,720 681 4,736 8,595 Cash Flow from other Invst Act (Ex Capex) 3,868 1,065 (3,166) (3,265) Proceeds from Issue of Share 51 368 254 32 Capital Inc/(Dec) in Borrowings 13,700 (1,425) (1,015) (1,015) Divided paid 0 (385) (506) (709) Interest Paid (1,535) (999) (886) (842) Others (21,999) 1,174 883 830 Increase/(Decrease) in Cash (3,195) 479 301 3,626 Source: Company data, I-Sec Research

Financial Summary
Table 5: Profit and Loss statement
(Rs mn, year ending March 31) Operating Revenues (Sales) FY10 FY11 FY12E FY13E 46,254 51,402 55,663 63,228

Operating Expenses 34,929 41,369 45,104 51,437 EBITDA 11,325 10,033 10,559 11,791 24.5 19.5 19.0 18.6 % margins Depreciation & Amortization 1,339 1,435 1,726 1,960 Gross Interest 2,184 999 886 842 Other Income 755 1,174 883 830 Recurring PBT 8,557 8,773 8,830 9,820 Less: Taxes 1440 1315 2116 2258 Less: Minority Interest 28 21 (15) (15) Add: Profit from Associates (Rec.) 1,066 2,112 2,503 3,265 Recurring Net Income 8,156 9,549 9,232 10,841 Add: Extraordinaries/Exceptional (1,518) (2,737) (1,327) 0 Net Income (Reported) 6,638 6,811 7,905 10,841 Less: Amortization Adjustment 1,668 1,704 1,524 1,544 Recurring Adjusted Net Income 6,488 7,844 7,708 9,297 Note: Restructuring fees worth 126mn received from largest client, BT is treated as pass-through in reserves and surplus in year of receipt and TechMs treatment of amortising the same over 19-20 quarters from Q1FY10 is adjusted to PAT Source: Company data, I-Sec Research

Table 8: Key ratios

(Year ending March 31) FY10 Per Share Data (Rs) Adj EPS Adj Diluted EPS Adj Cash EPS Dividend per share (DPS) Book Value per share (BV) Growth Ratios (%) Operating Income (Sales) EBITDA Adj Net Income Adj Diluted EPS Adj Cash EPS Valuation Ratios (x) P/E on adj. EPS P/E (on Diluted EPS) P/CEPS P/BV EV / EBITDA Adj EV/Adj. EBITDA EV / Sales EV / FCF Operating Ratio Software Development Expenses/Sales (%) SG&A/Sales (%) Other Income / PBT (%) Effective Tax Rate (%) NWC / Total Assets (%) Fixed Asset Turnover (x) on average Receivables (days) on average Payables (days) on average D/E Ratio (x) 53.0 49.4 63.3 3.5 298.7 3.6 (4.8) (29.7) (29.7) (24.4) 12.4 13.3 10.4 2.2 8.1 6.2 2.0 33.6 FY11 62.3 59.7 71.9 2.6 312.3 11.1 (11.4) 20.9 20.9 13.6 10.6 11.0 9.1 2.1 9.2 7.1 1.8 135.5 FY12E 60.0 58.7 72.7 3.4 327.6 8.3 5.2 (1.7) (1.7) 1.1 11.0 11.2 9.0 2.0 8.6 6.2 1.6 19.2 FY13E 72.2 70.8 85.8 4.7 377.1 13.6 11.7 20.6 20.6 18.1 9.1 9.3 7.7 1.7 7.3 5.0 1.4 10.0

Table 6: Balance sheet

(Rs mn, year ending March 31) FY10 Assets Total Current Assets of which cash and deposits with FI Total Current Liabilities & Provisions Net Current Assets Investments of which Strategic/Group of which Other Marketable Net Fixed Assets Intangibles Capital Work-in-Progress Total Assets of which cash and equivalents 19,346 2,187 8,665 10,681 30,145 29,696 449 6,042 76 3,208 50,076 2,636 FY11 23,455 2,666 8,711 14,744 29,080 29,070 10 6,107 76 1,168 51,100 2,676 12,227 (638) 159 1,260 10 0 38,091 39,351 FY12E FY13E 27,025 34,779 2,966 13,870 13,154 32,246 30,246 2,000 6,181 76 1,168 52,750 4,966 6,593 19,758 15,021 35,512 33,512 2,000 6,321 76 1,168 58,021 8,593

Liabilities Borrowings 13,672 Deferred Tax Liability (276) Minority Interest 139 Equity Share Capital 1,223 Face Value per share (Rs) 10 Reserves & Surplus 0 Net Worth 35,317 Total Liabilities 36,540 Source: Company data, I-Sec Research

11,227 10,227 (729) (926) 144 129 1,285 1,289 10 10 0 0 40,823 47,303 42,108 48,591

62.1 13.4 8.8 16.8 18.1 8.4 77 37 0.4

66.2 14.3 13.4 15.0 24.4 8.5 81 27 0.3 15.3 15.1 14.3 20.7 4.9 0.4 19.5

66.8 14.2 10.0 24.0 19.5 9.1 85 24 0.3 13.8 13.8 12.8 18.9 6.6 0.5 19.0

67.9 13.4 8.5 23.0 19.1 10.1 84 29 0.2 14.7 15.3 13.5 20.5 7.6 0.7 18.6

Table 9: Quarterly trend

(Rs mn, year ending March 31) Jun-10 Net sales 11,337 % growth (YoY) 1.9 Recurring EBITDA 2,127 Margin (%) 18.8 Other income 253 Extraordinaries Inc / (Loss) 0 Recurring Net Income 1,443 Source: Company data, I-Sec Research Sep-10 15,339 0.0 2,818 18.4 83 0 1,874 Dec-10 Mar-11 12,111 12,615 0.0 0.0 2,498 2,590 20.6 20.5 521 317 0 0 2,055 2,065

Return/Profitability Ratio (%) Recurring Net Income Margins 14.0 RoIC (Based on Avg) 28.8 RoCE (Based on Avg) 23.8 RoNW (Based on Avg) 23.2 Dividend Payout Ratio 7.7 Dividend Yield 0.5 EBITDA Margins 24.5 Source: Company data, I-Sec Research

Tech Mahindra, May 30, 2011

ICICI Securities

I-Sec investment ratings (all ratings relative to Sensex over next 12 months) BUY: +10% outperformance; HOLD: -10% to +10% relative performance; SELL: +10% underperformance

ANALYST CERTIFICATION
We /I, Krupal Maniar, CA, CFA and Varun Sharma, PGDM, research analysts and the authors of this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.

Disclosures:
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