Buy Mphasis: PPFAS Research

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Buy Mphasis: PPFAS Research

Parag Parikh Financial Advisory Services (PPFAS) is bullish on Mphasis and has recommended buy rating on the stock in its December 1, 2011 research report.

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Parag Parikh Financial Advisory Services (PPFAS) is bullish on Mphasis and has recommended buy rating on the stock in its December 1, 2011 research report.

"Mphasis has been saddled with a lot of negative expectations. It began primarily with the parent controlling Mphasis' margins & it has ended with the the entire HP Services business line suffering a slowdown. The part where the margins were dictated by HP (the Parent & biggest customer/partner) has always been the concern. Double whammy hit when HP couldn't get its act together in growing the Services business acquired from EDS. The management flux at HP & the directionless approach so far in the services area has proved to be very costly for Mphasis."

"The sales grew ~1% YoY owing to slower HP channel growth which comprises 62% of Mphasis' revenues. Net profits were down YoY by 25%, which is part of the huge profitability slump over the past three quarters. Any IT company worth its salt can earn these mid teen margins & we can expect Mphasis to maintain this steady average through both HP & Direct channel. The revenue mix between HP & Direct Channel has moved from 67:33 to 62:38 which is a good sign towards de-risking the company's exposure from purely one client. For the Direct channel business, Mphasis acquired Wyde Corp for their insurance platform. Their Direct channel revenue growth QoQ has been impressive at 21% including the acquisition. Mphasis has also began tapping Non Enterprise Services business of HP namely imaging, technology solutions & professional services. This opens up new opportunities to add to the service line since skills required are not entirely different from current offerings. The ITO business mix which used to be majority HP has now shifted to 30% Direct channel sales. The margins on the Direct channel more or less remain the same as the HP channel."

"The only negative aspect for Mphasis or any other HP subcontractor is about the margins that HP allows them to earn from the services offered. Here HP had the upper hand & will continue to have the upper hand. The contractors will be free to decline revenue if it keeps coming at lower rates than they can possibly work with. Due to Mphasis being part of the HP group, one more disadvantage for its Direct Channel business would be the size of the deals they can approach. Since HP would want to take all the $100 Mn dollar (and above) deals, Mphasis would have to compromise with sub $50 Mn deals. That involves getting more & more deals to sustain revenue growth. One positive in this situation is that only 13% of Mphasis' overall revenue is Fixed price based. So that contract pricing can be negotiated for 87% of the revenue. Despite the problems surrounding Mphasis since the past three quarters, the company earns an RoE of 21%. The company has ~` 19,000 Mn in cash (post dividend) & generates $15 Mn each month in cash through operations. Nearly 1/3rd of the company's market value is equal to the cash on books. Combined with a good acquisition plan the RoE can be sustained. The company doesn't seem to be interested in returning the bulk of its cash via a buyback or a large special dividend, so we will need to observe how they use their cash in the future."

"Coming back to the question of valuation, we have to consider how long can we wait for the tide to turn in Mphasis' favor. This can happen when HP starts showing good growth on it's services business, which has been just 2% YoY this year. With a new CEO in place the probability of things getting in order soon, is very high. Mphasis is available at ~8x Oct 11 earnings. We recommend a BUY considering the high probability of HP revenue kicking in going ahead," says Parag Parikh Financial Advisory Services research report.

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To read the full report click on the attachment