Reduce MphasiS; target of Rs 340: Emkay

“Mphasis reported gross rev of US$ 252 mn (-5.2% QoQ) with revenue decline led by 11% sequential decline in rev from HP channel (HP ES rev declined by 13% QoQ) as Direct business grew by 2.8% QoQ. While weakness in HP is along expected lines, the sharp pace of decline continues to worry with mgmt expecting the weakness to persist (we highlight that rev from HP channel have declined by 32% from peak rev of US$ 204 mn in QOct’10, refer table below). EBITDA mgns at 19.7% were flat sequentially helped by 9.6% QoQ currency depreciation as company implemented wage hikes/promotion during the qt. Profits at Rs 2.1 bn (+10% QoQ) missed expectations (Emkay est Rs 2.3 bn) driven by lower than expected operational performance. Overall HC increased by 460 people QoQ to 37600 after 4 successive qtrs of HC decline albeit led by hiring in the BPO segment (co added 1,400 people QoQ here) with HC continuing to decline in the Applications and the ITO segment.”

“While mgmt expects pressure and decline in the HP channel to continue, Direct business (proportion of direct business has increased by ~1200 bps over the past 4 qtrs to 45% of rev in QJuly’12) could see moderation in growth driven by the macro uncertainty as deal closures take longer. Further we see limited room to improve margins at Mphasis given (1) continuous revenue pangs, (2) no room to improve operational levels like utilization and (3) need to step up S&M investments as company intends to drive growth in the direct business.”

“Valuations at 10x FYOct’12/Oct’13E P/E are inexpensive with cash at 29% of market cap limiting any case for sharp absolute downsides, however need to be weighed in the context of continuous operational challenges. Moderation in revenue growth in the direct business will amplify the decline in HP channel business ahead. Retain reduce with an unchanged TP of Rs 340. Delisting /Buyback offer from the parent /company remains an upside risks to our call,” says Emkay Global Financial Services research report.

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