Tech it

IPO REVIEW

Client diversification and JVs with large players would drive growth.

Tech Mahindra, the joint venture between Mahindra & Mahindra (M&M) and British Telecom (BT), with revenues of over Rs 1,200 crore in FY06, is approaching the market with an IPO to fund the development of new facilities and infrastructure.

The company will garner Rs 400 crore at the lower end of the price band (Rs 315) and over Rs 460 crore at the higher end (Rs 365). With exports by Indian IT and ITES sector to telecom service providers (TSPs) having increased by 98 per cent from 2002 to 2005, future looks good.

Attractive prospects
Tech Mahindra is engaged in the business of providing IT services and solutions in the telecom domain. Currently, the company employes over 10,000 professionals and has 16 sales offices worldwide and 10 delivery centres in two countries. It plans to set up a campus in Kolkata. It has a presence in Mumbai, Pune, Bangalore, Chennai and Noida.

The company expects good growth in business from TSPs. President-corporate affairs, Sujit Baksi says, "We are looking at increasing our business from telecom equipment manufacturers. We would also expand our service offerings."

Other growth drivers according to Baksi, include maintaining existing accounts and growing them, getting new accounts, entering new geographies and acquisitions.

Inorganic growth will help the company acquire new skill sets, more clients and new areas of operation. The company plans to tackle competition with its know-how, decrease in attrition rates (down from 26 per cent to 17 per cent) and large clients.

Diversifying its client base
Starting off as a service provider for BT in October 1988, the company has been diversifying its client base gradually. For instance, the share of BT in the total revenues, decreased from over 83 per cent in Q1 FY05 to 68 per cent during FY06.

This came down further to about 58 per cent in Q1 FY07, according to Baksi. The top five clients accounted for 90 per cent of the revenues in Q1 FY05, which reduced to 87 per cent in Q4 FY06.

The other major client is AT&T, whose share in total revenues in FY06 was about eight per cent at Rs 99 crore. The same has touched Rs 49.5 crore in just the first quarter of FY07.

In November 2005, the company acquired Axes Technologies and thus got clients like Motorola, Alcatel and Lucent. The revenues from these clients from November 2005 to March 2006 were Rs 41.3 crore. Some time back, the company also bagged a client in Indonesia, viz. Hutchison Telecom. It added a total of 20 clients in FY06.

However, it has to be noted that the company's operating margin has reduced from about 36 per cent in FY02 to about 22 per cent in FY06. When contacted, the company was unable to give a break-up of client-wise margins.

Although Europe still accounts for a major chunk of its revenues, the company has a presence in North America, the Asia-Pacific and Africa. While Europe accounts for 75 per cent of revenues, North America contributes 21 per cent and the rest comes from other regions.

It has announced a JV with Motorola for developing and delivering application solutions. According to Vineet Nayyar, managing director & CEO, the company will focus on partnering with large players such as Motorola.

For FY06, the company posted a 31 per cent growth in income from services to Rs 1,242.7 crore. Operating profit went up by 98 per cent to Rs 267.9 crore, while the net profit has gone up by 130 per cent to Rs 235.4 crore.

Baksi further says that the company's Q1 FY07 profits (20 per cent q-o-q growth) compares well with the overall growth in profits of its competitors that also operate in the telecom space, (Infosys: 21 per cent growth, Wipro: fall of six per cent and TCS: six per cent growth.)

High risk?
However, analysts add that despite the entry into the telecom equipment segment, the company continues to operate in just a single vertical, viz. telecom, which could be looked at as an element of risk.

Though the company is expanding its client base, it faces business concentration risk with bulk of the revenues still coming from BT. While the company has been increasing its client base, it refused to give any projections about how its non-BT revenues could grow in future.

Moreover, the space in which it operates is crowded with Indian and global IT majors. So, competition will be stiff and the challenge would be to sustain margins, especially in the event of any slowdown in the sector.

Valuations
According to an IT analyst from a Mumbai-based brokerage firm, if the numbers of Q1 FY07 are sustained going forward, then the valuation for FY07 expected earnings works out to 8-9x, which looks reasonable.

At the lower end of the price band, as per the basic EPS of Rs 22.63, the valuation comes to 13.9x and at the higher end of the band it comes to 16.13x. 
 

FINANCIALS
(Rs crore)	FY06	FY05	Change(%)
Income from services	1242.67	945.64	31.41
Operating profit	267.87	135.03	98.38
OPM (%)	21.56	14.28	"�
Net profit	235.37	102.39	129.88
EPS (Rs)	22.63	"�	-
P/E: Lower end: 13.9x, Higher end: 16.13x

Other companies providing IT solutions to the telecom sector trade at: TCS - 27.2x, Infosys - 32.37x, Wipro - 28.43x and Sasken - 42.16x, on a trailing 12 months EPS. Sasken trades at a premium despite the not so good Q1 numbers.

The Tech Mahindra issue opens on August 1 and closes on August 4. Post-issue, the shareholding of M&M would reduce from 56.14 per cent to 51.3 per cent, while that of BT would come down from 42.35 per cent to 36.24 per cent.