23 November 2010

MphasiS (MPHL IN)
Talk of pricing pressure is not evident from the 4Q FY11 results
Software: India R. Ravi (91) 22 6622 1014 (ravi.r@in.daiwacm.com)
Price (23 Nov)
Reuters code ADR/GDR code Shares per ADR/GDR

Rating: 1

Target price: Rs765.00

MBFL.NS n.a. n.a.

What has changed?
• MphasiS announced a revenue increase of 5.2% QoQ and a net-profit rise of 4.7% QoQ for 4Q FY10, almost in line with our forecasts. The EBITDA margin contracted by 100 basis points QoQ as a result of increased manpower costs.

Market data
SENSEX Index Market cap EV 3-mth avg daily T/O Shares outstanding Free float Major shareholder Exchange rate 19,691.84 (US$bn) 2.84 (US$bn; 11E) 2.68 (US$m) 6.74 (m) 210 (%) 39.3 HP/EDS (60.8%) Rs/US$ 45.409 3M 1.6 (5.4) 6M (3.5) (23.3)

• Contrary to the market’s expectations, billing rates for application-service revenue were flat sequentially, and onsite rates improved from US$71/hour for 3Q FY11 to US$72/hour for 4Q FY11. This revenue stream (65% of total revenue for FY11) improved by 5.8% QoQ for the fourth quarter, and the gross-profit margin expanded by 140 basis points QoQ to 30.9%. • The gross-profit margin for business process outsourcing (BPO) expanded by 270 basis points QoQ to 17.4%, leading to a gross-profit increase of 18.2% QoQ. Infrastructure services (23% of full-year revenue) recorded a gross-profit margin decline sequentially. However, this business’s gross profit numbers are not strictly comparable as its third-quarter revenue included one-off revenue of Rs170m. • As manpower costs increased by 10.5% QoQ and administrative costs rose by Rs118m QoQ, Mphasis’s EBITDA margin declined by 90 basis points QoQ to 23.8%. In addition to increased costs, the margin contraction was attributable to the fall in the utilisation rate for the company’s offshore infrastructure-services operation to 66% for 4Q FY11, from 73% for 3Q FY11. • Mphasis recorded a forex gain of Rs130m, so other income overall rose steeply to Rs310m for 4Q FY11, from Rs174m. In addition, as the company still has tax credits, the effective tax rate rose from 7.4% for 3Q FY10 to 9.6% for FY10. • We have not revised our FY11 earnings forecasts, as we believe Mphasis is able to add clients across various revenue run-rate categories. We have revised down our FY12 EPS forecast by 3.1%, to reflect a modest upward revision to our taxrate forecast.

Performance (%)* 1M Absolute (2.2) Relative 0.1 Source: Daiwa Note: *Relative to SENSEX Index

Investment indicators
2011E 2012E 2013E PER (x) 10.4 9.7 9.1 PCFR (x) 14.9 11.3 10.3 EV/EBITDA (x) 7.8 6.5 5.6 PBR (x) 2.9 2.3 1.9 Dividend yield (%) 0.7 0.8 1.0 ROE (%) 32.1 26.5 22.7 ROA (%) 23.8 19.9 17.3 Net debt equity (%) net cash net cash net cash Relative to peers In line Relative to history In line Source: Daiwa forecasts

Income summary (Rs m)
Yr to 31 Oct 2010 2011E 2012E Revenue 50,366 60,743 70,065 YoY (%) 18.1 20.6 15.3 EBITDA 12,650 15,550 17,446 YoY (%) 12.1 22.9 12.2 Net profit 10,910 12,398 13,292 YoY (%) 20.1 13.6 7.2 EPS (Rs) 51.969 59.060 63.316 YoY (%) 20.1 13.6 7.2 CFPS (Rs) 32.482 41.097 54.239 DPS (Rs) 3.321 4.118 4.992 Source: Company, Daiwa forecasts 2013E 76,605 9.3 18,615 6.7 14,086 6.0 67.100 6.0 59.765 5.848

Price and relative performance
(Rs) 900.0 700.0 500.0 300.0 100.0 Rel to SENSEX Index 350 275 200 125 50 07/11 08/5 08/11 09/5 09/11 10/5 10/11

• We maintain our six-month target price of Rs765, based on a target 13x PER on our FY11 EPS forecast. Mphasis trades currently at what we see as attractive PERs of 10.4x for FY11 and 9.7x for FY12 on our EPS forecasts. Our FY12 earningsgrowth forecast looks muted given the upward revision to our tax forecast.

Source: Bloomberg, Daiwa

Forecasts revisions (%)
Revenue change Net profit change EPS change Source: Daiwa forecasts FY11E FY12E FY13E 0.0 0.0 n.a. 1.5 (3.0) n.a. 1.5 (3.1) n.a.

Catalysts and action
• We maintain our 1 (Buy) rating on Mphasis. Mpahsis had cash and liquid investments of US$365m for 4Q FY11 (an increase of US$40m compared with 3Q FY11), which we believe could be used for acquisitions over the next few quarters. If these acquisitions prove earnings-accretive, we believe they could lead to a rerating. In addition, the cash could be used potentially to buy back shares equating up to 10% of its net worth. Under U/S-77A of the Indian Companies Act, shareholders’ approval is not required and a repurchase could be done with a board resolution. If the company carries out a buyback, then we believe it could buy back 2.8% of its shares at the current share price, which would be earnings-accretive.

Fair value
Valuation (Rs/shr) Methodology Key assumption Source: Daiwa forecasts 765.00 - As above On FY11 EPS of Rs58.21


Global Equity Research

1 38.8 n.2 21.7 20./(exp.030 0 14.0x 11.635 127 632 8.100 67.886 3.000) 0 (3.567 2.) Offshore revenues (US$ m) 2009 35 4 39 19 60 23 31.099 2.026) 15.7 31.056 3.0 7.615 (3.968 2012E 16.522) (2.820) 13.) – YoY % EPS (adj.500 19. MphasiS has recorded revenue in excess of Rs10bn per quarter.965) 0 0 (1.013 1.6 15.561) (1. int.284 2.054 9.491 2.0 207.718 19.347) 16.4 48.200 17.072 53.) Onsite based engineers (No.041) 1.700) 0 (3.087 9.9 78.219 12.0 48.760 (2.5 22.590 2010 12.195 0 16.a.886 3.802 24.) Net-profit margin % (adj.026 (3.2 6. n. 6.612) 500 (7.a.7 3.665) (2.637 (1.6 12.6 7.487 50.650 2011E 18.) EBIT margin % (adj.000 4.8 16.730 1.791) (1.605 0 (51.260 11.969 51.181 (7. and we expect HP+EDS to account for 71% of its revenue over the next few years.420 810 2011E 50 6 56 20 67 25 44.659) 2010 1.099 2.965) (2.254 20.991) 0 (133) (733) 1.9 17.820 (2.Company background MphasiS is a 60.733 1.E.3 9.6 2.181 435 390 335 475 507 650 14.354 45.0x 6.3 190.9 24.283 2010 14.7 21.358 23.981) (1.1 33.490 23.200 88.086 67. n. MphasiS – financial summary Profit and loss (Rs m) Year to 31 Oct Application development Application maintenance Others Total revenue Other income COGS SG&A Other op.3 21.268 18.5 25. expenses EBIT Net-interest inc.030) 8.542 3.959 17.398 12.550 2012E 21.7 18.0 21.2 6.420 17.100 5.491) 0 0 (1.992 0 45.786 0 9.933 980 2012E 60 7 67 19 66 24 52.6 7.) – YoY % EBITDA margin % (adj.453) 0 58 (418) 468 108 0 1.1 13.214 19.4 19.422 9.639) (1.) EPS (reported) (Rs) EPS (adj.089 222 0 50 2011E 14.0 20.9 12.608 2.0 20.7 34.627 (1.420 1.445 23.886 16.6 35.292 63.728 2.6 20.0x 16.321 11.6 7.467 1.910 51.500 36.1 20. n.291 2.067 867 667 467 267 67 Nov-07 Nov-08 Nov-09 25.265 17.0 26.) (Rs) DPS (Rs) EBIT (adj.342 15.317 PER bands (Rs) 1.065 0 (46.362) 0 12.667 3. It derives two-thirds of its revenue from financial services.241 18.087 43.946 8.118 13.728 (641) 0 9.267 1.) 2009 12.1 26.260 468 0 9.587 22.340 0 17.519) (4.547) (1.9 30.1 23.316 4.060 59.760 1.295 49.992 15.091 3.192) 0 10.453 0 32.455) (2.7 6.5 79.033 642 2010 38 5 43 21 60 26 36.022) 9.323) (2.3 21.546 (1.386 (1.a.988) 0 (6.7 Key assumptions Year to 31 Oct Offshore efforts (m Man-months) Onsite efforts (m Man-months) Total efforts (m Man-Months) Offshore billing rates (US$) Onsite billing rates (US$) Blended billing rates (US$) Offshore based engineers (No.254 59.2 6.181 0 1 9.851 15.197) (1.a.615 2.785 0 12.930 70.099 42.292 13.0 76.935 (340) (7.195 154 0 8.1 25.836 0 0 0 3 3 3 15.512 3.799 3.331) 2011E 2012E 2013E 7.614 2.969 3.9 8.268 1.8%-owned subsidiary of Hewlett Packard (HP) and one of the premier IT-services companies in the Tier-II space.200 88.362) (4.594) (6.635 (1.060 4.737) (1.9 22.182 2.261 60.323) 0 13.023 14.316 63.730 15.349 74.984 2.185 21.5 26.910 10.5 37.852) 0 0 (837) 1.366 0 (33.367 28./others Pre-tax profit Tax Min.6 24.986 68.211 19.4 28.748 76.6 2.089 0 12. n.041 0 3 12.126) Cash flow (Rs m) Year to 31 Oct Profit before tax Depreciation and amortisation Tax paid Change in working capital Other operational CF items Cash flow from operations Capex Net (acquisitions)/disposal Other investing CF items Cash flow from investing Change in debt Net share issues/(repurchases) Dividends paid Other financing CF items Cash flow from financing Forex effect/others Change in cash 2009 9.637) 11.171 55.175 18.659 Key ratios Year to 31 Oct Sales – YoY % EBITDA (adj.035 (1.892 15.7 207.211 42.900 9.7 38.a.) ROAE (%) ROAA (%) ROCE (%) ROIC (%) Net debt to equity (%) Effective tax rate (%) Accounts receivable (days) Payables (days) Net interest cover (x) Net dividend payout (%) 2009 2010 2011E 2012E 2013E 123.9x 21.461 0 0 0 14.347 (3. Daiwa forecasts Daiwa Research Update 2 .049 2013E 17.099 30.0 18.7 net cash net cash net cash net cash net cash 6.3 48.743 0 (40.022 (641) (1./others Net profit (reported) Net profit (adj. div.) EBITDA (adj.195) 11.887 66.892 32.652) (1.8 19.412) (24.064 7.285 2.981 18.1 13.243 44.102 1./others Shareholders' equity Minority interests Total equity & liabilities Net debt/(cash) 2009 1.1x Nov-10 Source: Company.314 18.026) (2.308 32.035 454 369 11.3 78.438 60.6 9.340) 12.4 7.340 77 0 8.089) 6.633 1.446 2013E 24.898 16.753 15.522) 0 14.950 26.1 22.848 16.342 0 0 0 59.086 14.) – YoY % Net profit (adj.) Assoc/forex/extraord.325) (6.144 2013E 72 9 81 18 64 23 62.901) (4.706) (468) 8.7 32.192) (4.5 76.886 15.839 2.212) (4.349 74.608 (3.096 21.819 (4) (6.177 18.615 Balance sheet (Rs m) As at 31 Oct Cash & short-term investment Inventory Accounts receivable Other current assets Total current assets Fixed assets Goodwill & intangibles Other non-current assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Other non-current liabilities Total liabilities Share capital Reserves/R.102 (1.013 12. Since the acquisition of EDS by HP.318) (15.639 0 (26.5 2./pref.200) 0 (2.263) 1.6 22.6 20.2 30.536 14.554 18.398 59.285 43.044 2.030 193 0 5.

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