March 7, 2023
analysis123 analysis123
TECH MAHINDRA, Catching up
Call & Research Report by HDFC Securities
Sector: IT Services & Consulting
CMP Rs. 1085, Target Rs. 1140 (5% upside potential)
Target Period: 12 Months
We attended Tech Mahindra’s (TECHM) investor day, where the company reiterated its strategy with some added elements. There’s an apparent continuity in organic growth focus (vs. acquisition playbook earlier) with less than three quarters remaining for CEO transition. TECHM has trailed its peers historically in growth and operational performance. However, in an environment with reducing operational headwinds (cost of delivery, sub-con, attrition), the delta on earnings for TECHM can be higher than peers in FY24E (high teens growth vs. mid-teens for peers). In any case, drivers such as organic growth focus, synergy extraction from earlier acquisitions and delivery optimisation (sub-contracting & offshoring) will lead to a ‘catch-up’ on the operating profile. (1) Improved enterprise portfolio supported by prior acquisitions; (2) investments to scale P&P business (USD 450mn to USD 1bn targeted in three years) supported by the refresh of the existing platform (such as Comviva); and (3) uptick in partnership engagement (expected to drive ~40% of revenue ahead from ~30% currently) will be offset by the near-term macro challenges and translate into an 8.4% USD revenue CAGR over FY23-25E for TECHM over FY23-25E. Maintain ADD on TECHM, with a TP of INR 1,140, at 15x Dec’24E EPS, supported by a 17% EPS CAGR over FY23-25E and ~5% FCF & payout yield. TECHM is trading at 15.8x FY24E, which is in line with the 5Y/10Y averages but at a discount of 28% to the IT index (vs. a 22% discount historically). The announcement about leadership change and higher certainty on margin trajectory can be positive catalysts.
Leadership in CME vertical
Communication continues to be dominant in TECHM’s portfolio, with the vertical contributing 40% to revenue at USD 2.6bn annual revenue rate. The company’s leadership in the vertical is supported by a USD 1bn+ 5G related revenue and penetration in >100 telco clients on network initiatives, proximity to the customer base (including 12 of T20 wireless service providers, 5 of T5 equipment manufacturers), and 15% growth in TCV in the CME vertical (including 6 large deals in FY23E – Telefonica deal included), amplified by the acceleration in the Media & Entertainment sub-segment. TECHM’s end-to-end suite in the vertical is driving deals ranging from selling faster rollout of network services to automation with more IPs and platforms (such as Cloud Blaze Tech).
Focus on synergies and organic playbook
TECHM has spent USD 1.2bn over FY20-22 in 23 acquisitions adding >USD 500mn to TECHM’s revenue rate (one-third of incremental revenue over the FY19-23 period). These have led to improved capabilities in areas of digital engineering and hi-tech, supported by acquisitions of CTC, Lodestone, Cerium, and Allyis; in design with acquisitions of BORN, Bio, Mad Pow, WMW, and in Cloud with acquisitions of Digitalonus, Momenton, Brainscale, and Eventus. TECHM’s focus for the last three quarters has been to integrate (account teams, back office, systems & process) and drive synergies; the synergy pipeline stands at USD 1bn aiding visibility.
Margin accretion ahead
TECHM’s margin differential to tier-1 peers is slightly above the long-term average differential of ~7% lower margins, which is largely on the higher cost of delivery, while SG&A is at peers’ average. The drivers for margin increase are optimising sub- contracting, increasing offshore, rationalisation of non-accretive business and steady state on large deals. Some of the traditional levers such as utilisation have limited scope to improve margins, even as delivery metrics have improved (internal fulfilment up from ~50% to ~70%). We have factored in EBITM recovering from 11.8% in FY23E to 13.5/14% in FY24/25E, as compared to 14.6% in FY22.
BPS strength to continue
The BPO services (14% of revenue) vertical has outperformed and is likely to continue. The current penetration of BPS is only in 50 of the Top 200 clients, which provides ample growth opportunity. Acquisitions such as Perigord (life science vertical packaging artwork and labelling services) and Eventus (CX and customer management) have supported growth in the services. TECHM’s strategy in the services is to diversify from being CX services heavy currently and the company doesn’t consider generative AI to be a threat in the medium term for the segment.
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