Indian IT Services Sector – Add the Digitals

JainMatrix Investments presents an Industry report on the Indian IT Services sector. It’s a sector that is growing at 8-10% annually and has significant share in global outsourcing. An ecosystem of good college education and a large pool of talent, feed a clutch of globally competitive Indian IT Service firms. The digital demand has only grown post-covid, so the industry is looking at many years of global growth in early double digits. See the Conclusion section for our recommended IT Services portfolio.

We make our 11th Jan 2021 IT Services sector report public for your investing pleasure and success.

jainmatrix investments, IT Services

Additional sector reports:  Happiest Minds IPO – Ride the Digital Wave – Sept 2020    

                                               LT Tech Services IPO – The Make in India Firm – Sept 2016

Introduction and Profile

  • Indian IT services industry started over 30 years ago, but is now very large with revenues US$ 191 billion (INR 14 lakh crores). About 81% of revenues are from exports. See Fig 1a.
  • It has 17,000 firms & is an emerging global hub for Digital Skills, with 75% of global digital resources.
  • IT Services have contributed 7.7% to the India GDP in 2019 which is expected to grow to 10% by 2025 (IBEF). In FY19, the industry employed 41 lakh people. It is also fueling innovation, as there are around 5,300 tech start-ups in India.
  • Exports rose at a CAGR of 8.05% during FY16-19. Export of IT services has been the major contributor, accounting for 54% of total IT export (including hardware) during FY19.
  • Globally, the sector is headed towards achieving USD 1 trillion (INR 75 lakh crores) of revenues by 2022.

Fig 1a – Market Size in India and Fig 1b – Share of Demand by Country

  • USA dominates global Country Share of demand, with EU, China and Japan coming next, see Fig 1b.
  • In Fig 1b, market share of Indian IT industry looks small but this is domestic demand in USD. India is a dominant supplier of IT services globally and has the fastest growing industry in the world with most key players having a HQ or development centers here.
  • BFSI is a key business vertical for IT & BPM industry, in terms of major revenue-share. Adoption of new technologies is needed for growth & competitive advantage in Banking & Insurance domain.
  • Other important sectors are Life Sciences & Healthcare, Retail & CPG, Communications & Media, Manufacturing, Telecom and Technology & Services.
  • Indian IT industry’s USP is cost competitiveness, good skills, resource availability and project management skills for providing IT services.  
  • Tier II and III cities are gaining traction among IT firms aiming to grow business in India, facilitated by skilled local resources, affordable real estate, favorable Govt. regulations, tax breaks and SEZ schemes. A hub and spoke model is developing with Tier I city as hubs and tier II, III and IV as spokes.
  • India is a top location for Global Capability Centers (GCCs), which concentrate on workers and infra to handle operations (back-office, corporate business-support, accounting & finance, transaction processing and contact centers) and IT support (app. development and maintenance, remote IT infra, and help desks), to enhance productivity. Some large companies use GCCs as a center of excellence for innovation and research.
  • About 70% of India-based GCCs belong to US companies, 20% European and 10% Asia-Pacific.
  • According to Nexdigm, India is home to over 1,750 GCCs, which is 50% of all such centers globally. GCCs here employ over 10L employees, generating a total economic value of around $28.3 billion.
  • IT Services in India are growing at a fast pace due to the globally competitive firms that provide world-class services. The Human talent pool available in India is highly skilled and trainable, a key strength of the IT Services sector. The IT infra here has also developed to global standards.

IT Sector Progress and News

  • NASSCOM (National Assn. of Software & Services Cos.) launched an online platform to up-skill 40 lakh tech professionals. It partnered with GE Healthcare for digital healthcare solutions for the market.
  • IT service firm DXC Technology, will set up its first global analytics unit in Bengaluru.
  • Govt. of India (GoI) announced a national program on AI (artificial intelligence) and a new National AI portal. GoI has identified IT as one of 12 champion service sectors for developing an action plan. It has set up a ₹5,000 crore ($ 745 m) fund for realizing the potential of these champion service sectors.
  • As of Feb’20, there were 421 approved SEZs (Special Economic Zone) across the country, and of these, 276 are from IT & ITeS. These provide tax incentives for exports. Software Technology Parks of India (STPI) has set up 57 centers for single window clearance and infra facilities, and for Excise Duty exemptions on buying local goods.
  • Technology for many businesses was considered a support function. This has changed as tech. has become business critical, enabling employee productivity, revenue growth from eCommerce, cost savings and faster customer support & communication.
  • TCS took the #1 spot with M-cap of $144 b among IT Services organizations, dethroning Accenture which is trailing by just $1b (Dec ‘20).

Impact of Covid

  • In Q1FY21, Indian IT sector has emerged as a winner post lockdown. With Work from Home (WFH) at 95%, all the big IT firms saw robust demand from clients, particularly cloud & automation. Infosys gained in revenue and profits; IT index gained 22% in July. Similarly in Q2FY21, IT sector gained due to increased tech spending by clients in digital transformation.
  • Due to automation, spending on IT infra has outpaced HR. Job creation has been limited with offers being rolled out more on contractual basis than full-time, in both emerging & developed markets.
  • Many firms found that WFH employees are equally productive & this saves real estate costs as well. It also relieves firms of covid related responsibility and litigation.
  • IT Deals – Indian IT stocks jumped by 50%, on an average, between Mar-Sept ’20. Top IT firms have been closing deals – Infosys closed 2 big deals, Vanguard and Consolidated Edison (digital transformation); TCS won deals from Phoenix Group (life insurance and pension) for client analytics tool, and Morrisons (retail); Wipro from Marelli (auto software engg.) and HCL Tech from Ericsson.
  • Broker comments: Girish Pai of Nirmal Bang said that global clients shifted spending from internal IT, selling, general and administrative (SG&A) and hardware, to outsourcing and digital, to speed up the digital transformation processes such as migration to cloud.
  • Motilal Oswal, a brokerage firm, said that demand & utilization has normalized to pre-Covid levels with discussions being revived for deferred deals and margins expected to be resilient as well.

Relative Price Performance

  • The graph in Fig 2 – Relative Share shows the stock returns given by listed Indian IT Services firms over Oct’18 – Jan’21.
  • We can see that performance was steady for these firms till early 2020 in a +25 to -10% ranges, then there was a sharp fall due to Covid. Recovery came by July’20 and in next 6 months there was a dramatic price rise for many of them.
  • On the right side we can see the resultant share performance by order for the 2+ years.
  • Among large caps, L&T Infotech is #1, marked L1, Infosys #2, HCL Tech #3 and next are Wipro #4, TCS #5 and Tech Mahindra #6. Among mid-caps, the rankings are Persistent is #1, marked M1, others are Mindtree #2, Mphasis #3, LTTS #4 and Sonata Software #M5.
  • Even so, the entire IT Services pack has performed very well as even the lowest performance was 42% gains over 2+ years, while the highest is an amazing 179% gain.

Fig. 2 – Relative Share Price

Large Cap Firms – Benchmarking and Sales Charts

Fig 3a – LC revenue and Fig 3b – MidCap

In Fig 3a we map the FY20 revenues for Large Cap Firms. Revenue from exports is the major source.

  • TCS has the highest sales by value, almost two-fold to the nearest competitor Infosys.
  • In terms of India revenues, Tech Mahindra has the highest domestic sales followed by TCS.

Fig 4a – LC Benchmarking

  • In Fig. 4a – Benchmarking, we compare large cap IT services firms on key financial parameters.
  • The leader is marked in green and the laggard in red. The sum total of these parameters is the Score.
  • We can see that TCS is a clear leader, including RoCE and Return of Equity, while Wipro lags on this comparison amongst 6 large cap firms. L&TI however appears as a growth and profit leader.

Mid-Cap Firms – Benchmarking and Sales Charts

  • In a similar manner, we compare mid cap IT services firms. In Mid-cap basket, Sonata is the leader on financial parameters, including RoCE and RoE, whereas Persistent lags among the 5 firms.

Fig. 4b – Mid-caps Benchmarking

  • Among mid-caps, Mphasis has the highest revenues or sales, followed by Mindtree.
  • Sonata Software has the highest domestic sales by value and proportions.
  • Fig 4b above captures the MidCap firms revenue by domestic and exports.

Future of the Indian IT Services Industry

  • The comparative advantages of the country are – young population, good college education and ample science and technical courses. These feed this sector with quality resources.
  • India is developing as a critical part of execution and delivery of global business and IT Services, across industries & locations. Firms like TCS are covering more countries & expanding the market.
  • The growth of Telecom networks like 2G-4G and now 5G are bringing the world closer.
  • Covid has actually accelerated the rise of digital, eCommerce, internet and the IT Services industry. As larger firms enforced WFH for their employees’ safety, the physical presence has become unnecessary for work, for large swathes of industry. 
  • TCS as the #1 firm globally in terms of market capitalization has been able to sustainably mix high margins, high growth and a global vision. The other firms in the industry are growing in its wake and developing their own niches and strengths.
  • The industry is looking at many years of global growth in early double digits, even as IT services take early baby steps of growth in its own backyard, India. With programs like Aadhar card, UPI payments, GST, digital tax filing and FASTag, technology is proving the best way to transact at scale with speed and transparency, and also reduce corruption.
  • The success of the Indian IT Services firms has spawned the second generation of services firms such as Syngene Intl. (pharma R&D) and Tata Elxsi & LTTS (Engineering R&D) which are niche services players by technology or industry.
  • The key new IT services trends are WFH, cloud services, AI, IoT, robotics, mobile apps and machine learning.

Conclusion:

  • IT Services firms are always going to be needed to stitch together solutions for large Enterprises, and to help them navigate, evaluate and deploy in complex IT landscapes with multiple technology options.
  • Indian IT services companies have time and again proven their mettle and have the skilled resources and project management skills to deliver successfully. It is a dynamic, globally focused sector.
  • The 11 firms had an excellent share price performance range of 42% to 179% gains over 2+ years.
  • The weak INR may help India to continue to be a good base for service delivery teams and exports.
  • Large Caps: A LC IT Services portfolio will be more stable and safer for investors. We conclude from Fig 2, Fig 3a, and Fig 4a that of the 6 LC firms, the best 3 are L&T Infotech, TCS and Infosys.
  • Mid-Caps: A MidCap IT Services portfolio will be more volatile, but possibly provide better returns. We can see from Fig 2, Fig 3b and Fig 4b that of the 5 LC firms, the best 2 are Mindtree and LTTS.  
  • We recommend investors to buy this 5 firm portfolio in an equi-weight mode.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Punit Jain has equity holdings in LTTS, Sonata Software, TCS and L&T Infotech, all <1%. Punit Jain has worked at TCS (1995-2002) and in Sonata Software (2003-2012). Other than this, JM has no known financial interests in any of these firms. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JM at punit.jain@jainmatrix.com.

Happiest Minds IPO – Ride the Digital Wave

  • Date 05th Sept 2020; IPO Opens 7-9th Sept at 165-166/share
  • Valuations: P/E 34 times FY20, P/B 7.6 times (Post IPO)
  • Small Cap: ₹ 2,438 Mkt cap
  • Sector – IT Services
  • Advice: SUBSCRIBE

Here is a note on Indian Happiest Minds Technologies Ltd (HMT) IPO. jainmatrix investments, happiest minds

Summary

  • Key Strengths: HMT is a small but fast growing IT services firm with a focus on digital services.
  • HMT concentrates on new and emerging technologies, platforms and ecosystems, which have a greater impact on customers and help HMT stand out in a crowded industry.
  • The promoter Ashok Soota, is a successful executive and serial entrepreneur.
  • The Covid pandemic has accelerated outsourcing, offshoring and demand for digital services.
  • In FY20 the Revenues, EBITDA and Profits of HMT were ₹ 698 crore, ₹ 101.9 cr. and ₹ 71.7 cr. resp. In just 9 years the firm has gone from startup to $100 million of revenues, and Rs 100 crores of EBITDA, it is a good achievement.
  • Risks: 1) Valuations at PE of 34 times and PB of 7.6 times (TTM) are expensive. 2) Intense competition 3) Covid induced challenges – demand from customers as well as employee health 4) Rupee strengthening against USD
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2-3 year perspective.

IPO highlights

  • The IPO opens from 7 – 9th Sept 2020 in a Price Band of ₹ 165 – 166 per share
  • The IPO includes a Fresh issue of ₹ 110 cr. and an Offer for Sale of 3.56 cr. shares. So the Total IPO size is max 702 cr. of about 4.2 cr. shares.
  • This will be about 28% of the equity share capital of HM.
  • The lot size is 90 shares and Face Value ₹ 2 per share
  • The IPO share quotas for QIBs: Non-Institutional Investors: Retail is 75:15:10%.
  • The promoter & promoter group owns 61.8% in HMT which will fall to 53.3% post-IPO. Th other seller is CMDB-ll (JP Morgan Asset Management).
  • The unofficial/ grey market premium is ₹ 115-125 /share over IPO price. This is a positive.

Introduction

  • Happiest Minds Technologies provides end-to-end solutions in digital business, product engineering, infrastructure management and security services. It was incorporated in 2011.
  • The FY20 Revenues, EBITDA and Profits of HMT were ₹ 698 crore, ₹ 101.9 cr. and ₹ 71.7 cr. resp.
  • It offers solutions across the spectrum of digital technologies such as Robotic Process Automation (RPA), Software-Defined Networking/Network Function Virtualization (SDN/NFV), Big Data and advanced analytics, Internet of Things (IoT), cloud, BPM and security.
  • There are 3 key divisions: the Product Engineering Services (PES) unit helps by transforming the potential of digital by making the product secure and smart. The Infra Management (IMSS) provides an end to end monitoring and management capability for applications and infrastructure. The Digital Business (DBS) is focused on digital content management, connected retail and other customised offerings for clients.
  • In FY20, 96.9% of revenues were from digital services, one of the highest among Indian IT companies. See Fig 1 a, b and c for details of revenue by Service Lines, Industry and Geography. d) gives us the trends in onsite: offshore employee deployments.

jainmatrix investments, happiest minds

Fig 1 – HMT FY20 Revenues by (a) Service Lines (b) Industry Vertical and (c) Geography      (d) Onsite share (clickable)

  • HMT has 79% USA based business, higher than most Indian IT firms where it is 65-70%.
  • The HMT philosophy is quite simple – that the happiest people make happiest customers. Thus there is a focus in the company to keep employees motivated, engaged and happy.
  • The business units of the company are assisted by the 3 Centers of Excellence which are Internet of Things, Analytics / Artificial Intelligence, and Digital Process Automation.
  • As of FY20, the company had 157 active customers with average revenue per customer at USD 614,675. Its repeat business (revenue from existing customers) has steadily grown and contributes a significant portion of revenues.  There is a high degree of customer stickiness.
  • It has 2,439 employees.
  • Happiest Minds delivers services across industry sectors such as Retail, Edutech, Industrial, BFSI, Hi-Tech, Engineering R&D, Manufacturing, Travel, Media and Entertainment.
  • Key leaders: Ashok Soota (77, Promoter, Exec. Chairman-Dir.), V. Narayanan (ED-CFO) J. Anantharaju (V. Chairman, President-CEO PES), Rajiv Shah (Pres-CEO DBS) and C. Ramamohan (Pres-CEO IMSS).

News, Updates and Strategies

  • Deep Tech can Enable Business Growth: Per a news report, HMT has Deep Tech capabilities like AI, 5G, Blockchain, drone-tech, 3D printing, advanced material, quantum computing, biotechnology, etc. These emerging technologies are powerful and can solve specific business problems, and enable growth for clients. The adoption has accelerated post Covid.
  • Happiest Minds is India’s Top 25 Best Workplaces in IT & IT-BPM – Nov 2019.
  • However attrition was high at 19 %, higher than industry levels of 17-18%.
  • Happiest Minds has positioned itself as “Born Digital, Born Agile”.
  • The IPO share quotas indicate a tilt towards QIB, with smaller quotas to NII and Retail.
  • The Digital Content Monetization is a software as a service platform from HMT that helps firms digitize and monetize their content, delivering it to their customers, partners, and users. DCM comes with consumption-based pricing, and is powered by IBM Cloud.
  • Post Covid, the Indian IT services firms are seeing a surge in offshoring biz. This may be due to cost pressures from clients, or even a change in attitude caused by Work from Home (WFH) as firms allow employees to WFH to stay safe and productive during the pandemic.
  • The Covid pandemic has accelerated investments in technology infra as corporates have upgraded to allow WFH and also redesigned the customer and employee interactions.
  • HMT works with partners like Microsoft, Amazon Web Services, McAfee, IBM, PTC, etc.
  • On Sept 4 HMT raised ₹ 315.9 cr. from 25 anchor investors, ahead of its IPO. Anchor investors included Govt. of Singapore, Pacific Horizon Investment Trust, Integrated Core Strategies Asia Pte, Aditya Birla Sun Life MF, Axis MF, Goldman Sachs India Fund, HDFC Life Insurance, Franklin Templeton MF, ICICI Prudential MF, Kuwait Investment Fund, Fidelity Asian Values Plc and SBI MF.

IT Services Industry Outlook in India

  • The global sourcing market in India continues to grow at a higher pace compared to the IT & BPM industry. India is the leading sourcing destination globally, accounting for 55% market share of the US$ 200-250 billion services sourcing business in 2019-20. Indian IT & BPM firms have set up over 1,000 global delivery centers in 80 countries across the world. (IBEF)
  • IT & BPM industry global revenue was US$ 191 billion in FY20, growing at 7.7% y-o-y. It is estimated to reach US$ 350 billion by 2025. Moreover, revenue from the digital segment is expected to form 38% of the total industry revenue by 2025. (IBEF).
  • The Covid pandemic has sharply accelerated the adoption of digital solutions and automation across corporates and personal consumers. The safety and isolation requirements for employees in factories and offices and individual consumers has resulted in high demand for eCommerce based purchasing, employee WFH solutions, video call services and demand for contact free work and customer interaction solutions.
  • While the pandemic has accelerated the demand for digital, it is unlikely that the trend will reverse, as it has benefited productivity and efficiency. For example WFH may partially reverse in time but it may emerge as a permanent option as it has been widely accepted.

Financials of HMT

  • HMT’s revenues, EBITDA and PAT over the years are in Fig 2. The firm moved from losses in FY18 to good profits by Q1FY21. EBITDA and PAT margins have improved from FY18-20.
  • EPS too is sharply up, from losses in FY18 to an excellent result in Q1FY21.
  • In Fiscal 2018, HMT had restated loss for the year of ₹22.5 cr. This was due to relatively lower revenue from contracts with customers and higher employee benefit expense and finance costs. Further, to write off accumulated losses, the Company reduced the Securities Premium Account of HMT by ₹159.5 cr., after approval from the NCLT, Bengaluru bench through its order to the scheme of reduction of capital filed by HMT.
  • RoCE was 28.9% and RoE was 27.1% in FY20, a positive.

jainmatrix investments, happiest minds

Fig 2 – HMT Financials (clickable)

Benchmarking

We benchmark HMT against listed small IT service firms and the leader TCS. See Fig 3.

jainmatrix investments, happiest minds

Fig 3 – Benchmarking (clickable)

While the other firms are larger than HMT, we can draw some parallels:

  • The valuations of HMT are higher than all the others.
  • Sales growth has been good a leader in HMT. Profits cant be measure as HMT was loss making to years ago.
  • D/E ratio is highest here. One of the objects of the fresh issue in IPO is to reduce debt.
  • Margins are still on the lower side as HMT is building scale for its operations.
  • Return ratios are high while not being highest.
  • The Revenue per employee is low, indicating that HMT is investing in employees for growth.

Positives for HMT and the IPO

  • Ashok Soota is the promoter, he has a great track record as a software executive at Wipro, and serial successful entrepreneur who started (and created great value with) Mindtree and now Happiest Minds. He has built great teams in these firms. He is well known also due to several books he has written on entrepreneurship. Many investors will be drawn in by him, to buy into this, his next firm. However at 77, he may be unlikely to be able to take an active / executive role in the firm.
  • However there is a solid next line of management team in place at HMT.
  • HMT says it is “Born Digital, Born Agile” and has over 90% of revenues from digital services, quite higher than most other Indian services firms. There is no doubt that digital services are a high demand, cutting edge space with better growth prospects.
  • The Indian IT services firms are generally debt free, high cash and RoE generating firms once they stabilize operations. HMT should be able to do this in 1-2 years post IPO.
  • The philosophy at Happiest Minds is simple yet powerful – that happy employees ensure happy customers. While this is well known, there appears a special focus on this at HMT.
  • In just 9 years the firm has gone from startup to $100 million of revenues, and Rs 100 crores of EBITDA, is a good achievement.
  • The covid pandemic offers an opportunity to grow faster as customers are forced to work remotely and need more solutions and support.

Risks and Negatives for HMT and the IPO

  • Valuations at PE of ~34 times and PB of ~7.6 times (FY20 trailing basis) are expensive. However a premium is usually demanded by good quality firms in their IPOs.
  • While HMT may present a digital focus, and a large percentage of business from digital, most Indian software services firms have a digital business segment, and their significant legacy businesses may actually offer an opportunity to add a digital layer. So competition is intense for HMT and the key in IT services has always been to adopt and absorb new technologies fast and roll these out to clients.
  • HMT appears to be just another vanilla 1st generation IT services firm, when we are already seeing the 2nd generation services firms focused on Engineering R&D, Pharma R&D, legal, etc.
  • The 79% tilt to USA of business can be a constraint if visa availability declines there.
  • The financial performance of HMT has been uneven, and there’s no certainty that the solid FY19 and FY20 will be followed by a good FY21 post IPO.
  • While Covid offers some opportunities, there is no doubt that many economies are entering a recession and corporate spending for the most part may reduce over the next 1-2 years.
  • IT services are facing competition from 1) the enterprise Product firms 2) the large application and product firms dedicated to Google Android, Apple and Microsoft platforms and 3) the Social Media firms.
  • The INR:USD is at 73.3 today. After many years of 5% a year average weakening of INR against USD, in the last few months the trend appears to have reversed. Indian economic factors such as lower crude prices, lower gold imports, international trade surplus, large forex reserves, falling fiscal deficits and USA Fed policies all point to a stable or strengthening of INR against USD. We expect INR to be in a 70-75 range against USD over the next year.

Overall Opinion and Recommendation

  • IT services are always going to be needed to stitch together solutions for their clients, and to help them navigate, evaluate and deploy the complex IT landscapes and technology options. Indian IT services companies have time and again proven their mettle and have the skilled resources and project management skills to deliver successfully.
  • Happiest Minds as a small-cap firm has many of the quality ingredients required to succeed including great management, new digital tech focus and good employee policies.
  • If HMT continues its growth story over 5 years, this IPO entry price will look quite reasonable.
  • Risks: 1) Valuations at PE of 34 times and PB of 7.6 times (TTM) are expensive. 2) Intense competition 3) Covid induced challenges – demand from customers as well as employee health 4) Rupee strengthening against USD
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2-3 year perspective.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake ownership or financial interests in HMT or any group company. Punit Jain intends to apply for this IPO in the Retail category. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

 

 

 

Mindtree Ltd. – A Possible Star

_____________________________________________________________

  • 12 June 2013
  • CMP: Rs 800
  • Mid Cap – Mkt Cap 3550 crores.
  • Advice:  Buy

Executive Summary

Mindtree Ltd is a mid-sized IT services company based out of Bangalore. It has good management, experienced professionals drawn from the industry. The growth of the firm has been steady. Revenues, EBITDA and PAT have gained by 26%, 27% and 25% CAGR over the last 6 years. Mindtree has reached a certain critical size in terms of revenue and employees, from which growth can accelerate and it can be a large cap in 4-6 years. We expect these plans to play out and make it a very rewarding investment. 

(Find below a limited public report. Subscribers have access to the full report including Risks, Price – PE and EPS charts, Financial Projections, Benchmarking and 2 year Price Targets)

Mindtree Ltd. (MT) is a new age Mid Cap software services firm based in Bangalore.

Business Snapshot:

  • The consolidated turnover is Rs 2,362 crores and Profits 339 cr (FY13).
  • The Chairman is Subroto Bagchi and MD-CEO is Krishnakumar Natarajan; they co-founded the firm in 1999. Today it has about 11,600 employees, spread over Bangalore, Chennai, Hyderabad and Pune.
  • MT has a focus on 4 business verticals; USA is the largest revenue market, see Fig 1 A and B.
  • A recent achievement was the UID/Aadhaar project where MT developed the core application.

Fig 1 – Mindtree by Segments (A) and Geographies (B) for FY2013 (JainMatrix Investments)

Fig 1 – Mindtree by Segments (A) and Geographies (B) – JainMatrix Investments

Pricing Snapshot

The view of the share price of MT in 6 years since the 2007 IPO shows us:

  • From the IPO at Rs 425, the share price has risen by an annual average of 11.5% in 6 years.
  • The share has been volatile, as post IPO the peak was 1021, and the bottom 187 in 2009.
  • The Dividend has risen to the current 120%, see Fig 2, indicating a dividend yield of 1.5%.

Fig 2 – Price and Dividend History (JainMatrix Investments)

Fig 2 – Price and Dividend History (JainMatrix Investments)

Financial Snapshot

  • The Revenues, EBITDA and PAT have gained by 26%, 27% and 25% CAGR over 6 years.
  • MT is virtually debt free and has Cash on its books of 603 cr. or Rs 145/ share.
  • The average PE over the last 6 years is at 20 times. The P/E has moved in a range of 9-35 times, and is currently at 10 times.
  • In the last 3 years, the P/E of MT has been in the 8-14 times range, even as the share price has increased 2.5 times, in line with EPS growth.

Fig 3 – Financials Snapshot (JainMatrix Investments)

Fig 3 – Financials Snapshot (JainMatrix Investments)

 Opportunities and Strategies

  • The worldwide end-user spending in IT Services was US$ 845 billion in 2011, while Indian turnover was $88b, indicating a 10.4% global market share. (Source: Gartner, NASSCOM). Thus there is ample opportunity to grow.
  • Also big opportunities lie in adjacent /related markets like Software Products and bundled Hardware-Software solutions.
  • The industry contributed to 7.1% of the Indian GDP.
  • India has a competitive advantage in IT services due to availability of skilled manpower, good telecom/ internet infrastructure, English language skills and a lower cost structure.
  • With the industry having taken off in India in the 90s, the Indian firms now have sufficient scale, maturity and focus to be in contention to win IT services business in many global markets.
  • The recent USD strengthening (to around Rs 58) has improved the outlook for all IT exporters.
  • The IT Services industry has for long been linear in its growth, with addition of human resources contributing much of the business growth. But new business models are Non-linear, like SaaS, Outcome based contracts, platform based solutions, creation of IP, Products, etc.
  • MT’s identified business verticals of Product Engineering Services, Auto & Retail, BFSI and Travel, Media & Services are large sectors with good potential. Newer IT business trends like Mobility, Cloud and Open Source also seem to be well mapped. (Some important trends that we’d like to see MT into are Social Media and Big Data and Analytics).
  • MT is quite clear that growth will be organic and not through M&A. This is beneficial for investors.
  • With employee base > 10,000 and IT services turnover > 2000 crores, MT can be seen as a firm that has crossed a certain critical mass and now can bid for much larger new assignments.
  • MT is reducing its long tail of ‘small clients’ and focusing on mining its Fortune 500 clients to add service lines and grow business rapidly.

Opinion, Outlook and Recommendation

  • Over the next 2-3 years, exports growth is going to become very important in the Indian economy. The Software sector which is the leading exporter (25% of Indian exports in FY13) will receive a number of sops and benefits. In addition the USD strengthening will also boost sector performance.
  • MT is at a critical phase of growth, where it should be able to accelerate revenues and profits from this point, having achieved a certain critical mass.
  • MT has cash on its books of Rs 145 per share. In other words, a share of Rs 800 actually costs you only Rs 655. This is not an empty hope or wish. The savvy management has increased the Dividend this year from 40% to 120% to distribute this cash. Further shareholder enriching events can be expected in the medium term such as increase in dividends, bonus shares, share buyback, etc.
  • MT has gone through a cycle of very high expectations (and valuations) at the time of IPO, to a current state of low expectations. However it retains its essence of a savvy experienced management, global presence, absorption of new technologies and willingness to take small risks.
  • MT is a Buy at current levels.

JainMatrix Knowledge Base

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