>TECH MAHINDRA (PRABHUDAS LILLADHER)

Tech Mahindra (TechM) reported Q3FY10 results below our expectation due to the ongoing restructuring process with BT account. We believe that demand in the telecom sector has started showing early signs of stabilization, but for TechM, any gain made would be eroded by key account problem. We reiterate our ‘Reduce’ rating.

■ Below expectation, non-recurring gain boosted topline by Rs1.5bn: TechM’s revenue grew by 4.0% QoQ to Rs11.8bn, ahead of our expectation Rs11.3bn. However, topline included ~Rs1.5bn (last 3 quarters amortization) non-recurring gain from BT restructuring. Excluding this, revenue declined by 9.2% QoQ. For the next quarter, Rs1.5bn would be down by Rs1bn due to one-quarter accounting. BT restructuring helped a one time pay of £126m (Rs9.6bn) that company will amortize over the next four years (~Rs0.5bn/quarter).

■ Other key highlights – restructuring to give reprieve: 1)TechM used the BT restructuring fee to pay-off debt of Rs4.5bn and Rs3.5bn in Q3FY10 and Q4FY10. 2) The deal restructuring with BT for Barcelona and Strada would help TechM gain definitive volume of work. The company is also reaching a definitive agreement for Andes contract (expected to finalize in Q4FY10). The management was confident of £70m run-rate from BT. 3) Total debt outstanding ~Rs17bn and cash of ~US$140m. 4) The company has total hedged position of $735m (USD-INR @ Rs46.3) and £280 (GBP-USD @ $1.80). 4) EBITDA margin erosion by 198bps (including non-recurring payment) is attributed to lower utilization level and currency appreciation. We believe that margin could be further down next quarter due to lower non-recurring revenue contribution. 5) The performance in non-BT (top 2-10 clients) witnessed growth of 10% QoQ in INR terms, a silver lining of improved business environment in telecom vertical.

■ Valuation & Recommendation: We believe that BT trouble and subdued IT spending in telecom vertical could reduce earnings visibility in the near term. However, we liked the non-BT revenue growth that would shield further downside risk to our numbers. We reiterate our ‘Reduce’ rating, with a target price of Rs900, a target multiple of 14x FY11 earnings.

To read the full report: TECH MAHINDRA