>TECH MAHINDRA (ICICI SECURITIES)

We initiate coverage on Tech Mahindra (TechM) with HOLD as we believe that risks such as high client concentration and focus on single vertical will likely result in revenue & EBITDA underperformance (ex-Mahindra Satyam) versus peers. The Mahindra Satyam (erstwhile Satyam) acquisition was the right step in diversifying long-term organic risk, but achieving normalised EBITDA margin for Satyam is an uphill task and seems difficult till H2FY11/FY12. We strongly believe that for TechM, the margin for error is low versus peers considering organic business risks and the difficult task of turning around Satyam. Therefore, any major valuation re-rating is unlikely and we prefer other large peers, with BUY on HCL Technologies, Infosys and Tata Consultancy Services (TCS).

■ TechM – Real struggle still to start. TechM’s revenues have grown at a scorching ~47% over FY05-09 with 78% CAGR through non-British Telecom (BT) clients. Our analysis indicates that capex growth for most of TechM’s top-5 clients (still 75% of revenues) and telecom operators in the US/Europe is likely to be muted in the coming years. This is besides continuing trouble in BT and current high base, which indicate weakening revenue growth visibility for TechM. We believe, revenue growth, excluding BT and US/Europe, would require investment and will likely take toll on
margins. Within non-BT clients, most of the growth is likely to come through higher offshoring (not yet witnessed) and from clients outside the US and Europe (which still form 14% of current revenues; margin in these markets is likely to be lower).

■ Mahindra Satyam – Running a tight ship. The Satyam acquisition has put TechM in the league of other Indian IT large-caps, who are now moving up the value chain (e.g. Axon acquisition by HCL Tech). The current valuation of Satyam is already factoring in ~15-20% EBITDA margin in FY11E-12E versus likely single-digit EBITDA margin in FY10. Hence, we believe further valuation re-rating for Satyam (trading at FY11E & FY12E EV/E of 9.6x & 6.7x) is dependent on margin upside beyond 20%, which is an uphill task for the management and unlikely till FY12.

■ Initiate with HOLD and Rs925 target price based on sum-of-the-parts (SOTP): i) Rs533 for TechM (excluding Satyam), discounting FY12E diluted EPS by 13x (our EPS calculation excludes amortisation of restructuring fees over five years received from BT) and implied EV/E of 7.8x based on adjusted EBITDA and ii) Rs392/TechM share through Satyam – target EV/E of 7.4x Satyam’s FY12E recurring EBITDA, which is at ~40-45% discount to Infosys’s and ~10-15% discount to HCL Tech’s target multiples. (EV/E is a better multiple for Satyam given less predictability on items below EBITDA with restatement of earlier years’ accounts in future.) Our target price discounts consolidated FY12E diluted adjusted EPS (including Satyam) by 14x.

To read the full report: TECH MAHINDRA