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1QFY2012 Result Update | IT

August 16, 2011

Tech Mahindra
Performance Highlights
(` cr) Net revenue EBITDA EBITDA margin (%) PAT* 1QFY12 1,292 242 18.7 180.3 4QFY11 % chg (qoq) 1,262 259 20.5 206 2.4 (6.6) (183)bp (13) 1QFY11 1,134 213 18.8 144 % chg (yoy) 14.0 13.5 (10)bp 24.8

ACCUMULATE
CMP Target Price
Investment Period
Stock Info Sector Market Cap (` cr) Beta 52 Week High / Low Avg. Daily Volume Face Value (`) BSE Sensex Nifty Reuters Code Bloomberg Code IT 9,457 0.9 813/539 58,339 10 16,730 5,035 TEML.BO TECHM.IN

`725 `783
12 months

Source: Company, Angel Research; Note:*Excludes share of profits from Mahindra Satyam

For 1QFY2012, Tech Mahindra reported mixed results. The companys revenue was almost in-line with our estimates, but its operating margin and core PAT came in below expectations. Growth came from the non-BT business yet again, which grew by 5.8% qoq with BT at 1.5% qoq due to cross-currency gain. BT has now started retendering its work; this poses risk to Tech Mahindras revenue run rate of 70mn72mn quarterly. However, due to the companys stake in Mahindra Satyam, we maintain our Accumulate view on the stock. Result highlights: For 1QFY2012, Tech Mahindra reported revenue growth of 4.1% qoq to US$289.8mn due to 2.0% qoq volume growth. In INR terms, revenue came in at `1,292cr, up 2.4% qoq. OPM slipped to 18.7%, down 183bp qoq, due to higher employee cost related to 1,638 employees (largely trainees) added in IT services, which pulled down utilisation by 300bp qoq to 71%. Outlook and valuation: The companys five-year multi-million dollar deals bagged in 4QFY2011 from Vodafone are expected to ramp up in from 2QFY2012. We expect the non-BT business to grow at a CQGR of 4.5% and 4.6% in FY2012E and FY2013E, respectively, with BTs quarterly revenue likely to be flat at US$116mn. Thus, we expect a 13.4% revenue CAGR over FY201113E. Core operating margin is expected to fall due to impending wage hikes and utilisation remaining a limited lever because of strong fresher hiring. Core EPS is expected to grow at a mere 1.5% CAGR over FY201113E. The only potential upside is due to the companys stake in Mahindra Satyam, which is improving its overall profitability (33% to PAT). We continue to value the company at 55% discount to Infosys target PE i.e., at 9x companys consolidated EPS of `87 and maintain an Accumulate rating with a target price of `783.

Shareholding Pattern (%) Promoters MF / Banks / Indian Fls FII / NRIs / OCBs Indian Public / Others 71.1 1.2 8.7 19.0

Abs. (%) Sensex Tech Mahindra

3m (8.8) 8.6

1yr (7.4) 1.8

3yr 10.0 (7.6)

Key financials (Consolidated, Indian GAAP)


Y/E March (` cr) Net sales % chg Reported net profit % chg EBITDA margin (%) FDEPS (`) P/E (x) P/BV (x) RoE (%) RoCE (%) EV/Sales (x) EV/EBITDA (x)
Source: Company, Angel Research

FY2009 4,465 18.6 1,014 27.2 77.4 9.4 4.9 48.7 56.6 2.0 7.3

FY2010 4,625 3.6 700 (30.9) 24.5 53.6 13.5 3.3 24.6 19.8 2.5 10.0

FY2011 5,140 11.1 643 (8.3) 19.5 49.4 14.7 2.8 22.3 16.6 2.0 10.4

FY2012E 5,364 4.4 1,072 66.8 17.1 81.2 8.9 2.2 24.7 14.5 1.9 10.9

FY2013E 6,001 11.9 1,147 7.1 17.0 87.0 8.3 1.8 21.2 14.6 1.5 9.0

Srishti Anand
+022 3935 7800 Ext: 6820 srishti.anand@angelbroking.com

Ankita Somani
+022 3935 7800 Ext: 6819 ankita.somani@angelbroking.com

Please refer to important disclosures at the end of this report

Tech Mahindra | 1QFY2012 Result Update

Exhibit 1: 1QFY2012 performance (Consolidated, Indian GAAP)


(` cr) Net revenue Cost of revenue Gross profit SG&A expense EBITDA Dep. and amortisation EBIT Interest Other income PBT Income taxes PAT Minority interest PAT after minority interest* Profit from associates Exceptional item Final PAT Diluted EPS(`) Gross margin (%) EBITDA margin (%) EBIT margin (%) PAT margin (%) 1QFY12 1,292 854 438 197 242 33 208 22 46 232 51 181 1 180 96 276 13.7 33.9 18.7 16.1 13.9 4QFY11 1,262 799 463 204 259 39 220 21 32 231 23 208 2 206 (114) 92 7.1 36.7 20.5 17.5 16.4 200.3 93.7 (277)bp (183)bp (135)bp (241)bp 0.5 125.2 (13.0) (56.3) (12.7) % chg (qoq) 2.4 6.9 (5.3) (3.5) (6.7) (13.7) (5.5) 1QFY11 1,134 746 388 175 213 35 177 26 25 176 31 145 1 144 144 11.1 34.2 18.8 15.6 12.7 91.3 23.4 (31)bp (7)bp 47bp 121bp 31.6 63.1 24.8 16.7 24.8 % chg (yoy) 14.0 14.5 13.0 12.3 13.6 (5.6) 17.4

Source: Company, Angel Research; Note: *Excludes share of profits from Mahindra Satyam

Exhibit 2: 1QFY2012 Actual vs. Angel estimates


(` cr) Net revenue EBITDA margin (%) PAT* Actual 1,292.5 18.7 180.2 Estimate 1,288.0 21.0 209.0 Var. (%) 0.3 (230)bp (13.4)

Source: Company, Angel Research; Note: *Excludes share of profits from Mahindra Satyam

In-line revenue growth


For 1QFY2012, Tech Mahindra reported a mixed performance, with almost in-line revenue but lower operating margin and core PAT. Dollar revenue came in at US$289.8mn (vs. our expectation of US$288.3mn), up 4.1% qoq, on the back of volume growth of 2.0% qoq and aided by favourable cross-currency movement. In rupee terms, revenue came in at `1,292cr (vs. our expectation of `1,288cr), up 2.4% qoq. INR growth came in lower as against dollar revenue growth due to INR appreciating against USD on a qoq basis. Non-BT accounts again continued as the primary growth drivers for the company, growing by 5.8% qoq with revenue coming at US$173.9mn. Going ahead, the company expects business from non-BT accounts to be its key growth driver.

August 16, 2011

Tech Mahindra | 1QFY2012 Result Update

Exhibit 3: Trend in revenue growth for non-BT accounts


180 170 160 8.3 150 138 0.7 (1.1) 0 151 164 9.1 174 8 5.8 12

(US $mn)

150 140 130 120 110 100 1QFY11 2QFY11


Non BT

(4) 3QFY11 4QFY11


qoq growth

1QFY12

Source: Company, Angel Research

Revenue from the BT account grew by 1.5% qoq to US$116mn, primarily on account of USD appreciating against GBP. Management maintained its near-term guidance for the quarterly revenue run rate from the BT account to be at 70mn72mn. However, this revenue run rate may pose a downside risk, as BT is retendering its contracts. This may lead to Tech Mahindra losing its share in BT contracts, as clearly the client is looking out for a lower pricing opportunity as part of its cost-cutting drive. So, even if the company manages to hold or gain its share, it is expected to be operating margin dilutive.

Exhibit 4: Revenue trend for BT account


125 120
(US $mn)

3.0 1.7 118 115 113 114 116 1.5

4 2 0 (2) (3.5) (4) (6)


(%)

115 110 105 (5.0) 100 1QFY11 2QFY11


BT

3QFY11

4QFY11
qoq growth

1QFY12

Source: Company, Angel Research

The companys revenue share from BPO services increased to 9.4% in 1QFY2012 from 8.0% and 6.3% in 4QFY2011 and 3QFY2011, respectively. This is due to revenue traction coming in from two major BPO deals signed by the company (one of Bharti Airtel for its Africa operations and the other in Philippines). However, revenue from TSPs, which contribute the most (~84%) to the companys revenue, stood almost flat qoq at `1,064.6cr, with 0.6% growth. Revenue from telecom equipment manufacturers (TEM) also increased by 6.4% qoq to `82.9cr.

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(%)

Tech Mahindra | 1QFY2012 Result Update

The companys top 25 clients drove its growth in 1QFY2012, by registering 4.1% qoq revenue growth. Also, revenue from the companys top 610 clients grew by 4.1% qoq.

Exhibit 5: Trend in revenue growth of top clients (qoq)


20 8.3 1.7 1.7 3.0 1.7 14.4 5.3 7.3 3.6 1.54.1 4.1

10

(%)

0 (5.0) (13.7) (20) 1QFY11 2QFY11 BT 3QFY11 Next 4 accounts 4QFY11 Next 5 accounts 1QFY12 (3.5)

(10)

Source: Company, Angel Research

Utilisations decline
During the quarter, utilisation level decreased by 300bp qoq to 71% from 74% in 4QFY2011. This was due to strong net employee additions of 4,517 in the company. Out of these, ~1,638 employees were added in IT services with majority of them as trainees out of 3,500 campus offers given this year. Maximum hiring was done on the BPO side, with net additions at 2,793, taking its total employee base to 13,804. Sales and support base scaled up by 86, taking the total employee base to 1,126. Attrition rate (annualised) of Tech Mahindra decreased to 20% in 1QFY2012 from 25% in 4QFY2011.

Exhibit 6: Trend in utilisation rate


3,200 76 2,400 75 1,306 359 69 1QFY11 2QFY11 (1,262) S/w professionals
Source: Company, Angel Research

2,522 74

2,793

78 76

Net addition no.

1,600 800 0 (800)

1,609

1,638

74 72

63

224

71

70 68

3QFY11

4QFY11

1QFY12

66 64

(1,600)

BPO professionals

Utilisation (%)

Continued focus on improvement of employee pyramid by adding more freshers has resulted in a decline in the pyramids bulge, with employees less than three years of experience increasing to ~38% from 33% (FY2011).
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(%)

Tech Mahindra | 1QFY2012 Result Update

Margins slip
In 1QFY2012, Tech Mahindras gross margin and EBITDA margin declined by 277bp and 183bp qoq to 33.9% and 18.7% from 36.7% and 20.5% in 4QFY2011, respectively, due to higher intake of freshers to do pyramid rationalisation, thus impacting utilisation by 300bp and leading to lower margin. However, the decline in the companys EBITDA margin was lower because of SGA expense rationalisation.

Exhibit 7: Margin trend


50

40

34.2

36.5

34.9

36.7

33.9

(%)

30 18.8 21.7 18.9 10 15.6 1QFY11 2QFY11 Gross profit margin 20.6 20.5 18.7

20

17.8 3QFY11 EBITDA margin

17.5 4QFY11

16.1 1QFY12

EBIT margin

Source: Company, Angel Research

During the quarter, PAT, excluding share from Mahindra Satyam, stood at `180cr (vs. our expectation of `208cr), down 12.7% qoq. However, PAT, including share from Mahindra Satyam, stood at `276cr due to strong earnings from Mahindra Satyam, which boosted Tech Mahindras bottom line by `96cr.

Client pyramid
Tech Mahindras client pyramid saw a mixed movement with 1) one of the US$20mn25mn clients moving down to the US$10mn15mn bracket and 2) three clients from the US$2mn5mn bracket moving up to higher brackets (one moved to the US$10mn15mn bracket and two moved to the US$5mn10mn bracket). Further, two new clients were added directly to the US$1mn2mn bracket. The active client base of the company remained stagnant at 128 during the quarter.

August 16, 2011

Tech Mahindra | 1QFY2012 Result Update

Exhibit 8: Client metrics


Particulars US$1mn2mn US$2mn5mn US$5mn10mn US$10mn15mn US$15mn20mn US$20mn25mn US$25mn50mn US$50mn+ Active clients 1QFY11 16 16 7 5 2 2 2 2 117 2QFY11 13 18 7 6 1 2 2 3 124 3QFY11 14 19 5 7 2 1 2 3 126 4QFY11 18 16 6 7 1 3 1 3 128 1QFY12 20 13 8 9 1 2 1 3 128

Source: Company, Angel Research

Outlook and valuation


Management is witnessing traces of demand revival from TSPs and foresees them to return to spending on 4G technology and cloud only in 2HFY2012. The companys five-year multi-million dollar deals bagged in 4QFY2011 from Vodafone Australia and Qatar operations are expected to ramp up in 2QFY2012 and 3QFY2012, respectively. We expect the non-BT business to grow at a CQGR of 4.5% and 4.6% in FY2012E and FY2013E, respectively, with BTs quarterly revenue expected to be flat at US$116mn. However, there is a caveat that BTs revenue may see a downside if the company losses out its market share in retendering process initiated by BT. In fact, even if the company manages to hold the share or increase it, it can be margin dilutive as the client has initiated this retendering process as part of its cost-cutting drive with lower pricing expectation. Thus, we expect a 13.4% CAGR in revenue over FY201113E. The companys core operating margin is expected to fall due to impending wage hikes as well as utilisation remaining a limited lever because of strong fresher hiring. These are expected to overcome the tailwind effect of 1) pyramid rationalisation and 2) SGA expense management. Thus, we expect EBITDA growth to remain almost flat at a 0.8% CAGR over FY201113E. However, PAT is expected to be supported by 1) the deep in-the-money hedges of 340mn and US$355mn with participation rates at 1.82 USD/GBP and 49.5 INR/USD, boosting forex gains for the company and 2) declining interest expense due to quick repayments possible from Mahindra Satyams strong earnings. Thus, the companys core EPS is expected to grow at a mere 1.5% CAGR over FY201113E. The only potential upside is due to the companys stake in Mahindra Satyam, which is improving its overall profitability. Since, the companys core earnings are subdued and the huge contribution (~33%) to its consolidated earnings is due to Mahindra Satyams profitability, we continue to value the company at 55% discount to Infosys target PE i.e., at 9x the companys consolidated EPS of `87 and maintain an Accumulate rating on the stock with a target price of `783.

August 16, 2011

Tech Mahindra | 1QFY2012 Result Update

Exhibit 9: Key assumptions


FY2012E Volume growth-Non BT Volume growth-BT Revenue growth (US$) USD-INR rate (realised) Revenue growth (`) EBITDA margin (%) Tax rate (%) EPS growth (%)* 23.6 0.7 13.8 44.4 4.4 17.1 23.0 (3.1) FY2013E 21.0 0.0 13.0 43.9 11.9 17.0 23.0 6.4

Source: Company, Angel Research ; Note: *Excludes share of profits from Mahindra Satyam

Exhibit 10: One-year forward PE (x)


1,900 1,600 1,300

(`)

1,000 700 400 100 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Price 23 18 Jul-10 Dec-10 May-11 8 4

13

Source: Company, Angel Research. Note: P/E includes share of profits from Mahindra Satyam 2Q FY2011 onwards.

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Tech Mahindra | 1QFY2012 Result Update

Exhibit 11: Recommendation summary


Company 3iInfotech Educomp Everonn HCL Tech Hexaware Infosys Infotech Enterprises KPIT Cummins Mahindra Satyam Mindtree Mphasis NIIT^ Persistent TCS Tech Mahindra* Wipro Reco Neutral Neutral Neutral Buy Accum. Buy Buy Buy Buy Buy Buy Buy Buy Buy Accum. Buy CMP Tgt Price (`) 29 273 521 411 81 2,393 117 165 73 359 392 46 302 974 725 341 (`) 578 88 3,200 145 206 89 445 482 69 424 1,368 783 419 Upside (%) 40.5 9.2 33.7 23.9 25.2 22.1 24.0 22.8 48.7 40.4 40.4 8.0 23.0 Target P/E (x) 14.0 11.5 20.0 9.0 12.0 12.0 11.0 11.0 10.0 11.0 22.0 9.0 16.0 FY2013 EBITDA (%) 21.5 45.6 38.5 17.9 15.1 30.6 16.1 16.1 15.0 13.3 17.6 13.8 19.5 28.9 17.0 18.7 FY2013E 2.5 5.7 8.7 10.0 10.5 15.0 7.2 9.8 9.9 8.9 8.7 6.7 7.8 15.7 8.3 13.0 FY2011-13E (4.3) 18.8 32.5 29.8 63.4 15.7 13.9 21.8 32.7 27.5 10.3 11.2 5.1 18.4 32.7 9.9 FY2013E RoCE (%) 12.0 11.1 13.9 18.1 16.8 24.7 15.2 20.6 11.6 16.9 17.7 12.4 16.6 30.2 14.6 13.8 FY2013E RoE (%) 15.1 15.3 17.1 23.8 17.8 22.7 13.4 17.7 13.8 15.4 17.0 16.6 15.4 31.3 21.2 19.8 P/E (x) EPS CAGR (%)

Source: Company, Angel Research. Note: ^Valued on SOTP basis,* EPS CAGR includes earnings from Mahindra Satyam

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Tech Mahindra | 1QFY2012 Result Update

Profit and loss statement (Consolidated, Indian GAAP)


Y/E March (` cr) Net sales Cost of revenues Gross profit % of net sales SG&A expenses % of net sales EBITDA % of net sales Depreciation and amortization % of net sales EBIT % of net sales Interest expense Other income, net of forex gain/(loss) Profit before tax Provision for tax % of PBT Recurring PAT Share from associates Exceptional item Minority interest Profit after minority interest Reported PAT Fully diluted EPS (`)
Source: Company, Angel Research

FY2009 FY2010 FY2011 FY2012E FY2013E 4,465 2,638 1,827 40.9 612 13.7 1,215 27.2 110 2.5 1,106 24.8 3 (38) 1,065 118 11.1 947 67 0 1,014 947 77.4 4,625 2,871 1,754 37.9 622 13.4 1,133 24.5 134 2.9 999 21.6 218 75 856 144 16.8 712 (9) 3 700 709 53.6 5,140 3,403 1,737 33.8 734 14.3 1,003 19.5 144 2.8 860 16.7 100 117 877 132 15.0 746 44 (143) 4 643 786 49.4 5,364 3,641 1,724 32.1 807 15.1 916 17.1 150 2.8 766 14.3 87 268 947 215 22.7 732 343 3 1,072 1,072 81.2 6,001 4,134 1,867 31.1 847 14.1 1,020 17.0 169 2.8 850 14.2 54 214 1,011 232 23.0 778 372 3 1,147 1,147 87.0

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Tech Mahindra | 1QFY2012 Result Update

Balance sheet (Consolidated, Indian GAAP)


Y/E March (` cr) Equity capital Preference capital Share premium Profit and loss Other reserves Net worth Secured loans Unsecured loans Total debt Deferred revenue Minority interest Total capital employed Gross block Accumulated depreciation Net block Capital WIP Total fixed assets Investments Deferred tax asset, net Inventories Sundry debtors Cash and cash equivalents Loans and advances Sundry creditors Other liabilities Provision Working capital Total capital deployed 11 1,954 908 (410) 498 154 652 435 20 1 902 538 295 (469) (205) (215) 848 1,954 14 5,035 1,131 (527) 604 321 925 3,015 28 1 1,042 219 673 (461) (129) (277) 1,068 5,035 FY2009 122 233 1,401 187 1,943 FY2010 122 237 1,783 744 2,887 750 1,385 2,135 FY2011 126 233 2,366 626 3,351 1,223 1,223 584 16 5,174 1,273 (670) 602 125 727 2,908 64 1,247 267 832 (510) (53) (308) 1,474 5,174 FY2012E 126 233 3,363 626 4,347 907 907 16 5,270 1,429 (821) 608 170 778 2,909 70 1,190 348 858 (512) (50) (322) 1,513 5,270 FY2013E 126 233 4,429 626 5,414 407 407 16 5,837 1,584 (990) 594 220 814 2,909 74 1,332 647 990 (560) (40) (330) 2,039 5,837

Source: Company, Angel Research

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Tech Mahindra | 1QFY2012 Result Update

Cash flow statement (Consolidated, Indian GAAP)


Y/E March (` cr) Pre tax profit from operations Depreciation Expenses (deferred)/written off/others Pre tax cash from operations Other income/prior period ad Net cash from operations Tax Cash profits (Inc)/dec in Sundry Debtors Inventories Loans and advances Sundry creditors Others Net trade working capital Cashflow from operating activities (Inc)/dec in fixed assets (Inc)/dec in investments (Inc)/dec in deferred tax asset, net Cashflow from investing activities Inc/(dec) in debt Inc/(dec) in deferred revenue Inc/(dec) in equity/premium Inc/(dec) in minority interest Addition to reserves on amalgamation Dividends Cashflow from financing activities Cash generated/(utilised) Cash at start of the year Cash at end of the year
Source: Company, Angel Research

FY2009 FY2010 FY2011 FY2012E FY2013E 1,170 110 1,280 (38) 1,242 (118) 1,124 194 0 65 (43) 5 222 1,346 (162) (14) (30) 3 0 (274) (57) (358) 441 98 538 780 134 (9) 906 73 978 (144) 834 (140) (0) (377) (8) (14) (539) 295 (407) (8) 2,135 5 3 288 (50) 2,381 (320) 538 219 760 144 (98) 805 114 919 (132) 788 (205) 1 (160) 49 (45) (358) 429 54 107 (36) 125 (912) 584 (0) 2 (119) (61) (506) 48 219 267 679 150 344 1,173 266 1,439 (215) 1,223 56 (26) 2 11 43 1,266 (201) (1) (8) (209) (316) (584) (0) (75) (975) 82 267 348 797 169 373 1,339 211 1,551 (232) 1,318 (141) (132) 48 (2) (227) 1,091 (206) (6) (211) (500) (81) (581) 299 348 647

(371) (2,580) (547) (2,995)

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Tech Mahindra | 1QFY2012 Result Update

Key Ratios (Consolidated, Indian GAAP)


Y/E March Valuation ratio(x) P/E (on FDEPS) P/CEPS P/BVPS Dividend yield (%) EV/Sales EV/EBITDA EV/Total assets Per share data(`) EPS (Fully diluted) Cash EPS Dividend Book value Dupont analysis Tax retention ratio (PAT/PBT) Cost of debt (PBT/EBIT) EBIT margin (EBIT/Sales) Asset turnover ratio (Sales/Assets) Leverage ratio (Assets/Equity) Operating ROE (%) Return ratios (%) RoCE (pre-tax) Angel RoIC RoE Turnover ratios(x) Asset turnover (fixed assets) Receivables days Payable days
Source: Company, Angel Research

FY2009 9.4 8.4 4.9 0.5 2.0 7.3 13.7 77.4 86.2 3.7 149.0 0.9 1.0 0.2 6.8 0.3 48.7 56.6 87.6 48.7 6.8 82 56

FY2010 13.5 11.3 3.3 0.5 2.5 10.0 12.3 53.6 64.0 3.3 221.4 0.8 0.9 0.2 5.0 0.3 24.7 19.8 22.2 24.6 5.0 77 49

FY2011 14.7 12.0 2.8 0.5 2.0 10.4 14.3 49.4 60.3 4.0 257.0 0.9 1.0 0.2 7.1 0.2 22.3 16.6 18.0 22.3 7.1 81 43

FY2012E 8.9 7.8 2.2 0.6 1.9 10.9 12.9 81.2 92.6 4.0 329.6 1.1 1.2 0.1 6.9 0.2 24.7 14.5 16.1 24.7 6.9 81 42

FY2013E 8.3 7.3 1.8 0.6 1.5 9.0 11.3 87.0 99.8 4.0 410.4 1.1 1.2 0.1 7.4 0.2 21.2 14.6 17.1 21.2 7.4 81 41

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Tech Mahindra | 1QFY2012 Result Update

Research Team Tel: 022 - 3935 7800

E-mail: research@angelbroking.com

Website: www.angelbroking.com

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Disclosure of Interest Statement 1. Analyst ownership of the stock 2. Angel and its Group companies ownership of the stock 3. Angel and its Group companies' Directors ownership of the stock 4. Broking relationship with company covered

Tech Mahindra No No No No

Note: We have not considered any Exposure below ` 1 lakh for Angel, its Group companies and Directors

Ratings (Returns):

Buy (> 15%) Reduce (-5% to 15%)

Accumulate (5% to 15%) Sell (< -15%)

Neutral (-5 to 5%)

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