2QFY2012 Result Update | IT

November 16, 2011

Tech Mahindra
Performance Highlights
(` cr) Net revenue EBITDA EBITDA margin (%) Adj. PAT* 2QFY12 1,333 204 15.3 190 1QFY12 1,292 242 18.7 276 % chg (qoq) 3.2 (15.5) (337)bp (31.1) 2QFY11 1,235 268 21.7 136 % chg (yoy) 8.0 (23.9) (642)bp 40.2

BUY
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 7,905 1.0 802/524 41,643 10 16,776 5,030 TEML.BO TECHM.IN

`606 `707
12 months

Source: Company, Angel Research; Note:*exclude one-offs

For 2QFY2012, Tech Mahindra reported a mixed performance. The companys revenue was almost in-line with our estimates, but its operating margin and core PAT came in below expectations. Growth came from non-BT business yet again, which grew by 7.3% qoq; while revenue from BT declined by 5.5% qoq due to closure of few projects. BT has now started retendering its work; this poses risk to Tech Mahindras revenue run rate. However, due to the companys stake in Mahindra Satyam, we maintain our Buy rating on the stock. Result highlights: For 2QFY2012, Tech Mahindra reported revenue growth of merely 2.2% qoq to US$296.2 due to flat qoq volume growth. In INR terms, revenue came in at `1,333cr, up 2.4% qoq. OPM slipped to 15.3%, down 337bp qoq, due to negative impacts of wage hikes given during the quarter and volume decline from BT. PAT, excluding share from Satyam, came in at `139cr, negatively impacted by higher interest cost of `72.1cr because it includes MTM loss of `52cr derived from foreign currency loans and higher depreciation costs. Outlook and valuation: We expect the non-BT business to grow at a CQGR of 3.1% and 2.8% in 2HFY2012E and FY2013E, respectively, with BTs quarterly revenue expected to be flat from here. However, there is a caveat that BTs revenue may see a downside if the company loses out its market share in the 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 10.1% CAGR in USD revenue over FY2011-13E. The companys core EPS is expected to have a negative CAGR over FY2011-13E. The only potential upside is due to the companys stake in Mahindra Satyam, which is improving its overall profitability. We continue to value the company at 55% discount to Infosys target PE i.e., at 9x the companys consolidated EPS of `78.5 and maintain our Buy rating on the stock with a target price of `707.

Shareholding Pattern (%) Promoters MF / Banks / Indian Fls FII / NRIs / OCBs Indian Public / Others 71.0 15.3 4.4 9.2

Abs. (%) Sensex Tech Mahindra

3m

1yr

3yr 78.7

0.3 (15.6)

(16.4) (12.4) 103.2

Key financials (Consolidated, Indian GAAP)

Y/E March (` cr) Net sales % chg Reported net profit % chg EBITDA margin (%) EPS (`) P/E (x) P/BV (x) RoE (%) RoCE (%) EV/Sales (x) EV/EBITDA (x) FY2009 4,465 18.6 1,014 27.2 77.4 8.8 4.6 48.7 56.6 1.9 6.9 FY2010 4,625 3.6 700 (30.9) 24.5 53.6 12.7 3.1 24.6 19.8 2.3 9.5 FY2011 5,140 11.1 643 (8.3) 19.5 49.3 13.8 2.6 23.5 16.6 1.9 9.8 FY2012E 5,487 6.7 993 54.5 16.6 71.5 9.5 2.1 22.7 14.0 1.7 10.3 FY2013E 5,929 8.0 1,036 4.3 15.9 78.5 8.7 1.7 19.3 13.4 1.5 9.2

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

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

Source: Company, Angel Research

Please refer to important disclosures at the end of this report

Tech Mahindra | 2QFY2012 Result Update

Exhibit 1: 2QFY2012 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 Adj. PAT Diluted EPS Gross margin (%) EBITDA margin (%) EBIT margin (%) 2QFY12 1,333 907 426 222 204 51 153 72 97 179 39 139 1 139 102 (50) 240 190 10.5 32.0 15.3 11.5 1QFY12 1,292 854 438 197 242 33 208 22 46 232 51 181 1 180 96 276 276 20.9 33.9 18.7 16.1 (13.0) (31.1) (49.8) (193)bp (337)bp (459)bp (23.0) (22.8) (23.0) (28.6) (23.0) % chg (qoq) 3.2 6.2 (2.7) 13.0 (15.5) 51.8 (26.3) 2QFY11 1,235 784 450 182 268 35 234 27 8 215 42 173 1 173 107 (143) 279 136 11.4 36.5 21.7 18.9 (13.9) 40.2 (8.0) (450)bp (642)bp (742)bp (16.9) (6.0) (19.6) (28.6) (19.6) % chg (yoy) 8.0 15.6 (5.3) 22.1 (23.9) 46.1 (34.3) 1HFY12 2,626 1,761 865 419 446 84 362 94 143 410 90 320 1 319 198 (50) 517 467 31 32.9 17.0 13.8 1HFY11 2,369 1,530 838 357 481 70 411 53 34 391 73 318 1 317 107 (143) 424 280 22.5 35.4 20.3 17.4 22.0 66.5 39.7 (247)bp (334)bp (358)bp 4.9 23.6 0.6 (7.7) 0.7 % chg (yoy) 10.9 15.1 3.1 17.3 (7.4) 20.0 (12.0)

PAT margin (%)

Source: Company, Angel Research

10.4

13.9

(359)bp

14.0

(356)bp

12.2

13.4

(123)bp

Exhibit 2: 2QFY2012 Actual vs. Angel estimates

(` cr) Net revenue EBITDA margin (%) PAT* Actual 1333 15.3 139 Estimate 1351 16.3 177 Var. (%) 1.4 (101)bp 27.3

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

Muted revenue growth

For 2QFY2012, Tech Mahindra reported moderate revenue growth of merely 2.2% qoq, with revenue coming at US$296.2mn. This was because of a 5.5% qoq decline in revenue from BT account. Volume growth was flat qoq. In INR terms, revenue came in at `1,333cr, up 3.2% qoq. Non-BT accounts again continued as the primary growth drivers for the company, growing by 7.3% qoq with revenue coming at US$186.6mn. Going ahead, the company expects business from non-BT accounts to be its key growth driver.

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Tech Mahindra | 2QFY2012 Result Update

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

190 180 170 9.1 8.3 164 5.8 150 151 174 7.3 187 8 12

(US $mn)

160 150 140 130 120 2QFY11 0.7 3QFY11 Non BT

0 4QFY11 1QFY12 qoq growth 2QFY12

Source: Company, Angel Research

Revenue from the BT account declined considerably by 5.5% qoq to US$109.6mn (67mn) because of project closures during the quarter. Management indicated that BT business may continue to decline in the next few quarters, 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 1.7 118 115 114 (3.5) 116 1.5

4 2 0 (2) 110 (4) (5.5) (6)

(%)

115 110 105 100 2QFY11

3QFY11 BT

4QFY11

1QFY12 qoq growth

2QFY12

Source: Company, Angel Research

The companys revenue from telecom service providers (TSPs), which contribute the most (~81.5%) to the companys revenue, grew by 2.1% qoq to `1,087cr; however, revenue from telecom equipment manufacturers (TEMs) declined by 2.7% qoq to `80.6cr. The companys top 6-10 clients drove its growth in 2QFY2012, by registering whopping 13.6% qoq revenue growth. Also, revenue from the companys top 2-5 clients grew by 9.3% qoq during the quarter.

November 16, 2011

(%)

Tech Mahindra | 2QFY2012 Result Update

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

20 15 10 14.4 13.6 9.3 3.6 1.5 4.1 4.1

(%)

7.3 5.3 1.7 1.7 3.0 1.7

5 0 (5)

2QFY11

3QFY11 BT

(3.5) 4QFY11 Next 4 accounts

1QFY12

2QFY12

Next 5 accounts

Source: Company, Angel Research

Utilization level improve

During the quarter, the companys utilization level increased by 100bp qoq to 72% from 71% in 1QFY2012 as the company did strong hiring in 4QFY2011 and 1QFY2012, and these hired employees turned billable in 2QFY2012. Net reduction of software employee base by 1,255 employees comes out as a course of concern. Again in this quarter, maximum addition was done in the BPO employee base of 2,071, taking its total employee base to 15,875.

Exhibit 6: Trend in utilization rate

3,200 2,400 75 76 2,522 1,609 74 800 63 0 (800) (1,600) 2QFY11 (1,262) S/w professionals
Source: Company, Angel Research

2,793 2,071 1,638

78 76

Net addition no.

1,600

224

0 71

72

72 70

3QFY11

4QFY11

1QFY12

2QFY12 (1,255) 68

BPO professionals

Utilisation (%)

Margins slip
In 2QFY2012, Tech Mahindras EBITDA and EBIT margin declined by 337bp and 459bp qoq to 15.3% and 11.3%, respectively, due to negative impact of wage hikes given from July 1, 2011, and reducing business from BT.

November 16, 2011

(%)

74

Tech Mahindra | 2QFY2012 Result Update

Exhibit 7: Margin trend

40 35 30 36.5 34.9 36.7 33.9 32.0

(%)

25 20 15 10

21.7

20.6

20.5

18.7 15.3

18.9

17.8

17.5

16.1 1QFY12

11.5 2QFY12

2QFY11

3QFY11 Gross profit margin

4QFY11 EBITDA margin

EBIT margin

Source: Company, Angel Research

During the quarter, PAT, excluding share from Satyam, came in at `139cr, negatively impacted by 1) higher interest cost of `72.1cr (vs. 22.3cr in 1QFY2012) because it includes MTM loss of `52cr derived due to foreign currency loans and 2) higher depreciation of `50.7 vs. `33.4cr in 1QFY2012 as the company discarded an overseas facility, which was no longer required. These negative impacts on PAT were partially offset by higher other income of `97.2cr vs. 46.0cr in 1QFY2012. PAT, including share from Satyam, came in at `240cr.

Client pyramid
Tech Mahindras client pyramid witnessed a mixed movement with 1) one of the US$50mn+ clients moving down to the US$25mn-50mn bracket, 2) one client from the US$10mn-15mn bracket moving up to the higher bracket of US$15mn-20mn and 3) two clients from the US$10mn-15mn bracket moving to the lower bracket of US$5mn-10mn. The active client base of the company remained stagnant at 128 during the quarter.

Exhibit 8: Client metrics

Particulars US$1mn2mn US$2mn5mn US$5mn10mn US$10mn15mn US$15mn20mn US$20mn25mn US$25mn50mn US$50mn+ Active clients 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 2QFY12 19 14 13 6 2 2 2 2 128

Source: Company, Angel Research

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Tech Mahindra | 2QFY2012 Result Update

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. We expect the non-BT business to grow at a CQGR of 3.1% and 2.8% in 2HFY2012E and FY2013E, respectively, with BTs quarterly revenue expected to be flat from here. However, there is a caveat that BTs revenue may see a downside if the company loses out its market share in the 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 10.1% CAGR in USD revenue over FY2011-13E. PAT is expected to be supported by 1) the deep in-the-money hedges of 330mn and US$400mn with participation rates at 1.82 USD/GBP and 50 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 have negative a CAGR over FY2011-13E. 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 `78.5 and maintain our Buy rating on the stock with a target price of `707.

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 (%)
Source: Company, Angel Research

FY2013E 15.3 (3.4) 15.3 46.0 8.0 15.9 23.0 9.9

24.5 (4.8) 24.5 46.2 6.7 16.6 22.5 45.1

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Tech Mahindra | 2QFY2012 Result Update

Exhibit 10: One-year forward PE (x)

1,900 1,600 1,300

(`)

1,000 700 400 100 Jan-08 Jul-08 Price Jan-09 23 Jul-09 Jan-10 18 Jul-10 13 Jan-11 8 Jul-11 4

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

Exhibit 11: Recommendation summary

Company HCL Tech Hexaware Infosys Infotech Enterprises KPIT Cummins Mahindra Satyam Mindtree Mphasis NIIT^ Persistent TCS Tech Mahindra* Wipro Reco Buy Accumulate Neutral Neutral Neutral Accumulate Buy Buy Buy Neutral Accumulate Buy Neutral CMP (`) 411 84 2,776 121 169 74 398 289 47 317 1,116 606 375 Tgt Price (`) 545 94 80 462 382 60 1,220 707 Upside (%) 32.7 11.8 8.1 16.1 32.4 27.3 9.3 16.6 Target P/E (x) 14.0 11.0 18.0 8.5 10.0 11.0 10.0 11.5 7.5 9.0 20.0 9.0 15.3 FY2013 EBITDA (%) 17.7 16.9 30.6 15.7 15.4 15.0 14.4 15.5 16.3 20.0 28.7 15.9 18.8 FY2013E P/E (x) 10.5 10.1 17.6 8.1 10.3 10.1 8.7 7.3 5.9 8.6 18.3 7.7 15.4 FY2011-13E EPS CAGR (%) 26.1 70.4 14.8 8.9 19.9 31.7 35.6 0.4 19.3 2.5 17.0 26.1 6.1 FY2013E RoCE (%) 20.6 18.4 24.0 15.0 18.6 11.3 18.6 13.4 11.0 15.8 29.8 13.4 13.6 FY2013E RoE (%) 22.4 19.2 22.5 12.4 17.1 13.5 16.5 14.5 15.6 14.8 30.9 19.3 18.6

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

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Tech Mahindra | 2QFY2012 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 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 49.3 5,487 3,678 1,809 33.0 897 16.3 913 16.6 169 3.1 744 13.6 140 211 814 183 22.5 631 364 3 993 993 71.5 5,929 4,036 1,893 31.9 949 16.0 944 15.9 167 2.8 777 13.1 54 151 873 201 23.0 672 366 3 1,036 1,036 78.5

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Tech Mahindra | 2QFY2012 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 2,365 627 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 3,288 728 4,374 907 907 16 5,297 1,433 (839) 594 165 759 2,909 70 1,218 370 878 (526) (50) (329) 1,560 5,297 FY2013E 126 233 4,251 747 5,356 407 407 16 5,779 1,588 (1,006) 582 267 849 2,932 75 1,316 555 978 (560) (40) (326) 1,923 5,779

Source: Company, Angel Research

November 16, 2011

Tech Mahindra | 2QFY2012 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/(utilized) 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 65 (43) 5 222 1,346 (162) (371) (14) (547) (30) 3 0 (274) (57) (358) 441 98 538 780 134 (9) 906 73 978 (144) 834 (140) (377) (8) (14) (539) 295 (407) (2,580) (8) (2,995) 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 2 (117) (61) (504) 49 219 267 604 169 366 1,138 208 1,346 (183) 1,163 29 (46) 16 18 18 1,181 (200) (1) (7) (208) (316) (584) 101 (70) (869) 103 267 370 723 167 368 1,258 148 1,406 (201) 1,205 (98) (100) 34 (13) (178) 1,027 (258) (23) (7) (288) (500) 19 (73) (554) 185 370 555

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10

Tech Mahindra | 2QFY2012 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 8.8 7.9 4.6 0.6 1.9 6.9 12.8 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 12.7 10.6 3.1 0.5 2.3 9.5 11.7 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 13.8 11.3 2.6 0.6 1.9 9.8 13.5 49.3 60.3 4.0 257.0 0.9 1.0 0.2 7.1 0.2 22.3 16.6 18.0 23.5 7.1 81 43

FY2012E 9.5 7.7 2.1 0.6 1.7 10.3 12.4 71.5 88.0 4.0 331.6 1.2 1.1 0.1 7.2 0.2 22.7 14.0 15.6 22.7 7.2 81 42

FY2013E 8.7 7.5 1.7 0.6 1.5 9.2 10.3 78.5 91.2 4.0 406.1 1.2 1.1 0.1 7.0 0.2 19.3 13.4 15.7 19.3 7.0 81 41

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Tech Mahindra | 2QFY2012 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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12