27 May 2010

BSE Sensex: 16666

Rs599
Mphasis OUTPERFORMER

RESULT NOTE Mkt Cap: Rs125.6bn; US$2.65bn

Analyst: Hitesh Shah, CFA (91-22-6622 2565; hitesh.shah@idfc.com)

Result: Q2FY10
Comment: In-line revenues; Margin ahead of expectations
Last Report: 5 April 2010 (Price Rs637; Recommendation: Outperformer)
Key valuation metrics
Year to October (Rs m) Sales chg yoy (%) Net Profit EPS (Rs) chg yoy (%) PER (x)
2008 29,683 - 3,971 18.9 - 31.7
2009 42,639 43.6 9,087 43.2 128.3 13.9
2010E 50,420 18.2 10,632 50.4 16.7 11.9
2011E 60,934 20.9 11,259 53.3 5.8 11.2
2012E 74,199 21.8 13,563 64.2 20.5 9.3
Source: Company, IDFC Securities

Key result highlights

• In-line quarter – Mphasis reported revenues of US$261m (exp: US$260m) – 4.7% qoq growth and 25% yoy growth; In
INR terms, revenues were Rs12.2bn – growth of 2.4% qoq and 16% yoy. EBIT margin at 22.5% were flat qoq (Exp:
20.7%) – better INR realization, lower depreciation helped company maintain EBIT margin. Net profit was flat qoq
and up 18% yoy to Rs2.67bn (Exp: Rs2.5bn) – better margin contributed to earnings surprise.
• Application and ITO services on track; BPO services close to bottoming out – In USD terms, Application services
revenues grew 6.1% qoq while ITO services grew 10.5% qoq – ahead of industry growth rates. BPO services declined
by 12% qoq pulling overall growth rates. Management indicated that BPO services business was close to bottom and
should start growing in a few quarters.
• Investors concerns on HP channel profitability overdone – Mphasis has seen rate revision for the HP channel (HP
as client and migration services – 28% of revenues) in the last quarter. Also, management spoke about marginally
higher sales commission to HP for joint-go-to-market channel (~44% of revenues). These has fueled concerns
amongst investors about the profitability of HP channel getting reflected in the recent stock performance. In our
view, most of these negatives are priced in at ~12x FY10E and ~11x FY11E EPS.
• Long term growth thesis intact – A play on HP-EDS rightshoring strategy, we expect the growth traction to sustain
in the coming years as Mphasis continues to get its fair share of offshore shift by the parent. Management is taking
right initiatives in consolidating BPO facilities in metros like Chennai and Mumbai as salary levels and lease rentals
in these cities are higher than tier2 and tier3 cities.

Valuations and View: Quarterly results were broadly in-line with the expectations with some positive surprises in
margin and net profits. We expect company to continue strong performance in coming quarters and have raised our
FY10E EPS by ~5% keeping FY11/12E EPS largely unchanged. Investors concerns about profitability of HP channel are
not completely unwarranted; however they are overdone and are largely priced in at ~12x FY10E EPS, in our view. We
remain positive on the stock and rate it as Outperformer with 12month target price of Rs850/share (based on ~16x FY11E
EPS). Mphasis stock remains one of our top pick in non-tier1 large cap IT services space.

IDFC Securities Ltd.

Naman Chambers, C-32, G- Block, Bandra-Kurla Complex, Bandra (East), Mumbai 400 051 Tel: 91-22-6622 2600 Fax: 91-22-6622 2501

“For Private Circulation only” and “Important disclosures appear at the back of this report”
 IDFC Securities

Q2FY10 results
Rs m Q2FY09 Q1FY10 Q2FY10 QoQ YoY (%)
Cons. Revenues ($ m) 208.7 249.1 260.8 4.7 24.9
Revenue 10,485 11,916 12,205 2.4 16.4
Cost of Revenue 7,074 8,210 8,443 2.8 19.4
Gross Profit 3,411 3,706 3,762 1.5 10.3
Gross Margin 32.5 31.1 30.8 (28bp) (171bp)
Total Operating Expenses 1,145 1,028 1,014 (1.4) (11.5)
Operating Profit (EBIT) 2,266 2,678 2,748 2.6 21.3
EBIT Margin 21.6 22.5 22.5 4bp 90bp
Dep and Amort 552 453 403 (11.1) (27.1)
EBITDA 2,818 3,131 3,151 0.6 11.8
EBITDA margin 26.9 26.3 25.8 (46bp) (106bp)
Forex gain/losses 124 240 157 (34.6) 27.0
Profit before tax 2,419 3,008 3,023 0.5 24.9
Income Tax Expense 174 325 350 7.7 100.6
Net Income 2,245 2,683 2,673 (0.4) 19.1
Net margin 21.4 22.5 21.9 (62bp) 49bp
Adj. EPS (Rs.)
Basic 10.74 12.80 12.73 (0.5) 18.5
Fully Diluted 10.69 12.73 12.66 (0.5) 18.4
Source: Company

‰ Other result highlights

™ Hedges – Company has hedges of US$598m at the rate of Rs47.8/USD, GBP hedges of GBP53m at the rate of
Rs78.4/GBP and AUD hedges of AUD19m at the rate of Rs40.7/AUD.
™ Attrition – Company saw attrition inching up to ~25% in Application and ITO services.
™ Wage hikes – Company has planned industry level wage hikes (13-15% offshore and 2-3% onsite) starting Q3FY10
and should see some margin decline on back of the same.
™ Fortify acquisition – Effective May’10, company would report consolidated financials including the recent acquition
of Fortify Infrastructure Services – a global provider of offshore based Remote IT Operations and Management (ROM)
services. With presence in India and US, it gives MphasiS access to marquee customers, an experienced management
team, a talent pool and a platform to provide ROM services. Fortify has annual revenues of US$20m.
™ Facility consolidation – Company is taking initiatives in the right direction by consolidating facilities in higher cost
locations like Indian Metros and opening more centers in Tier2 and Tier3 cities. Company has wounded up its
Chennai BPO facility and is in the process of wounding up its Mumbai BPO facility in Q3FY10.
EBIT margins – trends and sustainability

EBIT margins on reported basis have held on for Mphasis on back of good hedging gains in revenue line. Ex of heding gains,
margins for Mphasis have seen a steady decline on back of pricing discounts. We expect the margins to stabilize in the range of
18-20% over next few quarters (ex of hedging gains/losses). With a consistent hedging policy and commendable hedge
positions, we expect company to have decent hedging gains in coming few quarters as long as INR remains below Rs47/USD
helping company report relative stable EBIT margins around 20-22% band.

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 IDFC Securities

Mphasis EBIT margin over the last 6 quarters

EBIT Margin EBIT margin (ex forex hedging gains/losses)
24.0%

22.5%

21.0%

19.5%

18.0%
Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10

Source: Company

‰ Changes to estimates and target price

We have tweaked our volume and pricing assumptions in-line with the latest quarter. We have marginally changed our
INR assumption to Rs46/USD for May-July’10 and Rs0.50 appreciation every quarter thereafter. Net-net, we have raised
FY10E estimates by ~5% while keeping FY11/12E largely unchanged.

Earnings revision table

Year to 31-Mar FY10E FY11E FY12E
Net income – Recurring
- New 10,632 11,259 13,563
- Old 10,141 11,223 13,768
Change (%) 4.8 0.3 (1.5)
Recurring EPS – Fully diluted
- New 50.38 53.32 64.24
- Old 48.11 53.25 65.33
Change (%) 4.7 0.1 (1.7)
Source: IDFC Research

‰ Other key result tables

Segment wise revenues (US$ m)
Application services BPO services ITO services
280 261
249
229 237
47
209 41
210 200 45
44
35
34 39 39
39 41
36 36
140

169 180
70 146 151
130 133

0
Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10

Source: Company

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 IDFC Securities

Key HR metrics
Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10
Mphasis total
Employees 29,988 33,810 32,753 33,524 35,690 37,119
- net add 1,193 3,822 (1,057) 771 2,166 1,429
IT Services
- Onsite 1,581 1,589 1,684 1,858 2,006 1,813
- Offshore 9,648 9,917 9,685 10,328 10,524 12,241
Total 11,229 11,506 11,369 12,186 12,530 14,054
- net add 638 277 (137) 817 344 1,524
BPO Services
- Onsite 116 146 129 144 150 153
- Offshore 13,840 17,237 16,262 16,161 17,288 16,603
Total 13,956 17,383 16,391 16,305 17,438 16,756
- net add (16) 3,427 (992) (86) 1,133 (682)
ITO Services
- Onsite 24 24 33 31 43 56
- Offshore 4,779 4,897 4,960 5,002 5,679 6,253
Total 4,803 4,921 4,993 5,033 5,722 6,309
- net add 547 118 63 42 677 574
Source: Company

Key Execution metrics

Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10
Utilization rates – Application services (%)
Ex. Trainees
Onsite 84 86 83 87 85 87
Offshore 72 73 74 81 78 75
Blended 74 75 75 82 79 77
Inc. Trainees
Onsite 84 86 83 87 85 87
Offshore 75 77 77 83 77 73
Blended 76 79 78 84 78 75
Billing rates – Application services (US$/hr)
Onsite 71 71 72 72 72 72
Offshore 22 22 22 22 23 23
Utilization rates – BPO services (%)
Ex trainees 65 63 63 70 76 76
Inc. trainees 58 53 55 65 70 70
Billing rates – BPO services (US$/hr) 10 10 9 8 7 7
Utilization rates – ITO services (%)
Ex. Trainees
Onsite 85 98 98 85 83 83
Offshore 78 83 83 85 85 80
Blended 78 83 83 85 85 80
Inc. Trainees
Onsite 85 98 98 85 83 83
Offshore 73 76 77 80 79 76
Blended 73 76 78 80 79 76
Billing rates – ITO services (US$/hr)
Onsite 70 70 70 70 70 72
Offshore 21 21 22 22 18 18
Source: Company

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 IDFC Securities

Revenue Mix
(%) Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10
By Vertical
BFS 43.2 40.2 41.3 41.0 42.3 38.1
Technology & OEM 24.8 24.4 22.6 21.6 17.7 17.7
Telecom 9.2 11.8 10.6 12.3 11.7 13.8
Manufacturing and Retail 12.9 12.5 13.0 12.6 12.5 15.0
Logistics 5.2 6.2 5.0 5.1 5.7 6.3
Healthcare 5.4 7.1 7.5 6.4 7.1 6.4
By Geography
USA 67.9 70.6 66.3 63.6 61.7 60.4
Europe 21.8 20.4 19.9 19.9 20.3 19.0
AsiaPac 11.1 11.3 13.7 15.6 15.0 17.8
By Service-line
AM 34.6 33.3 35.2 36.4 37.8 37.7
AD 31.0 32.0 28.4 26.7 27.7 29.0
Customer service 8.5 8.0 8.3 7.3 6.5 5.6
Tech helpdesk 7.6 6.7 5.5 5.5 5.7 5.5
Transaction processing 5.0 5.1 5.1 6.0 5.7 5.1
IMS 10.3 13.6 14.4 13.6 11.0 12.5
KPO 3.9 3.6 3.0 2.7 2.3 2.0
Source: Company

Key Client Metrics

Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10
Client relationships
1+ m USD Clients 95 109 106 106 105 106
5+ m USD Clients 31 34 33 39 34 37
10+ m USD Clients 21 22 23 23 22 22
20+ m USD Clients 7 6 9 11 9 11
Receivable days 80 77 75 72 77 76
Client concentration (%)
Top client 15.0 14.0 14.0 12.0 12.0 11.0
Top 5 clients 36.0 31.0 34.0 30.0 31.0 30.0
Top 10 clients 50.0 43.0 48.0 45.0 44.0 45.0
Source: Company

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 IDFC Securities

Analyst Sector/Industry/Coverage E-mail Tel. +91-22-6622 2600

Pathik Gandotra Head of Research; Financials, Strategy pathik.gandotra@idfc.com 91-22-662 22525
Shirish Rane Construction, Power, Cement shirish.rane@idfc.com 91-22-662 22575
Nikhil Vora FMCG, Media, Mid Caps, Education, Exchanges nikhil.vora@idfc.com 91-22-662 22567
Ramnath S Automobiles, Auto ancillaries, Real Estate, Oil & Gas ramnath.subramaniam@idfc.com 91-22-662 22570
Nitin Agarwal Pharmaceuticals nitin.agarwal@idfc.com 91-22-662 22568
Chirag Shah Metals & Mining,Telecom, Pipes, Textiles chirag.shah@idfc.com 91-22-662 22564
Bhoomika Nair Logistics, Engineering bhoomika.nair@idfc.com 91-22-662 22561
Hitesh Shah, CFA IT Services hitesh.shah@idfc.com 91-22-662 22565
Bhushan Gajaria Retailing, FMCG, Media, Mid Caps bhushan.gajaria@idfc.com 91-22-662 22562
Salil Desai Construction, Power, Cement salil.desai@idfc.com 91-22-662 22573
Ashish Shah Construction, Power, Cement ashish.shah@idfc.com 91-22-662 22560
Probal Sen Oil & Gas probal.sen@idfc.com 91-22-662 22569
Chinmaya Garg Financials chinmaya.garg@idfc.com 91-22-662 22563
Aniket Mhatre Automobiles, Auto ancillaries aniket.mhatre@idfc.com 91-22-662 22559
Abhishek Gupta Telecom abhishek.gupta@idfc.com 91-22-662 22661
Ritesh Shah Pharmaceuticals, IT Services ritesh.shah@idfc.com 91-22-662 22571
Saumil Mehta Metals, Pipes saumil.mehta@idfc.com 91-22-662 22578
Vineet Chandak Real Estate vineet.chandak@idfc.com 91-22-662 22579
Kavita Kejriwal Strategy, Financials kavita.kejriwal@idfc.com 91-22-662 22558
Swati Nangalia Mid Caps, Media, Exchanges swati.nangalia@idfc.com 91-22-662 22576
Sameer Bhise Strategy, Financials sameer.bhise@idfc.com 91-22-662 22574
Nikhil Salvi Construction, Power, Cement nikhil.salvi@idfc.com 91-22-662 22566
Shweta Dewan Mid Caps, Education, FMCG shweta.dewan@idfc.com 91-22-662 22577
Dharmendra Sahu Database Analyst dharmendra.sahu@idfc.com 91-22-662 22580
Rupesh Sonawale Database Analyst rupesh.sonawale@idfc.com 91-22-662 22572
Dharmesh R Bhatt, CMT Technical Analyst dharmesh.bhatt@idfc.com 91-22-662 22534
Equity Sales/Dealing Designation E-mail Tel. +91-22-6622 2500
Naishadh Paleja MD, CEO naishadh.paleja@idfc.com 91-22-6622 2522
Paresh Shah MD, Dealing paresh.shah@idfc.com 91-22-6622 2508
Vishal Purohit MD, Sales vishal.purohit@idfc.com 91-22-6622 2533
Nikhil Gholani MD, Sales nikhil.gholani@idfc.com 91-22-6622 2529
Sanjay Panicker Director, Sales sanjay.panicker@idfc.com 91-22-6622 2530
V Navin Roy Director, Sales navin.roy@idfc.com 91-22-6622 2528
Nirbhay Singh SVP, Sales nirbhay.singh@idfc.com 91-22-6622 2595
Suchit Sehgal AVP, Sales suchit.sehgal@idfc.com 91-22-6622 2532
Pawan Sharma MD, Derivatives pawan.sharma@idfc.com 91-22-6622 2539
Jignesh Shah AVP, Derivatives jignesh.shah@idfc.com 91-22-6622 2536
Sunil Pandit Director, Sales trading suniil.pandit@idfc.com 91-22-6622 2524
Mukesh Chaturvedi SVP, Sales trading mukesh.chaturvedi@idfc.com 91-22-6622 2512
Viren Sompura VP, Sales trading viren.sompura@idfc.com 91-22-6622 2527
Rajashekhar Hiremath VP, Sales trading rajashekhar.hiremath@idfc.com 91-22-6622 2516

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