Stock Review: MPHASIS

THE Bangalore-headquartered IT services and BPO company MphasiS reported a strong volume growth in the quarter ended July 2010. This was mainly driven by growth in its acquired businesses. The company is expected to keep the tempo intact considering the potential of its acquired businesses and its strengthening relationship with the parent HP.

    MphasiS has aggressively pursued inorganic growth in recent times. In the last one year, it has acquired two companies — AIG's captive IT arm in last August and remote IT solutions provider Fortify Infrastructure Services in February. These decisions now seem to be working in its favour.

    In the July quarter, volume of its core operations grew by 7%, which was in line with the growth reported by its larger IT peers earlier during the June quarter. More importantly, volumes in its acquired businesses grew by a strong 12%.

    Apart from acquisitions, MphasiS is also benefiting from its relationship with the parent HP. More than twothird of its revenue comes from HP's client engagements. In the July quarter, of the 22 new client additions, 16 were through the HP channel.

    To further leverage this relationship, MphasiS has revised its HP billing strategy from the July quarter. Under this, it has devised a fixed rate card for one-third of the channel revenue, which includes migration and HP's internal projects.

    An immediate impact of this change was a sharp 9.6% drop in average bill rates for the applications divison in the July quarter. While this impacted operating profit before depreciation — it would have fallen by 7% sequentially had it not been for Rs 23 crore of one-time profit — the effect appears to be short term in nature.

    The MphasiS management believes that the new rate card arrangement would offer more room to improve margins through efficient project management. In earlier arrangements, such benefits were passed on to HP.

    Going ahead, MphasiS looks well positioned to take advantage of existing growth avenues and also to find new ones. For, even though its majority revenue comes from the HP channel, the amount is insignificant considering the size of HP's enterprise pie. MphasiS generated close to $630 million (Rs 3,027 crore) through HP in FY09, while HP alone earned close to $24 billion (Rs 115,200 crore) from the segment.

    This leaves a wide scope to grow the HP link further. Also, MphasiS currently earns just about 5% return on its cash and equivalents of Rs 1,487 crore. The cash can be deployed towards its inorganic initiatives thereby improving its return on assets.

    At the Thursday's close of Rs 622.9, the stock traded at 12 times its trailing twelve-month earnings. P/Es of other Tier-I IT players are in the range of 22-28. Given its healthy margins and strong growth potential, the valuation of MphasiS looks attractive at the current level.