Stock Review: MphasiS

Due to the lack of near-term positive triggers, a further upside in MphasiS looks limited. Investors can reduce their exposure to the stock

 

WE had recommended the stock of IT services provider MphasiS in August 2009 and the stock had gained over 28% in the year. However, the company reported a slower growth in revenue and operating profits than some of its bigger peers during the quarter ended September 2010. Its business volume growth lagged behind the momentum reported by the top IT players. Despite its focus on improving direct sales channel, MphasiS is yet to reduce its dependence on the parent HP. Higher employee attrition is another concern. These factors are likely to restrict the growth in its stock valuation in the medium turn. Investors are advised to reduce their exposure to the stock.

BUSINESS:

MphasiS provides IT and business process outsourcing services to various verticals, including banking, financial services and insurance, telecom, manufacturing, healthcare and retail. Unlike its bigger peers, including TCS and Infosys, which have diversified their revenue across various offerings, MphasiS still draws two out of every three rupees revenue from application development and maintenance services.

   This is gradually changing since in the past four quarters. It has improved share of infrastructure management services from 13% to 18% of the revenue. Business and knowledge process outsourcing contributes another 7%.

   The US is the largest market for MphasiS, contributing two-third of the total revenue. The rest comes from Asia Pacific, Europe and Middle East regions. The company has been able to maintain a higher proportion of revenue from its offshore development centres compared to its peers. Higher offshoring component tends to boost operating margin due to low cost of labour when compared with onsite costs.

CONCERNS:

MphasiS has not shown any major growth in its verticals in the past two quarters unlike other bigger IT players. Its September 2010 quarter, revenue growth was mainly due to a 53% sequential surge in telecom vertical revenue. A part of this growth was because of addition of a large client account, while the remaining was owing to a boost in revenue after an outage issue at one of the sites in the previous quarter. Revenue from other verticals did not show much growth.

   The company has long been trying to reduce its dependence on its parent HP for new client accounts. It has also taken an inorganic route to acquire capabilities to do so. A higher proportion of direct channel revenue is expected to offer better control to MpahsiS on deliverables and higher profitability. But the company still earns a significant portion of revenue from HP engagements.

   New client additions are also mainly driven through this alliance. In the September quarter, number of its direct channel clients declined while that from HP channel grew. The company may take a few more quarters before it could make a significant shift to the direct channel strategy.

   The gains from its past acquisitions are fully captured by its financial numbers. Hence a further jump in the growth would come only on account of growth in business volumes. The addition of bigger client accounts was sluggish during the past two quarters, which could restrict its revenue growth in the near term.

VALUATIONS:

At the current price level of 600, the stock trades at a trading 12-month P/E of nearly 12. This is at a discount to the top tier IT players, which command a P/E of more than 20. However, it does not make the stock attractive since medium-term growth looks restrained. Investors can reduce their exposure to the stock.