Stock Review: MphasiS

 

The stock of MphasiS has been on a slippery track after its lacklustre performance in the January quarter. But for investors with a higher risk appetite, the valuation might just click

 

   THE Bangalore head-quartered IT solutions provider MphasiS has lost more than one third of its market capitalisation in the past one month. The company's depressed performance in the January 2011 quarter was a major trigger for the sharp drop in its valuation. Analysts have raised concerns over the company's inability to maintain stable billing rates for the business coming through its parent HP and over sluggishness in non-HP revenue.

   The company has embarked on a transformation programme to tackle issues related to its future growth. It has increased the focus on emerging markets and on the government segment of IT business. It is also taking efforts to expand its presence in payment solutions and product re-engineering. The next two quarters will be crucial for investors to understand the implications of the company's plans.

BUSINESS:

MphasiS earned over 5,000 crore revenue in the 12 months ended January 2011 selling IT services and solutions to its global clientele. It offers software application development and maintenance, transaction processing and infrastructure management solutions. Of this, applications development and maintenance are the biggest business segment, contributing twothirds to the revenue. The company's reliance on this relatively low-margin business is still high despite past attempts to improve its presence in other service offerings. Other bigger IT players have gradually increased their focus on such better margin yielding services.

   Over two-thirds of its revenue come from the US region, another 20% from Europe, and the rest from Asia Pacific and the Gulf. Its major verticals are banking and financial services, technology and telecom, which account for threefourths of the total revenue. The NYSE-listed Electronic Data Systems Corporation, a global IT services provider, acquired MphasiS in June 2006. EDS, in turn, merged with HP in May 2008. EDS now owns a little over 60% stake in MphasiS.

CONCERNS AND OPPORTUNITIES:


The initial spurt in its growth soon after MphasiS became a part of the HP family has receded. Its sales and profits were sluggish during the past four quarters, in sharp contrast to the robust volume growth of its peers. Furthermore, none of its verticals has shown a major recovery in demand despite the fact that other larger IT players have reported a strong traction in banking and finance projects.

   A major reason for this slack is that sales through the HP channel, which accounts for two-thirds of the total revenue, have not grown much. MphasiS grew its revenue through HP's client engagements by a meagre 1% in the January 2011 quarter on a year-on-year basis. Also, despite its efforts to improve sales from the non-HP channel, the division's revenue remained stagnant during the quarter.

   MphasiS has also taken billing rate cuts from the HP channel clients in the past, which tends to pull down overall profitability. Some analysts feel that margins get squeezed due to such rate cuts at a time when the topline is sluggish.

   What is positive is that the company still has a healthy cash balance of close to 1,800 crore. Given the company's past record of inorganic growth, the funds can be deployed to acquire skills necessary for growth in the focus areas. It has recognised product engineering and payment solutions as focus areas. In the January quarter, its direct channel captured more new clients than the HP channel citing the improvement in MphasiS' own sales stream.

VALUATIONS:

The stock trades at nearly half of its 52-week peak of 711. Much of the erosion in its value has incurred after its January 2011 quarter results. At close to 390, the stock currently trades at far below the downwardly revised price target of 480-600 by some of the brokerages. Its trailing priceearnings ratio works out to be 7.8, much lower than the tier-I IT players, who command P/Es of above 25. While the current valuation of MphasiS looks far too attractive, investors need to keep a close eye on its performance in the next two quarters to assess its future growth potential.