Tech Mahindra

TechM's telecom vertical focus and high single client dependence should drive nearterm performance ahead of larger peers seeing demand moderation from BFSI clients. Even on our cautious margin outlook, we see current valuations as attractive.

TechM could grow ahead of larger peers in the near term
Tech Mahindra's (TechM) focus on telecom vertical (100% of revenues) and high client concentration (top client BT is 65% of revenues) should actually help in the near term as other major players are seeing demand moderation given the high exposure to the BFSI vertical. We expect 30% growth in US$-term revenues for TechM vs an average of 26% for the larger peers in FY09. Ramp-up in the deals won over the last six months should help - it won a US$350m fiveyear deal from BT (though 70% of it was for existing work), a US$200m seven-year deal from a non-BT client, and US$25m deal from Telecom New Zealand. Traction in the US$1bn five- year deal from BT Global Services is also picking up, with the run-rate at US$20m at the end of 4Q08. Note, TechM's revenues have grown at 13.4% CQGR over the last eight quarters, ahead of 9.8% growth in telecom revenues of the top five players. The company has also announced exclusive
talks with BT for a large deal that involved US$110m of an upfront non-refundable payment.

While we retain our cautious view on margins…
We hold our view that high client dependence restricts margin flexibility. Improving utilisation and controlled headcount addition has helped in the recent quarters. However, we see utilisation peaking as recruitment picks up in 1Q09. We forecast a 238bp decline in reported EBITDA margin over FY08-12. The decline would be 425bp if we treated the upfront cash payment to clients (reported as exceptional items in FY07 and FY08) as operational expenses. We do not discount recurrence of such contract structures going forward, given management's willingness. A higherthan-expected reduction in transition cost is, in our view, the potential upside to margin not built into our forecasts.

…we believe current valuations are a good entry point. Upgrade to Buy
The stock has corrected 43% YTD vs 20% decline in the BSE IT Index. We expect marginal rerating as a better-than-peers quarterly performance could partially allay investors' concerns on upfront cash payment to clients. We upgrade to Buy with 32% upside potential. Our one-year forward target price of Rs848 is based on 9x 12-month forward EPS, supported by 20% EPS CAGR over FY08-12F.