Tech Mahindra - Acquisition to enhance growth outlook - Reliance Securities

Tech Mahindra acquires Hutch's BPO business: Tech Mahindra has acquired 100% shareholding of Hutchison Global Services Pvt Ltd (a wholly owned subsidiary of Hutchison 3 Global Services Holding Ltd) for ~US$87.1mn, which is payable upfront. The company was in the race to acquire this BPO business since last couple of months. London-listed Serco, which acquired Intelenet last year, was also in the race.

- Background of Hutch BPO: Mumbai-based Hutchison Global Services Pvt Ltd (HGS) does captive back office technology work and customer service support for the group's mobile telephony services in UK, Ireland and Australia. The BPO business provides services to its clients from its five locations in Pune and Mumbai and has an employee base of ~11,500 employees.

- Impact: Tech Mahindra has been struggling on top-line front with revenues from its top client declining quarter over quarter. Recently, British Telecom (accounting for 36% of the company's revenues) sold ~14% stake in the company, which sparked further concerns regarding top-line growth for the company. Thus, this acquisition comes in as a huge positive for the company. As part of the deal, the clients of HGS have committed to procure services worth US$845mn over a 5 year period. Hence, the acquisition would add ~10-11% to Tech Mahindra's FY2014E top-line. On a combined revenue base of Tech Mahindra and Mahindra Satyam, the acquisition would add ~4-5% to the FY2014E top-line.

- Management gearing up to double revenues: Management has set a target to double combined revenues of Tech Mahindra and Mahindra Satyam from ~US$2.4bn in FY2012 to ~US$5bn by FY2015. Company has designed a strategy to achieve this target, which also includes inorganic growth. Management is confident of achieving this target in the next three years having successfully completed three year journey of reviving Mahindra Satyam.

Outlook and Valuation

We believe that the acquisition would provide steady revenue base for the company. Considering the acquisition, we have revised our top-line estimates by ~10% for FY2014E to factor in the revenues from HGS. However, assuming that the company will use debt to fund the acquisition, our bottom-line estimates are revised marginally upwards by ~4% for FY2014E. Based on our pro-forma EPS of ~Rs93 for the combined entity, we arrive at a target price of Rs840 for Tech Mahindra (on a post merger basis). Given the current stock price, we maintain our Neutral rating on the stock with a fair value of Rs840.

Risks to the view

- The uncertainties plaguing the US and European economies can lead to volatility in earnings in the short term

- Acquisition of HGS increases company's exposure to telecom vertical, which has been underperforming over last two years due to lack of capital spending

- We have factored in USD/INR rate of Rs53 and Rs52 for FY2013E and FY2014E respectively. Any sharp appreciation in INR will negatively impact our estimates

- Higher than expected decline in revenues from BT can hamper the company's performance.

Source : Equity Bulls

Keywords