To Buy MphasiS, Wait For News On Acquisition

Mphasis announced results for the quarter ending July 31, 2012 (Q3FY12) after the closing bell on August 29, 2012. The result was taken positively by the markets with an increase of close to 2 per cent in the stock prices of Mphasis. Like other mid-cap IT companies, this company too has benefited from dynamic factors leading to disintegration of larger deals into smaller ones and multi-sourcing of deals. The YTD returns for Mphasis have been 25.29 per cent.

In the quarter under review, the topline of Mphasis saw a growth of 1.98 per cent with revenues reaching Rs 1,355.12 crore in Q3FY12 from Rs 1,328.87 crore in Q2FY12. The company had been highly dependent on its top client and parent, Hewlett-Packard Co (HP). Over time, revenues from this front have been declining, putting pressure on Mphasis to generate revenues from the direct channel. The company has managed to post overall growth even with a reducing proportion of revenues coming in from the HP channel. The direct channel to HP channel mix in Q3FY12 was down to 45:55 from 42:58 in Q2FY12 and from 33:67 in Q3FY11. Business from the HP channel saw a negative growth of 2.30 per cent QoQ. At the same time, the company’s direct channel business grew at a robust 5.8 per cent QoQ.

The company saw an improvement in the margins despite increases in salary and promotions in this quarter. The salary hike implemented by the company was 3 per cent for onsite employees and 8 per cent for Indian employees. With this, the EBIT margin and net profit margin of the company improved by 44 bps and 115 bps respectively. With this, the EBIT margin improved sequentially from 16.24 per cent to 16.68 per cent and the net profit margin from 14.25 per cent to 15.40 per cent. The operating profit and net profit of the company stood at Rs 225.99 crore and Rs 208.74 crore respectively.

The company managed to add 24 new clients in the quarter, 7 of which are in the Banking and Capital Market (BCM) segment that is the key segment of Mphasis. Commenting on client additions, the management said that the pipeline is good but the closure of deals is choppy. There have been changes in the way things have been panning out with customers being open to newer models. The management though is not seeing a significant trend on pricing pressure and is confident of delivering growth rate above the market.

In terms of cash, the company added Rs 236.6 crore in cash and cash equivalents of Rs 2,575.1 crore. The company plans to make an acquisition using this sum in the pool towards accelerating their pace in emerging services. We are on the lookout for acquisition. a dedicated team is working on that, said MphasiS CEO Ganesh Ayyar. Having a stronghold in traditional services, IT companies have been focusing their resources towards strategic moves in this field to gain long-term benefits. The acquisition issue which has been on the table for Mphasis since ages has been fixed with a deadline of September 23, 2012 after which the management said they would return the cash to shareholders in some form.

The reducing dependency of Mphasis on large clients is a sign of lesser risk for the company. Growth from the direct channel has been robust, leading to overall strength in the revenue and profitability of the company. We believe that the company will benefit largely if the process of acquisition goes through well. The company plans to acquire a company to leverage its position in the emerging services market which, when executed, will deepen the roots of the company. We recommend investors to hold on and keep an eye on this stock with respect to news about acquisitions. Investors can buy this stock for medium term gains when such news is released in the public domain.