Mphasis Ltd: Stock to lookout for?

Mphasis is an Information Technology solutions provider with major clients in US market.

The company was formed in June 2000 after the merger of Mphasis Corporation and BFL Software Limited. In June 2006, EDS purchased a controlling stake in this company.Then, in August 2008, Hewlett-Packard (HP) acquired EDS. Further, in September 2016, Blackstone Group through its fund “Marble II PTE” acquired Mphasis’s holding from HP & the Company became a Blackstone group of Company since then.

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Shareholding Pattern

Current promoter of Mphasis Ltd is Marble II Pte Ltd which owns 56.18% of the shares as on 31 March 2020. Marble II Pte Ltd is Singapore based technology company. It is a unit owned by PE firm Blackstone Group.

As on 31 March 2020, Mutual Funds hold 6.78% of total shares of Mphasis, foreign portfolio investors hold 23.87%, Financial Institutions/Banks’ holding is 2.08% and Insurance companies hold 5.26%.

mphasis research report with details of shareholding pattern
mphasis research report with details of major shareholders FY20

Executive Management

(i) Mr. Davinder Singh Brar – Chairman

Mr. Davinder Singh Brar joined the Board of Mphasis on 8 April 2004 and elected as the Chairman of the Board effective 11 December 2015. He was also the Director of the Reserve Bank of India (RBI) during 2000-2007. Mr. Davinder started his career with Associated Cement Companies (ACC). Later, he joined Ranbaxy Laboratories Ltd, where he rose to the position of Chief Executive Officer (CEO) and Managing Director.

Mr. Davinder holds a bachelor’s degree in electrical engineering from Thapar Institute of Engineering and Technology, Patiala. He also holds master’s degree in management from Faculty of Management Studies from the University of Delhi (gold medalist – 1974).

Thus, he holds good working experience.

(ii) Mr. Nitin Rakesh – Chief Executive Officer And Executive Director

Mr. Rakesh joined Mphasis as its Chief Executive Officer and Director in January 2017. Prior to that, he was Syntel’s CEO & President & also served in various capacities from 2002 to 2008 and 2012 to 2016. Also, he held the position of CEO & MD of Motilal Oswal Asset Management Company Ltd form 2008 to 2012. Also, he was Chief Executive of State Street Syntel Services, a joint venture between Syntel & State Street Bank.

In addition, he has worked with the TCG Group, a transnational private equity and investments firm as the Head of Banking & Financial Services Sales at TCG Software Services between 1999 to 2002.

Moreover, he is a member of The Wall Street Journal (WSJ) CEO Council & an industry expert and practitioner with the Forbes Technology Council (FTC). Mr. Nitin globally advises their readers on current, as well as future, technologies and trends.

By qualification, he holds a Bachelor’s degree in Engineering (Computer Science) from Delhi Institute of Technology, Delhi University. He also received his Master’s in Management from Narsee Monjee Institute of Management Studies, Mumbai and is an alumni of Harvard Business School’s CEO Workshop.

His remuneration for FY20 is Rs. 12.28 crore. It is 0.14% of net sales and 1.04% of net profit for the year.

Total Managerial Remuneration for FY20 amounted to Rs. 18.20 crore which is 1.57% of PAT.

Change in ownership

2006:

EDS (Electronic Data Systems), which is an American multinational information technology company, acquired 62% stake in Emphasis.

Earlier, Mphasis was merged entity of the US-based IT consulting company Mphasis Corporation and the Indian IT services company BFL Software Ltd.

2008:

Hewlett Packard (HP) acquired EDS. Consequently MphasiS became a subsidiary of Hewlett Packard (HP).

Further, in 2009 Mphasis re-branded its identity by dropping EDS association to become “Mphasis, an HP Company”. HP owned close to 62% in Mphasis & Mphasis got around 50% of its revenues from HP.

2016:

Blackstone acquired Hewlett Packard Enterprise’s 60.5% stake in MphasiS. The acquisition took place at an average price of Rs 430 per share. Approximate amount of deal amounted to $1 billion.

Later in 2018, Blackstone had sold a total of 8% stake in Mphasis at an average price of Rs 926 and reduced their stake to 52% in the company.

2020:

Then in March 2020, Blackstone acquired 4.01% stake in Mphasis for about Rs 525 crore ($69 million) after its share price fell more than 1/3rd from its year-high.

Business Model

(i) Business Segments

mphasis research report with details of business segments

These are the industries served by Mphasis Ltd.

Banking & Capital Market (BCM) Industry contributes the most of company revenue & profit contribution is 42%. The total revenue from BCM segment amounted to Rs. 400.85 crore (46% of total revenue).

This vertical includes clients from following sectors:

mphasis research report with details of banking & capital market segment

Secondly, Emerging Industries segment contributes 27% of the total revenue. The revenue for the segment amounted to Rs. 241.31 crore for FY20. Emerging Industries include:

mphasis research report with details of emerging industries revenue

(ii) Geographic Revenue Segments

mphasis research report with details of geographic distribution of revenue

*EMEA = Europe, Middle East and Africa
*ROW = Rest of the World

Company’s high percentage of revenue comes from North America. The company intends to grow other regions, more specifically Europe.

(iii) Revenue as per Service Type

mphasis research report with details of revenue as per services lines
  • Application Maintenance: Annual income from existing clients for maintenance of applications.
  • Application Development: Income from customer specific applications development. Thus, growth in this segment means addition of new clients or additional applications development for existing clients.
  • Infrastructure Management Services: Includes data centre services, end user support, AI-led automation, network & communication, cloud services, digital operations.
  • Knowledge Processes: Income from outsourcing of relatively high-level processes of customers & Risk, Compliance and Transaction management solutions in the US housing market.
  • Transaction Processing: Claims processing, account opening & maintenance, data processing & management

Onsite Revenue accounted to 58% of revenue & offshore revenue is 42% for FY20.

Fixed price contracts accounted for 26% of revenue & Time and Material contracts revenue is 74% for FY20. Increase in Fixed price contracts revenue is important for margin expansion.

Partnerships

Till FY15, Mphasis had Services Agreement which made HP Companies to purchase services from Mphasis & its subsidiaries in accordance with the terms thereof.

HP business accounted for 26% of total revenue of FY16 which was 71% for FY10. The company had concentration risk with HP Business in earlier years.

Post acquisition by Blackstone, Mphasis’s revenue includes revenue from DXC/HP channel. As part of this agreement, HP & Blackstone agreed on the terms of a Master Services Agreement (MSA) for a period of five years, with an additional three automatic renewals of two years
each. Thus, HP committed a minimum revenue amount of $990 million over the next five years.

Now Mphasis has 4 revenue categories – Direct International Business, the HPE/DXC Channel, Blackstone Portfolio companies & New Business.

Direct International business accounts for 70% of total revenue & DXC/HP business accounts for 27% of the total revenue for FY20.

DXC/HP Relationship

In FY17, with new ownership of Mphasis, the company entered Master Services Agreement (MSA) for a period of 5 years. It further includes 3 automatic renewals. Under this MSA, HP committed a minimum revenue amount of $990 million over the next 5 years. Thus, the agreement goes till 2027.

The company is connected with HP channel fore more than 10 years. Thus, the management is confident on its further long term relationship as value-added partner. This is because Mphasis holds knowledge & deep understanding of those clients for their value addition.

As on 31 March 2020, $300 million TCV of deals remain pending under the MSA. The company characterizes the deals under the channel in different ways of working style, whether closely with clients or otherwise. But the clients remain of DXC/HP.

88% of revenue of DXC/HP business is from DXC.

Blackstone Portfolio

The company does not report the revenue from Blackstone portfolio separately. But, it is an important opportunity for growth. The management recognizes over 100 companies under Blackstone which can be opportunity of growth for Mphasis.

Blackstone companies is a growth driver for Mphasis.

Important Financial Parameters

(i) Net sales & Profit

mphasis research report with details of growth of net sales
mphasis research report with details of growth of PAT

(The period of March 2014 represents 5 months of operations till 31 March 2014, due to change in the financial year.)

Good growth factors: Revenue grew at CAGR of 9% from FY15 to FY20. Secondly, PAT grew at CAGR of 12% (FY15 to FY20).

  • The operating profit margin (EBITDA margin) is 20.67% in FY20.
  • PAT margin for FY20 is 13.40%.
  • The ROCE of 26% is quite good.

The margin & return ratios have remained stable over last 10 years.
Moreover, Dividend payout ratio remained above 45% since 2012.

(ii) Cash & Investments

mphasis research report with details of Cash & Bank
mphasis research report with details of Free Cash Flow
  • FCF/Sales of Mphasis is 14% for FY20. Ratio above 5% is considered good. It has remained positive for last 10 years.

(The period of March 2014 represents 5 months of operations till 31 March 2014, due to change in the financial year.)

Amount Returned to Investors

mphasis research report with details of amount returned to investors

Investments

Mphasis holds investments of Rs 1,326 crore as on 31 March 2020 in short term & long term financial assets. Company holds Cash & Investments of Rs. 2,451 crore as on 31 March 2020.

Growth of Business Segments

mphasis research report with details of growth in business segments
mphasis research report with details of growth in market segments

As a % of total revenue:

  • Direct International: 70%
  • DXC/HP Business: 27%
  • Others: 3%

Under Direct International business, Direct Core business forms 83% of the direct international revenue for FY20. The remaining includes Digital Risk business which is mortgage origination, refinance & home equity loan processing space. Digital Risk business depends of US interest rates environment. Currently, as interest rates fall, the mortgage volume & the refinance volume will actually go up. Thus, digital risk revenue expects to grow

FY16:

  • From FY16, Mphasis embarked focus for growth on Digital business & NextGen services. The company won deals with total contract value (TCV) of USD 303 million. Of this, 55% focused on Next Generation & Digital services.
  • During the year, the company exited domestic BPO business i.e. in India.
  • Revenue from HP channel continued to decline on account of ramp down by HP customers.
  • Banking, Capital Markets & Insurance grew 21.3% and 16.9% respectively over FY15. This growth is on account of growth in Direct Core & Digital Risk.

FY17:

  • The company got access to the portfolio of Blackstone companies. Also, new agreement brought greater visibility to the HP channel business.
  • Both Emerging Industries and ITCE impacted by exit of domestic BPO business.
  • The deal wins for FY17 amounted to $365 million with 61% of these in the areas of New Gen Services. In 4th quarter Mphasis signed first deal in Blackstone portfolio.
  • The digital risk revenue got negatively impacted due to unfavorable US interest rate environment.
  • In FY17, management gave EBIT margin guidance of 14-16%.

FY18:

  • Direct International deal wins rose to $551 million for FY18. 83% focused on Digital, Governance Risk & Compliance and NextGen Services.
  • Revenue from New Gen services grew by 39% for the year.
  • Moreover, growth triggered from Blackstone portfolio companies as well.
  • $158 million worth of deals signed under Blackstone portfolio.
  • The EBIT margin guidance rose to 15-17% (constant currency) after considering investments in IP assets as well as sales and marketing efforts.

FY19:

  • Mphasis achieved highest revenue growth in last 10 years.
  • Deals won amounted to TCV of $616 million. 79% of the same focused on New Gen services.
  • Due to large transformation deal win from DXC channel, resulted in increase in revenue by 32%.
  • 46% of the digital core revenue contributed by new gen services. Thus, New Gen services accounted for 27% of overall revenue.
  • Blackstone portfolio brought good growth in revenue, though not reported separately. Management gave rough estimate of 5% of digital core revenue.

FY20:

  • In the year 2020, Mphasis got the status of Premier Consulting Partner in the AWS Partner Network (APN) for Cloud & cognitive solutions to Amazon Web Services (AWS) platform.
  • Net TCV of new deals amounted to $715 million.
  • Europe region is another focus area for management. The same grew by 14% in FY20. Similarly the region is expected as growth driver for FY21.
  • Achieved 50% increase in proportion of revenues from large deals defined as $25 million or more of TCV. The same is driven by a surge in interest in digital transformation deals post the COVID crisis.
  • New Gen services now contributes 27% of overall revenue.
  • Around 88% of DXC/HP revenue is from DXC.
  • Ratio of revenue from fixed price contracts increased to 26% from 24% of revenue. Fixed Price contracts form important margin lever for Mphasis.

Cost Structure

mphasis research report with details of cost structure

The highest cost for an IT company is employee benefit expenses. Employee benefit expenses of Mphasis account to 56% of revenue for FY20. Selling expenses amount to Rs. 491 crore which is 5.2% of revenue for FY20.

Growth Opportunities & outlook

(i) Digital Business

Next-Gen Technologies such as Industrial Automation, Robotics & Drones, Cloud, Internet of things (IoT), Augmented & Virtual reality (AR/VR technologies), Big Data and Analytics, AI and Blockchain are the key technologies driving the digital transformation business.

Demand for Digital transformation of companies is expected to grow with COVID-19 situation.

From Industry perspective, India has become one of the major hubs of digital capabilities with around 75% of global digital talent present in the country. Digital transformation business expected to be over one-third of total business revenue (39%) in 2020, up 10% from 29% in 2017 as per Gartner.

Mphasis focuses on re-skilling the employees for engagements in digital transformation.

(ii) Ever Expanding Blackstone Portfolio

Management believes there are continued opportunities to the existing Blackstone client base as well as the ever-expanding Blackstone portfolio. The penetration into the channel is at initial stage as there are more than 100 companies under Blackstone. The Blackstone portfolio registered more than 50% growth in last 2 years. And further expects to leverage from the same.

(iii) Regional Expansion

Mphasis recognizes Europe as key focus area for expanding revenue. Europe region revenue grew approximately 14% in FY20 in constant currency terms. For FY21 as well, management considers it as growth driver. As per management, expanding non-US footprint is amongst main drivers for revenue growth in last 2 years.

(iv) Increasing ratio is Fixed Price Contracts

FIxed price contracts add to the annuity portion of revenue. These are major growth drivers for margins of the company. The management focuses on increasing the ratio of fixed price contracts revenue. Even in the remainder 72% of the business which is broadly classified as T&M, the company drives a fixed capacity bucket which stands at 15% of revenues as of FY20.

Risks/Concerns

(i) Geographical concentration: 78% of the revenue is from US with high percentage from North America. Plans for Europe market penetration expansion as well as other non-US markets expect to mitigate the Geography concern.

(ii) Some Doubts over visibility of MSA: Post FY21, the guaranteed amount portion of MSA ends. Although it has 3 automatic renewals, but the definite amount of contracts ends. This brings some level of doubt over the continued relationship & amount of deal wins post FY21 from the channel.

But at the same time, management has guided assurance for long term continued relationship based upon the fact that Mphasis is engaged with HP channel clients from over last 10 years.

(iii) Key Client Loss: Retention of important clients over long term in this competitive environment is a challenge recognized by the company. The revenue of many contracts is to some extent dependent on the value addition by Mphasis. Any key client loss may impact the revenue growth & margins.

Moreover, confidential soft information of clients with the company is to be effectively managed during transition phases when most of the work is to be done offshore locations. This is important factor specially in COVID-19 situation.

Valuation

As on 7 July 2020:

  • Current market cap of Mphasis is Rs 17,180 crore.
  • Cash & Investments as on 31 March 2020 amount to Rs. 2,451 crore.
  • Good Earning Yield: E/P = 7% & EBITDA/EV = 11%
  • P/E is 15 & excluding cash & investments, P/E is 12.
  • EV/EBITDA = 9
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Author: PA Wealth Advisors

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