edelweiss wealth research tech mahindra ltd

Edelweiss Wealth Research

Tech Mahindra Ltd.

Date: September 22, 2021

Sushil Sharma

Research Analyst

[email protected]


Tech Mahindra Ltd

Telecom turnaround to accelerate growth

1

Sushil Sharma

Research Analyst

[email protected]

CMP INR: 1,460

Rating: Tactical BUY

Target Price: INR 1670

Upside: 14%

Bloomberg: TECHM:IN

52-week

range (INR): 709 / 1493

Share in issue (mn): 886

M cap (INR mn): 1,40,800

Promoter

Holding (%) 35.73

Date: September 22, 2021

Tech Mahindra (TECHM), part of the Mahindra group, is one of India’s top-5 IT services

companies. Digitalization driven strong demand should sustain Enterprise segment’s

(ES) strong growth. While Communications segment (CS) was a laggard, 5G deals

momentum is picking up. This should enable quicker growth recovery in CS.

Hence, we expect TECHM to deliver 13% revenue CAGR over FY21-23E. Improved

execution engine for managing costs, targeting large deals, talent management, and

cash conversion should help margins and further reduce finance cost, resulting in 17%

PAT CAGR over the same period.

Further, TECHM’s R&D lab (Makers Lab) along with partners has applied for Covid-19

drug patent, which will undergo trials and development process over the next ~1.5

years. If successful, earnings upside may flow in from FY24E.

The stock is trading at 22.1x FY23E EPS. Recommend ‘Tactical Buy’ with a target price

of INR1,670.

Strategy has stabilised and paying off; focus on operations and organisation TECHM’s strategy is built around services/offerings. This enables platform-driven cloudification for digital transformation, which is now paying off. The company’s deal- win value increased to USD2.2bn in FY21 (v/s USD3.7bn in FY20 and USD1.7bn in FY19) and OPM expanded to 14.2% in FY21 (expected to further expand in FY22). To sustain growth recovery, the company is ramping up its execution engine by prioritising talent re-skilling, large deals, project deliveries, targeted M&As and better collections.

Growth set to accelerate Enterprise segment (ES) is TECHM’s main growth driver, delivering 9.7% revenue CAGR over FY16-21 (growth comparable with peers Infosys and TCS). Over the same period, Telecom (part of Communications segment, CS) revenue CAGR declined to 0.7%. However, we believe CS will increasingly come into play as 5G matures.

Enterprise segment’s (60% of revenues, includes all verticals except Communications) growth should sustain as (a) ES is contributing majority of the deal wins, and (b) 75-80% acquisitions are feeding ES.

Communications segment (40% of revenues) is turning around, which we believe will accelerate further as deal wins suggest gradual ending of the disconnect (between 5G OEMs reporting more and more deals but IT service providers not witnessing sustained major deals).

Potential real option from R&D (under TECHM’s Makers Lab R&D hub) TECHM has filed for a Covid-19 drug patent along with Bengaluru-based Reagene Biosciences. Trials are expected to start in 3-4 months and the whole development process may take up to ~1.5years. Management believes Makers Lab output may influence revenues of USD1bn in the coming years. Recommend ‘Tactical Buy’ with target price of INR1,670 The stock is currently trading at 22.1x FY23E EPS. Aided by Digital led strong demand and uptick in 5G deals, we expect TECHM to deliver 13% revenue CAGR over FY21-23E. Improved execution engine for targeting large deals, managing costs, and receivables should garner 17% PAT CAGR over the same period. Hence, we rate the company ‘Tactical Buy’ with target price of INR1,670.

(INR mn) FY20A FY21 FY22E FY23E

Revenue (INR) 3,68,677 3,78,551 4,22,601 4,71,282 Revenue Growth (%) 6.1% 2.7% 11.6% 11.5% EBITDA 57,261 68,470 81,029 88,394 EBITDA Margin (%) 15.5% 18.1% 19.2% 18.8% EPS 46 50 61 66 Diluted P/E (x) 36.1 31.8 28.8 22.1

EV/EBITDA (x) 22.7 19.0 16.1 14.7

RoE (%) 19.2 19 20.2 19.1

Edelweiss Wealth Research 2

Index Tech Mahindra Ltd

Table of Contents Page No.

Focus Charts ............................................................................................................................................................... 3

I. Growth strategy aligned with digitalisation demand .............................................................................................. 4

II. Communication segment turning around aided by 5G uptick ................................................................................ 6

III. Sustainable margins driven by operational efficiency initiatives .......................................................................... 9

Outlook and Valuation ................................................................................................................................................ 12

Financials ..................................................................................................................................................................... 13


Focus Charts

Tech Mahindra Ltd

Story in a Nutshell

Exhibit 1: Revenue and margin improving Exhibit 2: Enterprise segment’s main growth driver

Exhibit 3: Communication segment’s share in deal wins

higher than its share in revenues… Exhibit 4: …leading to pick-up in the segment’s revenue

growth, which is likely to sustain

Exhibit 5: Valuation multiples mostly track revenue growth, so P/E (x) may sustain

Source: Edelweiss Wealth Research

4,351 4,771 4,971 5,182 5,111

5,845

6,546

8%

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FY17 FY18 FY19 FY20 FY21 FY22E FY23E

USD

mn

Revenues (LHS) OPM (RHS)

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TECHM TelecomSegment

Enterprisesegment

Infosys TCS

5yr CAGR (FY16-21) 3yr CAGR (FY18-21) 2yr CAGR (FY19-21)

37%

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Investment Hypothesis

Tech Mahindra Ltd

I. Growth strategy aligned with digitalisation demand

TECHM is already seeing traction from its ‘NXT.Now’ strategy. It is aimed at enterprises to run their

IT systems better and change and grow their business faster by using TECHM’s tools/offerings kit

around four big bets – (a) cloudification, (b) platforms, (c) business efficiency, and (d) user

experience.

To fully exploit ‘NXT.Now’ strategy, TECHM is focused on sustainable execution that have the

following elements:

● Delivery and priority areas – right-sizing high potential geographies, embedding artificial

intelligence (AI) tools in delivery platforms, and right-sizing the employee pyramid,

● Account managers to be empowered client partners for digital sales capability and client

specific innovation,

● Focus on six key industry verticals along with seven key service lines that includes 5G, cloud

and analytics, cyber security, engineering services, business process services, and marketing

office functions.

Exhibit 6: Expect double-digit growth over FY22-23E…

Source: Company Data, Edelweiss Wealth Research *CME (Communications, Media & Entertainment)

As a result of ‘NXT.Now’ strategy’s successful execution, TECHM is seeing growth strengthen.

Further, revenue growth recovery is expected to sustain as the Communication segment (includes

Communications, Media & Entertainment industry i.e., CME) is turning the corner and aiding the

Enterprise segment (includes all industry verticals except CME), thus, boosting overall growth.

Exhibit 7: Expect double-digit growth over FY22-23E… Exhibit 8: …as quarterly growth is showing sustained

recovery

Source: Company Data, Edelweiss Wealth Research

4,351 4,771 4,971 5,182 5,111

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Tech Mahindra Ltd

Exhibit 9: According to last 12 months (LTM) data for each quarter (to smoothen quarterly

volatility), deal wins growth is directly feeding into revenue growth. Since demand scenario is

robust, deal wins, and hence, growth recovery should sustain…


Exhibit 10: …deal wins balanced between Communication and Enterprise segments...


-2%

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Communications Enterprise Total Value



Tech Mahindra Ltd

II. Communication segment turning around aided by 5G uptick

While TECHM’s Enterprise segment’s performance was in line with peers, overall growth was being

dragged by the Communications segment. With Telecom original equipment makers (OEMs)

reporting more and more 5G deals with Telecom service providers (TSPs) and IT service providers

(like TECHM) to TSPs not witnessing sustained major deals, there is a disconnect. However, we this

disconnect would gradually disappear in the future.

Exhibit 11: Enterprise segment’s growth comparable with peers

Exhibit 12: Overall growth dragged by Telecom

Source: Company, Edelweiss Wealth Research

Exhibit 13: However, Communications is showing definite signs of a turnaround. We believe this

will gain further strength as Telecom service providers (if not enterprises) are adopting 5G at a

quicker pace...


-2%

0%

2%

4%

6%

8%

10%

12%

TECHM TelecomSegment

Enterprisesegment

Infosys TCS

5yr CAGR (FY16-21) 3yr CAGR (FY18-21) 2yr CAGR (FY19-21)

-0.9% -0.7% -0.8%

5.2%

-4.1%

17.2% 19.1%

8.0%

3.6%0.6%

FY17 FY18 FY19 FY20 FY21

Communications Enterprise

440

480

520

560

600

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15%

Jun-19 Sep-19 Dec-19 Mar-20 Jun-20 Sep-20 Dec-20 Mar-21 Jun-21

(USD

mn

)

QoQ YoY Revenues (RHS)



Tech Mahindra Ltd

Exhibit 14: 5G deals have shot up over last two years… Exhibit 15: ...and balance is shifting in favour of 5G (v/s 4G)

Source: Company Data, Edelweiss Wealth Research. Omdia and 5G Americas, Sep 23, 3030

Over 2020-25, telecom network management services market is expected to move towards

network service 3.0, which is based on open architecture, is cloud native and AI driven. Therefore,

TECHM is positioning itself as a continuous integrator rather than a network system integrator.

Though 5G implementation has been delayed, Communication Service Providers (CSPs) are

spending on improving network management to cater to the higher data demand owing to

remote working/access. TECHM has developed products like netOps.ai (AI driven network

operation platform) and GAiA to reposition itself.

Exhibit 16: 5G deals have shot up over last two years


18

143

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Ericsson Nokia Huawei

5.76.0 6.0 5.9 5.7 5.5

0.20.6

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2.4

3.0

2020 2021 2022 2023 2024 2025

USD

Bill

ion

s

4G 5G



Tech Mahindra Ltd

Exhibit 17: 5G spending in other parts of the ecosystem should reflect in TECHM’s

Communication segment deal wins in CY22 (which is already up after dip in CY20)…


Exhibit 18: …thus, we believe Communication segment’s recovery is sustainable...


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QoQ (%) YoY (%) Revenues (US$ mn, RHS)



Tech Mahindra Ltd

III. Sustainable margins driven by operational efficiency initiatives

Operating margins are expected to expand to 15.8% in FY22 (v/s 14.2% in FY21), as TECHM

embarked on cost-focused operational efficiency initiatives in H2CY20. The company (a) deployed

~100 data analysts to comb through each line item for cost savings, (b) redesigned work processes

and structure for greater efficiency, and (c) integrated portfolio companies’ back-office and front-

office through shared services. These measures are now showing results, and therefore, past

volatility in margins is expected to subside.

Exhibit 19: Margins have improved; TECHM’s efforts towards achieving operational efficiency

should mitigate past margin volatility


Exhibit 20: Declining DSOs show operational efficiency efforts leading to improvement in quality

of growth


8%

10%

12%

14%

16%


OPM NPM

67

7773 75

62

93

106

99

107

87


DSO DSO including Unbilled



Tech Mahindra Ltd

Exhibit 21: Stronger growth, better margins and improved operational efficiency has resulted in

higher Free Cash Flows (FCF) and better cash conversion (FCF to PAT ratio) …


Exhibit 22: …enabling the company to increase shareholder pay out (reached 90% in FY21) …


95%

73%

87%92%

162%

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140%

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180%

0

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(IN

R M

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FCF (LHS) FCF/PAT (RHS)

914 14

35

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28%33% 29%

76%

90%

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Tech Mahindra Ltd

Exhibit 23: …without compromising on acquisitions/investments. TECHM completed acquisitions worth USD227mn in YTD

CY21

Date Acquired assets Competency area Value (USD mn)

Jun’21 Brainscale, USA Cloud transformation related IT services 29

Apr’21 Eventus Solutions, USA Business Process Services 44

Apr’21 DigitalOnUs, USA Cloud native & hybrid cloud automation 120

Mar’21 Perigord Asset Holding, Ireland Packaging supply chain solutions 25

Jan’21 Payments Technology Solutions Will give access to 2 IP's/products for Payments 9

Oct’20 Momentum Pty, Australia Cloud & engineering services with BFSI focus 10

Oct’20 Tenzing Group, New Zealand IT services in Insurance in ANZ region 29

Oct’20 VitalTech, Texas, US IT services in Health care 3

Feb’20 Zen3 Infosolutions (America) Inc. AI, machine learnings and Cloud 64

Jan’20 Cerium Systems Private Limited. VLSI and design systems 35

Nov’19 Born Group Pte Ltd. Digital content and production 95

Aug’19 MAD Pow Media Solutions LLC Experience and strategic design services 17

Jul’19 Objectwise Consulting Group Inc PEGA software implementation 2

May’19 Altiostar Networks Inc Open vRAN 114

Apr’19 Vitaran Electronics RFID-based asset monitoring 18

Mar’19 K-Vision Co Ltd Japan-based mobile network solutions 2

Feb’19 Dynacommerce Holding BV Customer experience 5

Sep’18 Inter-Informatics spol sro ER&D in Aero, rail, and Machinery 12

Jun’18 Tradeix Ltd Open platform for trade finance 16

Sep’17 Emagine International Pty Ltd

Jul’17 Pininfarina SpA Italy-based automotive design 9

May’17 CJS Solutions Group LLC/The 90

Jun’16 Bio Agency Digital, customer experience design 66

May’16 Target Group Financial services outsourcing 164

Jan’16 Advanced technology solutions

Dec’15 Pininfarina SpA Auto/Industrial Design 94

Jan’15 SOFGEN Holdings Ltd Geneva based consulting services in BFSI space 30

Nov’14 Lightbridge Communications Corp Network management services 240

Apr’14 FixStream Networks Inc Analytics 10



Outlook and Valuation Tech Mahindra Ltd

IV. Recommend ‘Tactical BUY’ with target price of INR1,670 (14% upside

potential)

At CMP of INR1,460, the stock is valued at 22.1x FY23E EPS. Aided by strong demand environment

and greater uptick in 5G deals, we expect TECHM’s growth recovery to strengthen and sustain,

leading to 13% revenue CAGR over FY21-23E. Operating leverage of growth along with an improved

execution engine (to manage costs, target large deals, talent management, and receivables) should

help margins and further reduce finance cost, resulting in 17% PAT CAGR over FY21-23E. Hence, we

recommend ‘Tactical BUY’ on the stock with a target price of INR1,670/share.

We have not factored in any real option value from some R&D activities like the Covid-19 drug

discovery (TECHM has filed patent along with Bengaluru-based Reagene Biosciences). Trials are

expected to start in 3-4 months and the whole development process may take up to ~1.5years.

Exhibit 24: Return ratios have bottomed out in FY20


Exhibit 25: TECHM’s valuation reasonable in broad-based demand upcycle Mcap Revenue (INR mn) PAT (INR mn) P/E (x)

(INR mn) FY20 FY21E FY22E FY23E FY20 FY21E FY22E FY23E FY21 FY22 FY23

TCS 1,41,69,000 15,69,490 16,41,770 18,58,274 20,26,186 3,24,470 3,42,850 3,90,945 4,38,636 41.3 36.2 32.3

Infosys 71,74,000 9,07,910 10,04,720 11,81,017 13,54,005 1,66,390 1,94,230 2,37,443 2,68,692 36.9 30.2 26.7

HCLT 34,31,000 706760.00 7,53,790 8,46,686 9,36,736 1,10,570 1,11,690 1,39,801 1,69,915 30.7 24.5 20.2

Wipro 36,31,000 6,10,151 6,20,574 6,75,588 7,26,583 97,718 1,08,680 1,23,459 1,28,350 33.4 29.4 28.3

TECHM 14,08,000 3,68,677 3,78,551 4,06,821 4,41,352 40,330 44,280 48,856 55,013 31.8 28.8 22.1


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Financials Tech Mahindra Ltd

Income Statement (INR mn)

Year to March FY20A FY21 FY22E FY23E

Total operating income 3,68,677 3,78,551 4,22,601 4,71,282

Gross profit 1,08,934 1,19,996 1,36,121 1,49,661

Employee costs 0 0 0 0

Other expenses 0 0 0 0

EBITDA 57,261 68,470 81,029 88,394

Depreciation 16,633 15,084 15,596 17,437

Less: Interest expense 1,919 1,740 3,897 4,688

Add: Other income 11,924 7,871 8,930 9,410

Profit before tax 50,633 59,517 70,466 75,678

Prov for tax 11,604 15,999 17,416 18,163

Less: Other adjustment 0 0 0 0

Reported profit 40,385 44,268 53,800 58,266

Less: Excp.item (net) 0 0 0 0

Adjusted profit 40,385 44,268 53,800 58,266

Diluted shares o/s 884 880 885 886

Adjusted diluted EPS 46 50 61 66

DPS (INR) 17 17 17 17

Tax rate (%) 22.9 26.9 24.7 24

Important Ratios (%)


Cost of revenues (%) 70.5 68.3 67.8 68.2

SG&A expenses (%) 14 13.6 13 13

Depreciation (%) 4.5 4 3.7 3.7

EBITDA margin (%) 15.5 18.1 19.2 18.8

Net profit margin (%) 11 11.7 12.7 12.4

Revenue Growth (% YoY) 6.1 2.7 11.6 11.5

EBITDA growth (% YoY) -9.6 19.6 18.3 9.1

Adj. profit growth (%) -7.6 9.6 21.5 8.3

Valuation Metrics


Diluted P/E (x) 36.1 31.8 28.8 22.1

Price/BV (x) 6.5 5.7 4.9 4.3

EV/EBITDA (x) 22.7 19.0 16.1 14.7

Dividend yield (%) 1.5 1.5 1.5 1.5


Financials Tech Mahindra Ltd

Balance Sheet (INR mn)


Share capital 4,359 4,370 4,370 4,370

Reserves 2,13,772 2,44,280 2,80,411 3,20,990

Shareholders funds 2,18,131 2,48,650 2,84,781 3,25,360

Minority interest 3,933 3,795 3,045 2,295

Borrowings 24,282 16,618 15,288 14,124

Trade payables 32,566 27,850 31,395 35,246

Other liabs & prov 54,196 59,965 65,962 72,558

Total liabilities 3,73,535 3,96,780 4,43,132 4,95,280

Net block 26,609 24,632 16,219 6,202

Intangible assets 60,667 64,662 66,937 69,212

Capital WIP 501 1,183 1,420 1,704

Total fixed assets 87,777 90,477 84,576 77,117

Non current inv 1,444 891 891 891

Cash/cash equivalent 86,290 1,23,523 1,72,528 2,32,739

Sundry debtors 75,772 64,728 78,731 87,800

Loans & advances 0 0 0 0

Other assets 1,22,252 1,17,161 1,06,407 96,732

Total assets 3,73,535 3,96,780 4,43,132 4,95,280

Free Cash Flow (INR mn)


Reported profit 40,385 44,268 53,800 58,266

Add: Depreciation 16,633 15,084 15,596 17,437

Interest (net of tax) -42,060 -45,034 -92,421 -1,07,824

Others 32,172 50,985 86,637 1,02,352

Less: Changes in WC -17,521 15,635 9,053 14,088

Operating cash flow 29,609 80,938 72,665 84,319

Less: Capex -13,773 -17,065 -9,695 -9,979

Free cash flow 15,836 63,873 62,970 74,341

Valuation Drivers


EPS growth (%) -6.4 10.1 20.9 8.2

RoE (%) 19.2 19 20.2 19.1

EBITDA growth (%) -9.6 19.6 18.3 9.1

Payout ratio (%) 37.3 33.9 28.1 25.9


15

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