Espirito-Santo-Securities MIdcap IT Initiations

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FUNDAMENTAL INSIGHT
India | Technology | Small & Mid Cap | 1-October-2012
Midcap IT Thematic
Don't discount the discount
Tier-II IT companies have found favour in the last 12 months, giving
an absolute return of 44% and outperforming the BSE-IT index by
24%. The bulls argue that owing to higher growth the discount to
Tier-I should narrow, but we argue that the valuation discount is less
correlated to the growth gap and more skewed towards the margin
gap and inherent risks. We are selective Buyers of companies which
have built competitive advantage, and enjoy entry barriers and
hence margin cushion, either due to real scale or dominance of a
niche. We prefer Persistent, Polaris, Tech Mahindra, MphasiS and
also KPIT Cummins, on which we are initiating coverage.
Extrapolation of growth is fraught with risks
The general investment argument we come across for Tier-II IT companies is
that growth can take care of everything. This is probably the reason some of
these Tier-II IT names have gone up 50-7O% YTD. Put can cn yar's growth
figures be extrapolated to conclude that the valuation discount to Tier-I IT
shculo narrcw? V ocn't think sc.
Commentary on growth has already started to moderate: While most of
the Tier-II companies started CY12 with a strong outlook on growth, as the
year has progressed management commentary on growth has moderated.
The recent additions to the list are MindTree and Infotech Enterprises,
who starto th yar xpcting tc bat N/SSCOM's targt c -14%
growth but both have scaled this back to meeting the NASSCOM target.
Discount has high correlation to margin gap: The discount of Tier-II IT to
Tier-I has been due to i) lower growth, ii) sustained lower margins and iii)
the highly acquisitive nature of midcaps as they seek to build scale and
add capabilities. Of these, lower margins have historically led to higher
discounts. Our analysis suggests that reducing the margin differential has
led to valuation discounts narrowing rather than closing the growth gap.
Prefer companies that have either niche or scale: For sustained growth
the underlying business should either stick to a niche or have genuine
scale, not get stuck in between. In our view this is the only way to gain
and maintain competitive advantage, margin cushion and higher barriers
to entry. We like TECHM as its size and scale now allow it to compete
more effectively. We like Persistent due to its niche in the OPD segment
and sheer organic growth capability and increased size of deals
suggesting growing trust among its client base. KPIT Cummins is the
addition to our list given its impeccable track record in integrating and
managing acquisitions and building scale in the right service offerings. Our
Buy on Polaris is premised on competitive advantage in the products
segment, and focus is coming back to drive margins in services.
Valuations: playing for sustained earnings growth
We remain wary of the theory that 4 to 6 quarters of high growth can result in
a lower discount to larger peers. Rather our picks are dependent on
sustainability of long-term earnings and FCF and ROE generation. We initiate
with a BUY on KPIT and reiterate BUYs on Persistent Systems, TECHM, Polaris
and MphasiS. We initiate with a NEUTRAL on MindTree and reiterate our SELL
on Hexaware.
Company (Ticker) Rating
Price Mkt Cap Fair Value
Polaris Software (POL IN) Buy
Rs130.15 Rs12,945.66m Rs197.00
Persistent Systems (PSYS IN) Buy
Rs413.35 Rs16,534.00m Rs498.95
MphasiS (MPHL IN) Buy
Rs390.00 Rs81,791.81m Rs433.00
Tech Mahindra (TECHM IN) Buy
Rs853.10 Rs108,794.65m Rs991.18
Hexaware Technologies
(HEXWIN)
Sell
Rs120.00 Rs35,441.53m Rs100.00
KPIT Cummins (KPIT IN) Buy
Rs123.80 Rs22,085.68m Rs140.00
MindTree (MTCL IN) Neutral
Rs661.65 Rs27,021.06m Rs710.00
Source: Espirito Santo Investment Bank Research, Company
Data, Bloomberg
Analysts
Soumitra Chatterjee
+91 22 4315 6829
soumitra.chatterjee@execution-noble.com
Execution Noble Ltd
Nitin Padmanabhan
+91 (0) 22 4315 6830
nitin.padmanabhan@execution-noble.com
Execution Noble Ltd
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Page 3 of 14
Contents
Relative Valuation Table 2
Mid-cap IT - discount to Tier-1's justified 4
Breaking midcaps into bucket of high performers 7
. the discount hasn't narrowed 7
Then why the noise around midcap IT stocks 7
Tier ll lT has hardIy gained any share . 8
. and it wiII need many more Iarge deaIs 8
But some Tier 2 stocks have remained strong 8
Commentary has started to moderate 9
Despite these negatives we have four BUY ideas 9
Corporate Governance Framework
11
Company Section:
KPIT Cummins Infosystems (Initiate with BUY) 13
Polaris Financial Technology (Reiterate BUY) 21
MphasiS (Reiterate BUY) 28
MindTree (Initiate with NEUTRAL) 34
Hexaware Technologies (Reiterate SELL) 40
Disclaimer 51
3
Page 4 of 14
Mid-cap IT - discount to Tier-1s justified
In the last 10 years, Tier-II IT companies have mostly traded at a discount to
Tier- I IT and that discount has widened. Mid-cap IT has cro gcco 'Sell'
candidates whenever this discount has been close to single digits. The
discount has widened from an average of 17% in the early part of the decade
to 37% in the last four years.
Figure 2 Valuation discount to Tier 1 IT has only widened since FY10
Source: Espirito Santo Investment Bank, Company Data, Bloomberg
Why should mid-cap IT trade at a discount?
We identify four key reasons: i) differential in growth, ii) EBIDTA margin
differential, iii) sustained lower margins and iv) highly acquisitive nature of
midcaps as they seek to build scale and add capabilities.
Differential in growth vs. Tier 1 IT: On a 3 year, 5 year, 10 year CAGR
comparison, we find that the differential in growth between Tier-I and Tier-II IT
has always existed. It has increased from 0% over a 10 year period to 6% over
a 3 year period. However based on the next two years expected CAGR the
differential is down to nil, largely driven by i) company specific issues leading
tc lcwr grcwth in lncsys & Viprc ano ii) incrganic ccntributicn tc KPlT's
revenues from the Systime acquisition. The differential would not have
reduced were it not for the acquisition led growth of mid-cap companies.
Figure 3 Expectations build a zero growth gap v/s Tier II Figure 4 Expectations are based on consensus and our estimates
Source: Espirito Santo Investment Bank Source: Espirito Santo Investment Bank
Sustained lower margins vs. Tier-1: Lower margins vs. Tier-1s have historically
led to higher discounts. Figure 4 below indicates how a reducing margin
differential has led to lower valuation discounts in the past and vice versa.
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
0
5
10
15
20
25
30
FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13E
P/E (Tier-I IT) P/E (Tier-II IT) Val discount
Companies 10YR CAGR % 5YR CAGR % 3YR CAGR % Next 2YR CAGR%
TCS 29% 16% 27% 13%
Infosys 28% 14% 21% 10%
Wipro 25% 13% 16% 9%
HCL Tech 29% 22% 24% 17%
Tier - I 28% 15% 22% 12%
OP with Tier-II 0% 3% 6% 0%
KPIT 39% 21% 43% 23%
Hexaware 22% 5% 20% 15%
Infotech 29% 18% 27% 13%
Polaris FT 19% 12% 23% 15%
Mindtree 42% 21% 21% 11%
Persistent 40% 19% 28% 15%
Mphasis 33% 17% 13% 6%
Tech Mahindra 28% 5% 8% 10%
Rolta 23% 8% 5% 4%
Tier - II 28% 12% 16% 12%
4
Page 5 of 14
Figure 5 Widening margins have led to increasing valuation discount and vice versa
Source: Espirito Santo Investment Bank
The margin gap will remain or widen as:
Without scale or niche Tier-ll become 'me too' vendors: Lt's tak
the example of TCS with revenue of >$10bn and growing at 10%. This
means TCS will add incremental $1bn every year to its revenues. Any
pure play services company with revenue lower than $1bn becomes
largly a 'm tcc' vnocr as any vrtical cr srvic lin cr gcgraphy
of TCS is bigger than the entire revenue base of any Tier-II IT
company in India. In such a scenario TCS or any other Tier-I IT vendor
would be able to compete more effectively and manage the account
specific margins better even if pricing were to fall (read commodity
offerings), but for smaller players that would be difficult.
Figure 6 TCS' revenues from key verticals Figure 7 Total revenues of Tier-II IT companies
Source: Espirito Santo Investment Bank Research, Company Data Source: Espirito Santo Investment Bank Research, Company Data
Lower SG&A leverage: The lower margin profiles can largely be
attributed to lower scale benefits vs. Tier-1s. SG&A expenses on an
average are 5pp higher than Tier-1s.
Figure 8 SG&A expenses of Tier-II IT Figure 9 SG&A expenses of Tier-II IT
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
-60%
-40%
-20%
0%
20%
40%
FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13E FY14E
Val discount (LHS) EBIDTA% GAP - Tier2 v/s Tier 1 (RHS) Average margin gap in last decade
TCS Revenues ($m)
BFSI 4,509
Telecom 1,075
Manufacturing 1,447
Retail 1,315
Lifesciences & healthcare 556
Transportation 393
Energy & utilities 413
Others 551
Total 10,259
Company Revenue ($m)
KPIT 313
Hexaware 311
Infotech 324
Polaris FT 429
Persistent 209
Mindtree 400
Mphasis 1,119
Tech Mahindra 1,146
Rolta 364
Midcap IT SG&A as % of sales
KPIT 20%
Hexaware 17%
Infotech 17%
Polaris FT 19%
Mindtree 20%
Persistent 19%
Tech Mahindra 16%
Mphasis Not comparable
Rolta Not comparable
Average SG&A% 18%
Tier-1 SG&A as % of sales
TCS Not comparabl e
Infosys 12%
Wipro 12%
HCLT 14%
Average SG&A% 13%
5
Page 6 of 14
The SG&A gap of 5pp will continue to remain or widen in the worst case as the
revenue per client for most Tier-II IT companies ranges between $0.7m to
$2.0m. This is significantly lower when compared with $10m for Infosys and
TCS. To drive incremental growth, sales and marketing efforts have to be
increased which indicates lower leverage from SG&A as a margin lever.
Figure 10 Revenue per client of Tier-II IT
Source: Espirito Santo Investment Bank Research, Company Data
Mid-caps have been highly acquisitive: Almost all the nine companies within
our basket of mid-caps have been very acquisitive and have made significant
acquisitions relative to their revenue profile over the last decade. These
acquisitions were made to increase scale, build capabilities and gain access to
newer geographies. Four of the companies below have made at least one
acquisition representing c.50% of their revenues or more during the decade.
Four have made acquisitions >15% of their revenues.
Figure 11 Midcaps - risk takers with large acquisitions
Hence mid-caps bring with them significantly higher risk profiles vs. Tier-1s.
Moreover growth rates of Tier-1s over a 10 year period have been similar
despite no aggressive acquisitions, HCL Tech being the only exception having
acquired Axon (>15% of HCL Tech's revenues then).
Persistent Systems - the only non-acquisitive high performer: Amongst the
Tier-II IT companies mentioned above there have been few companies that
have grown faster than Tier-I IT, but this has largely been driven by
acquisitions, except for Persistent Systems, which has grown at 40% CAGR
organically over the last decade. While Persistent acquired Infospectrum,
which had a revenue run rate of $6m at the time of takeover (3.5% of revenues
at the time of acquisition), the revenue run rate of $6m never materialised in
full as the largest client of Infospectrum moved to HCL Tech post the
acquisition. Even if we remove the acquired revenues of Infospectrum, the
revenue CAGR of Persistent still remains over 39%.
Figure 12 Acquisitions by Tier-II IT companies (Only companies that have grown at higher than 10 year CAGR recorded by Tier-I IT considered)
Company Revenue ($ m) Number of clients Revenue per client ($ m)
KPIT 313 172 1.8
Hexaware 311 210 1.5
Polaris FT 429 267 1.6
Persistent 209 291 0.7
Mindtree 400 258 1.5
Mphasis 1,119 275 4.1
Tech Mahindra 1,146 131 8.7
Company Acquisitions No. of acquisitionsSignificant >15% of revenues
Hexaware Focus frame 1 1
Infotech enterprises Vargis, Tele Atlas, Geospatial integrated Solns, Time to market inc, TTM India, Integrated device technology, Daxcon, Wellsco 7 2
KPIT Cummins Infotech, Panex, Solv Central, Pivolis, CG Smith, Harita TVS, Sparta, In2Soft, CPG, Systime, 10 3
Mindtree Linc software, Aztecsoft, Kyocera, 7Strata 4 1
Mphasis Onida Infotech, Msource, Kshema Technologies Ltd, Princeton consulting, Eldorado computing, AIG captive, Fortify, Wyde 8 1
Polaris iBackoffice.com, Orbitech, Seec Inc, Laser soft, IdenTrust, Indigo Tx 5 1
Rolta Orion, Broech Corp, WhittmanHart consulting, Piocon Tech, One GIS, ACLS systems 6 1
Tech Mahindra Axes technologies, iPolicy Networks, Jataayu Software, Servista, Satyam, Hutchison Global Services, Comviva 7 2
Persistent Infospectrum 1 0
Companies 10YR revenue CAGR How the growth has come
Mindtree 42% Acquired Aztecsoft and Kyocera Wireless
Persistent 40% The only Tier-II IT company that has grown 40% CAGR that too organically.
KPIT 39% Acquired Systime, CPG, In2Soft, Sparta Cosnulting, Harita TVS, CG Smith, Pivolis, Solv Central, Panex Consulting and Cummins Infotech
Mphasis 33% Benefitted immensely due to acquistion of EDS by HP
Infotech 29% Acquired Daxcon Engineering and Wellsco and many smaller companies
6
Page 7 of 14
Breaking midcaps into bucket for high performers
We break the midcap bucket based on revenue growth expectations for FY13
- the key criteria being above, or below or within the NASSCOM growth
estimate range of 11-14% for the industry.
High growth bucket: We include Persistent Systems, KPIT Cummins,
Hexaware, Polaris and Infotech Enterprises as we (consensus for
Infotech Enterprises) expect them to beat the NASSCOM estimates of
11-14% growth in FY13.
Moderate to low growth bucket: MindTree, Tech Mahindra, Rolta and
MphasiS as we expect them to meet or miss the NASSCOM estimates
of 11-14% growth in FY13.
Figure 13 Tier-1 IT growth trends Figure 14 High growth bucket Figure 15 Moderate - low growth bucket
Source: Espirito Santo Investment Bank Source: Espirito Santo Investment Bank Source: Espirito Santo Investment Bank
.the discount hasn't narrowed
Despite higher growth than Tier-I IT over 3, 5 and 10 year periods in the
expected high growth bucket, the valuation discount has not really narrowed,
as the margin gap has remained the same.
Figure 16 Widening valuation discount (High growth Tier 2 v/s Tier 1) Figure 17 on increasing margin gap (High growth Tier 2 v/s Tier 1)
This has happened as investors continue to remain concerned on these
ccmpanis' ability tc crganically scal up and manage margins. Additionally,
consensus expectations of margins for FY14 indicate that the margin gap will
only widen as shown in figure 4. The valuation discount has historically
increased when the margin gap has increased.
Then why the noise around mid-cap IT stocks?
In the last year mid cap IT companies have given an absolute return of 44%
and have outperformed the BSE-IT Index by 24% on an average. This has
largely happened as select mid cap stocks have been in a constant upgrade
cycle.
TCS 29% 16% 27% 13%
Infosys 28% 14% 21% 10%
Wipro 25% 13% 16% 9%
HCL Tech 29% 22% 24% 17%
Tier - I 28% 15% 22% 12%
OP with Tier-II 0% 3% 6% 0%
KPIT 39% 21% 43% 23%
Hexaware 22% 5% 20% 15%
Infotech 29% 18% 27% 13%
Polaris FT 19% 12% 23% 15%
Persistent 40% 19% 28% 15%
Average 30% 15% 28% 16%
OP with Tier-I 2% 0% 6% 4%
MindTree 42% 21% 21% 11%
Mphasis 33% 17% 13% 6%
Tech Mahindra 28% 5% 8% 10%
Rolta 23% 8% 5% 4%
Average 31% 13% 12% 8%
OP with Tier-I 3% -2% -10% -5%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
0
5
10
15
20
25
30
35
P/E (Tier-I IT) P/E (Tier-II IT) Val discount
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
0%
5%
10%
15%
20%
25%
30%
EBITDA (Tier-I) EBITDA (Tier-II) GAP (RHS)
7
Page 8 of 14
Figure 18 Calender year wise absolute return from stocks Figure 19 Absolute and relative performance of Tier-II IT in last 1 year
Source: Espirito Santo Investment Bank, Bloomberg Source: KPIT Cummins, on which we are initiating coverage,
However, tier-II IT has hardly gained any share
NASSCOM data on worldwide IT spending and aggregate of revenues of Tier-I
and Tier-II IT suggest that the market share gains in Tier-II IT have been tepid
in last 7 years. In fact there have been no market share gains by Tier-II IT in the
last 4 years.
Table 1 Market share gains of Tier-I and Tier-II IT
Source: Espirito Santo Investment Bank, NASSCOM
And it will need many more large deals
While we agree that the number of deal announcements by Tier-II IT
companies has increased, there is a general sense on the street that the deal
sizes have also increased in the Tier-II IT space which should help them to post
high growth. While on absolute terms the deal sizes may look big, it has to be
seen on the current base over which it is going to add to revenues. Here we
find that on a percentage of revenue basis it has reduced, i.e. to post similar
growth these companies will have to win more deals given the current base.
Figure 20 Hexaware deals in CY02, 11 &12 Figure 21 MindTree deals in CY02, 11 &12
Source: Espirito Santo Investment Bank, Company Data Source: Espirito Santo Investment Bank, Compnay Data
But some tier-II stocks have remained strong
In our view, the street in largely divided about the growth expectations of
different companies and has divided them into two groups. The first group
consists of companies such as TCS, Cognizant, HCLT, Hexaware, KPIT
Cummins, MindTree and Infotech Enterprises. TPI data in Q4CY11 also fuelled
expectations of high growth from Tier-II IT firms when it mentioned that
number of contracts in the smallest band, $25 to $99M in TCV, have taken off
as shown in figure below.
Companies CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11 CY12YTD
Infosys Ltd. 17% 17% 50% 44% 50% -21% -37% 133% 32% -20% -6%
Tata Consultancy Services Ltd. 35% 27% 43% -11% -56% 214% 55% 0% 11%
Wipro Ltd. 2% 7% 29% 24% 30% -13% -56% 191% 20% -19% -5%
HCL Technologies Ltd. -32% 64% 12% 57% 20% 2% -65% 222% 23% -15% 44%
Tech Mahindra Ltd. 202% -32% -78% 300% -29% -18% 59%
MphasiS Ltd. 130% 89% -35% 16% 95% -7% -51% 349% -6% -49% 31%
Infotech Enterprises Ltd. 6% -8% -2% 182% 82% -3% -67% 193% 13% -37% 77%
Hexaware Technologies Ltd. 64% 255% 45% 9% 52% -57% -76% 349% 23% 29% 66%
Persistent Systems Ltd. 5% -24% 28%
Polaris Financial Technology Ltd -11% 37% -30% -23% 31% -27% -66% 330% -5% -29% 9%
KPIT Cummins Infosystems Ltd. 275% 88% 101% 16% 85% -4% -80% 368% 14% 1% 75%
MindTree Ltd. -19% -53% 194% -20% -29% 73%
Rolta India Ltd. -19% 22% -28% 153% 24% 182% -68% 68% -21% -64% 32%
$mn % % % % % %
Stocks Mkt Cap 1 M 3 M 6 M 1 Year 3 Year 5 Year
Infosys Ltd. 29,685 6% 5% -9% 11% 14% 47%
Tata Consultancy Services Ltd. 50,747 -2% 5% 9% 31% 116% 158%
Wipro Ltd. 18,675 4% -5% -11% 12% 9% 43%
HCL Technologies Ltd. 7,868 2% 20% 17% 46% 64% 104%
Tier- I Average 2% 6% 2% 25% 51% 88%
Tech Mahindra Ltd. 2,383 7% 36% 27% 49% 5% -26%
MphasiS Ltd. 1,681 6% 13% -5% 20% -38% 44%
Infotech Enterprises Ltd. 432 8% 28% 30% 67% 54% 43%
Hexaware Technologies Ltd. 748 2% 1% 11% 70% 238% 105%
Persistent Systems Ltd. 330 9% 8% 27% 37%
Polaris Financial Technology Ltd 269 8% 11% -20% 6% -11% 19%
KPIT Cummins Infosystems Ltd. 451 -2% 10% 56% 68% 236% 113%
MindTree Ltd. 560 -1% 14% 43% 96% 17% 32%
Rolta India Ltd. 238 9% -1% -22% -21% -58% -74%
Tier- II Average 5% 13% 16% 44% 55% 32%
BSE-IT 3% 6% -1% 19% 35% 28%
Tier- I Average outperformance to BSE-IT 0% 0% 2% 6% 16% 59%
Tier- II Average outperformance to BSE-IT 2% 7% 17% 24% 20% 4%
Forecast FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
Worldwide Spend 583 629 641 672 701 718 722 761
Market Share of Indian IT 3% 4% 5% 6% 7% 7% 8% 9%
Market share Gain - bp 71 119 114 69 20 125 91
Indian IT Exports 18 24 32 41 48 50 59 69
Tier-I as a % of Indian IT 38% 37% 40% 43% 42% 43% 46% 48%
Market share Gain - bp (29) 271 289 (88) 84 349 170
Tier-I Revenues 7 9 13 18 20 22 28 33
Tier-II as a % of Indian IT 5% 5% 6% 7% 7% 7% 7% 7%
Market share Gain - bp (16) 109 75 (9) (23) 20 (41)
Tier-II Revenues 971 1,257 2,035 2,933 3,364 3,432 4,187 4,614
($ m) 2002 2011 2012
TCV 32 100 100
Duration (yrs) 5 5 4
ACV 6 20 25
Revenue 51 308 370
% of revenue 13% 6% 7%
($ m) 2008 2011
TCV 30 35
Duration (yrs) 5 5
ACV 6 7
Revenue 184 331
% of revenue 3% 2%
8
Page 9 of 14
Figure 22 TPI data in Q4CY11 showing increase in number of smaller contracts
Source: TPI
But things have changed since then and the data from TPI in the last two
quarters (i.e. H1CY12) suggests that there is no material improvement in deal
counts or deal value. Moreover most Tier 2s have seen growth largely from
their existing top 10 clients.
Figure 23 Nos of contracts (TCV $25-$99m) Figure 24 Nos of contracts (TCV $100m+) Figure 25 Value of contracts awarded ($bn)
Source: TPI Source: TPI Source: TPI
Commentary has started to moderate
While most of the Tier-II companies started CY12 with a strong outlook on
growth, as the year has progressed commentary has moderated, most
recently with MindTree and Infotech Enterprises scaling back expectations
from bating N/SSCOM's 11-14% growth earlier in the year to now meeting it.
Despite these negatives we have 4 buy ideas
So how do we pick mid-caps for medium to long-term investment? We
recommend a barbell strategy: focus either on companies that are highly
competitive or dominant in a niche segment, meaning higher entry barriers
and ability to build competitive advantage, or focus on companies with real
scale. Avoid companies caught in the middle, with neither scale nor
dominance of any niche. Our preferred plays in each category are:
Play on scale: There are few firms in this category as it requires adequate
scale to be competitive in capability terms with the goliaths. Tech Mahindra is
our top pick in this category.
Niche play: We like Persistent Systems due to its strong organic growth
capability and increased size of deals which vindicates how trust is growing
with its clients. We remain positive on Polaris Financial Technology as it
continues to grow higher margin product revenues, whilst also improving its
margin focus in the services segment. lt isn't yt gtting th croit it osrvs
for improved disclosure levels and further improvement in this, especially on
products side, is feasible.
0
100
200
300
400
500
600
700
CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11
$25-$99m $100-$999m $1bn+
231
291 286
404
277
250
327
308
366
0
100
200
300
400
500
600
700
800
900
CY08 CY09 CY10 CY11 CY12
H1 H2
116 115
124
111
96
111
130
99
113
0
50
100
150
200
250
300
H1 H2
40.7
49.0
42.5
51.1
45.1
41.4
45.4
42.9
52.9
43.8 57.2
0
20
40
60
80
100
120
CY07 CY08 CY09 CY10 CY11 CY12
H1 H2
9
Page 10 of 14
Niche and scalable: The only addition to our list is KPIT Cummins given its
track record in integrating and managing acquisitions, which we would rate as
impeccable, and its success in building scale in the right service offerings.
Figure 26 Key Picks
Source: Espirito Santo Investment Bank Research
Company Key argument
KPIT Cummins Revenue CAGR of 42% in last 10 years
Organic revenue CAGR of 24% since 2006, only next to Persistent
Last decade margins have averaged at 16% and have consiously invested the incremental margins into building scale and new
service offerings thereby leading to consistent high growth
Impressive track record of beating guidance which is a rarity amongst mid cap companies
Persistent Systems Only mid cap IT company to have grown from $10m to $210m in last 10 years organically. CAGR of 40% in last 10 years
Average deal sizes are increasing which was unheard of in OPD business and is a key differentiator and only indicates the level of
trust and confidence created in minds of the clients
Last decade margins have averaged at 26% which is best in Tier-II pack and has the lowest margin differntial to Tier- I IT
Impressive operating and free cash flow profile
Tech Mahindra Successfully derisked the business away from BT. Seeing significant traction in large deal flow.
Have recently signed two large deals which will drive organic growth
Successfully pulled of the biggest IT acquistion in the India history and is leveraging it to scale to newer verticals
Polaris FT Have scaled up banking software products business from nil to $100m in last 6 years
Currently spends 21% of product revenues on R&D which over time should reduce to industry average of 10%. Still make 25%
margin on products
Have signed two large deals in the services segment which is expected to drive growth in H2FY13
Focussed on improving margins in the near term by broadning the employee pyramid and moving resource to offshore locations
10
Page 11 of 14
Corporate Governance Framework
Figure 27 Corporate Governance Framework
Larger Companies
Overall
Rating
Infosys GREEN GREEN GREEN GREEN GREEN
/nfosys consistency and conservatism with its accounting policies are well
known. Disclosures are also best in the industry. Amongst the 30 metrics
that we have, Infosys scores Green in 28 of those
Tata Consultancy Services GREEN GREEN GREEN GREEN GREEN
TCS has also been consistent and conservative with its accounting policies
and disclosures. Amongst the 30 metrics that we have, Infosys scores Green
in 27 of those.
Wipro GREEN GREEN GREEN GREEN GREEN
Like its peers, Wipros accounting policies and practices have also been
consistent. Amongst the 30 metrics that we have, Infosys scores Green in 28
of those.
HCL Tech GREEN GREEN GREEN GREEN GREEN
HCL Tech performs well on almost all of our accounting and auditing
checks. The promoter background has largely remained clean and the stake
salo by tho holoing company was for tho promotors philanthropic purposos.
Tech Mahindra GREEN GREEN GREEN AMBER AMBER
The amortisation of one-time refund of upfront cost savings as revenues
and an option with AT&T to acquire an 8% stake in Tech Mahindra at 1/5 of
market price (without any lock-in period) should have been disclosed in
both Tech Mahindra's and Mahindra and Mahindra's annual reports. We
give an AMBER light.
Smaller Companies
Overall
Rating
Polaris Financial Technology GREEN RED GREEN AMBER AMBER
Polaris performs fairly well on most of our accounting checks. However, a
lack of proper disclosure of product revenues and margins on a consistent
and quarterly basis, plus disclosure of licenses, implementation and AMC on
a consistent basis, are a few of the parameters where we believe Polaris
needs to improve. We give a green light on accounting and auditing and
promoter background and insider trading. While most of the metrics in
board and management have a Green or Amber rating, a relatively high
proportion of loans to related parties turns our overall rating of board,
management and related parties to Red and therefore our overall rating on
corporate governance changes to AMBER.
Hexaware Technology GREEN RED GREEN AMBER AMBER
Hexaware performs reasonably well on most of our accounting checks.
However, the forex fiasco in Q42007 and reconstruction agreement
between Apple Finance (promoted by Atul Nishar) and Aptech, wherein
shareholders of Apple Finance were allotted shares of the company at no
cost, are among the key reasons for the Amber rating. Relatively high
remuneration to directors on an absolute basis and relative to peers and
high YoY growth in remuneration paid to directors gives a Red light on
board, management and related parties.
KPIT Cummins GREEN GREEN GREEN GREEN GREEN
KPIT has had a successful track record of giving guidance and outperfoming
on that. Accounting and auditing checks too reveal no discrepency and
promoter back ground has been pretty clear.
Persistent Systems GREEN GREEN GREEN GREEN GREEN
Persistent scores well on almost all of our accounting and auditing checks.
The promoter background is also clean and in its short time as a listed
company, we know of no untoward event that might prejudice minority
shareholders. We give a GREEN light.
MindTree GREEN AMBER GREEN AMBER AMBER
MindTree has missed guidance on more than one occasion and guidance
giving procedure was aggressive which was later withdrawn due to lack of
visibility on business. Its unsuccessful venture on developing white label
handsets only to be later discontinued had cost minority shareholders
dearly.
MphasiS GREEN AMBER GREEN AMBER AMBER
Accounting policies are not an issue with MphasiS, but governance policies
are especially after Q4FY11 quartors results. Whilst we give a RED light to
attitude towards minority investors due to HP's attitude, MphasiS scores
Amber on other minority shareholders parameters like guidance to market
and disclosure of key news to minority shareholders and so the overall rating
thus remains AMBER.
Comments Company Accounting & auditing
Board, mgmt and related
parties
Promoter background &
insider trading
Attitude towards minority
investors
Comments Company Accounting & auditing
Board, mgmt and related
parties
Promoter background &
insider trading
Attitude towards minority
investors
11
Page 12 of 14
Valuation Methodology
DCF is our preferred method for valuation as:
Growth and margins can be relatively easily forecasted and
Companies generate free cash and declare c.20% of earnings as
dividends.
While select Tier-II IT companies have risen 50-70% YTD, our picks are
dependent on sustainability of long term earnings and sustainable FCF and
ROE generation.
Figure 28 Cash flow from operations as % of EBITDA Figure 29 Free cash flow as % of PAT
Risks to Fair Value
Please visit our website at www.EspiritoSantoIB-Research.com for up to date recommendation charts.
Average
Consolidated FY06 FY07 FY08 FY09 FY10 FY11 FY12 7 years
Infosys 82% 87% 88% 88% 90% 66% 76% 108%
TCS 68% 67% 66% 76% 86% 63% 51% 89%
Wipro 81% 88% 60% 73% 90% 70% 67% 99%
HCL Tech 82% 90% 89% 58% 94% 72% 71% 104%
Average Tier-I 78% 83% 76% 74% 90% 68% 66% 76%
MphasiS 86% 58% 25% 95% 70% 91% 80% 111%
Tech Mahindra 32% -39% -5% 66% 79% 46% 68% 54%
Persistent Systems 80% 107% 108% 41% 109% 100% 70% 135%
Rolta 63% 83% 97% 75% 65% 96% 75% 122%
MindTree 50% 77% 76% 51% 95% 28% 74% 99%
KPIT Cummins -40% 114% 51% 67% 65% 36% 46% 74%
Polaris Software Lab 104% 34% 71% 104% 114% 47% -4% 103%
Hexaware Technologies 63% 89% 96% 56% 75% 13% 64% 100%
Average Tier-II 55% 65% 65% 69% 84% 57% 59% 65%
CFO as a % of EBITDA Average
Consolidated FY06 FY07 FY08 FY09 FY10 FY11 FY12 7 years
Infosys 59% 60% 60% 70% 81% 52% 79% 103%
TCS 63% 53% 53% 82% 92% 57% 52% 101%
Wipro 61% 58% 29% 53% 92% 64% 61% 94%
HCL Tech 56% 53% 80% 40% 93% 60% 71% 102%
Average Tier-I 60% 56% 55% 61% 90% 58% 66% 64%
MphasiS 58% 14% 8% 101% 73% 85% 179%
Tech Mahindra 45% -24% -5% 97% 128% 33% 32% 139%
Persistent Systems -126% 42% 58% 35% 102% 52% 10% 79%
Rolta -18% -16% -15% -131% -35% 73% 64% -35%
MindTree 33% 28% -120% 242% 87% -34% 78% 142%
KPIT Cummins -206% -31% 1% 100% 97% 8% 27% -2%
Polaris Software Lab 40% 22% 68% 167% 154% 13% -71% 178%
Hexaware Technologies 49% 47% 119% -59% 101% 2% 39% 134%
Average Tier-II -16% 10% 14% 69% 88% 29% 25% 32%
FCF as a % of PAT
12
FOR IMPORTANT DISCLOSURE INFORMATION, INCLUDING DISCLOSURES RELATED TO THE U.S. DISTRIBUTOR OF THIS REPORT, PLEASE REFER TO THE FINAL PAGES OF
FUNDAMENTAL INSIGHT
KPIT Cummins
Niche, scalable and shaped for growth
KPIT Cummins is the only Indian midcap IT services company with a
very wide services portfolio focussed on the automotive,
manufacturing, energy and utilities verticals. It has filed over 40
patents, which makes it a unique play within the midcap IT space.
The performance through the last decade has also been impressive -
40% revenue CAGR and 43% PAT CAGR. While KPIT has acquired
much of its services capabilities, it has been very successful with all
the acquired companies, growing them at an average CAGR of 30%
since acquisition. As recently acquired entities scale up margins, we
see this as a significant buffer to current margins should the INR to
appreciate. We initiate with a fair value of Rs140 and a BUY.
A fair balance of risk and reward
KPIT has delivered a stock return of 30% CAGR in the last 10 years. Can KPIT
continue to deliver such returns in the future? We think so.
A unique DNA: KPIT is the only mid-tier IT that has successfully
mastered the art of acquisitions. KPIT's margins cvr th last ocao
have averaged at 16% - a very conscious strategy to reinvest
incremental margins in creating a strong front and back end to remain
relevant with clients. It understands that strong organic growth is a
pre-requisite to be able to successfully absorb acquired entities
(organically grown at a CAGR of 28% since FY06), quite unlike most
companies which acquire when there is a deceleration in growth.
Significant room for sustained high growth: KPIT guided for 32-35%
USD revenue growth in FY13 and organic revenue growth of 21-24%. It
has built scale across its services (Systime is among the top 12
partners for Oracle in JD Edwards; SAP a US$125m practice; auto &
engineering c.US$100m). Post two large acquisitions in the last three
years (Sparta, an SAP services company and Systime, an Oracle
services company), KPIT has been able to target and win large deals;
it won a total of US$210m in deals in FY12 (highest ever in a year).
Not without risk - management crucial: KPIT has successfully
acquired and integrated ten businesses to date. The scale up by these
acquired entities has been impressive (ave. 30% CAGR post acq.).
However Systim's payback by FY6 is ccntingnt on a 20% annual
growth rate and at least 15% margins from FY14. More acquisitions
and debt cannot be ruled out as it works towards target revenues of
US$1bn by FY17. Managmnt's ability tc uickly improve margins of
the acquired entities and time the next acquisition when the business
is ready to digest another target is crucial. KPIT has successfully done
this in the past and has a very clear acquisition philosophy, thereby
driving our faith in the stock.
Valuation:
/ highly succssul managmnt ano cpticn valu rcm Rvlc, KPlT's hybrio
engine venture, drives our BUY rating on the stock. The management has
consistently delivered in the past and the stock has delivered a positive return
in 7 of the last 10 years - 30% CAGR over the past decade. The stock currently
trades on a FY14E PER of 8.8. We initiate with a BUY and a FV of Rs140.
Accounting & corporate governance GREEN
Franchise Strength GREEN
Earnings Momentum GREEN
BUY
13% upside
Fair Value Rs140.00
Bloomberg ticker KPIT IN
Share Price Rs123.80
Market Capitalisation Rs22,085.68m
Free Float 74%
INR m Y/E 31-Mar 2011A 2012A 2013E 2014E
Revenue 10120 15000 22379 25106
EBITDA 1522 2181 3522 4026
EBIT 1111 1736 3053 3490
Pre Tax Profit 1103 1786 3003 3451
Net Income 948 1454 2156 2543
EPS 5 8 12 14
Free Cash Flow 221 396 2170 2149
Y/E 31-Mar 2011A 2012A 2013E 2014E
P/E 23.7 15.4 10.4 8.8
EV / Sales 2.1 1.5 1.0 0.9
EV / EBITDA 13.7 10.4 6.2 5.3
EV / EBIT 18.7 13.0 7.1 6.1
FCF Yield 1% 1% 9% 9%
Dividend yield 1% 1% 1% 1%
Data, Bloomberg
80
100
120
140
160
180
200
Oct 2011 Jan 2012 Apr 2012 Jul 2012 Oct 2012
KPIT IN vs BSE500 Index
Share Price Performance
Analysts
Nitin Padmanabhan
+91 (0) 22 4315 6830
Execution Noble Ltd
Soumitra Chatterjee
+91 22 4315 6829
Execution Noble Ltd
13
Page 2 of 11
A unique DNA
The master acquirer: In our opinion, KPIT is the only mid-tier IT company that
has successfully mastered the art of acquisitions, with over 10 successful
acquisitions in the past decade. All these acquisitions have grown impressively
sinc thn. Thr c th O acuisiticns wr gratr than 7% c KPlT's
revenues. Most mid-tier companies have faltered with large acquisitions,
however KPIT has consistently delivered in our view.
Figure 1 Acquisitions have scaled significantly
The secret sauce: A successful acquisition led strategy requires i) momentum
in the existing business to be able to comfortably absorb the acquired entity,
ii) a clear vision of how the company needs to be shaped over the longer term
and iii) a wider vision to carry existing entrepreneurs from acquired entities.
Momentum in the existing business: KPlT's EPlDT/ margins cvr th
past decade have averaged at 16% despite most peers aspiring for
higher margins. We understand that this was a conscious effort by
the management to reinvest excess margins in the core business to
maintain high growth rates. This effort has led to consistently high
organic growth rates allowing the company enough room and
bandwidth to acquire and integrate new entities.
Figure 2 High organic revenue growth . Figure 3 .driven by re-investments in the core business
Clear long-term vision: KPIT has over time successfully built a
business focussed on the manufacturing, utilities and automotive
verticals. With each acquisition it has sewed together a business with
service lines that allow differentiating versus a strategy of
commoditized offerings like ADM, IMS, BPO etc. The management
had articulated a US$100m revenue target over a 3 year time frame
when the company's rvnus wr cnly US$28m.
Wider vision to carry existing entrepreneurs from acquired entities:
Acquisitions not only fill gaps of capability, scale and reach, but also
add management depth if one is able to retain the promoters or key
personnel of the acquired entities. The promoters of Sparta, who are
now part of KPIT, built a US$300m business which was later sold to
Fujitsu and have a vision to run a US$1bn SAP practice. KPIT has
been able to retain most of the key talent. For instance the CFO of
CG Smith is the legal and secretarial head of the company; and the
promoter of Solvcentral is the practice director for BI in SAP.
Acquisitions Year
Size when
acquired ($m) FY12 ($m) Rationale CAGR%
Cummins Infotech 2002 $1 $66 /nchcr Custcmr - Cummins; Vrtical Fccus - Manuacturing 52%
Panex Consulting 2003 $7 $25 SAP Practice - Anchor Customer 15%
SolvCentral.com 2005 $4 $20 BI Practice - Anchor Customer 28%
Pivolis 2005 $2 $5 Direct Presence in France geography 19%
CG Smith Software 2006 $6 $45 Auto Electronics Domain; Auto OEM & Tier I Customers 39%
Harita TVS 2008 $1 $8 MEDS Practice 68%
Sparta Consulting 2009 $25 $72 SAP Practice; US Geography presence in SAP 42%
In2Soft 2010 $4 $6 Vehicle Diagnostic & Telematics, German Frontline 22%
CPG 2010 $11 $15 Oracle Consulting 17%
SYSTIME 2011 $50 $53 Oracle Consulting, JD Edwards Specialist 6%
Organic growth calculation FY06 FY07 FY08 FY09 FY10 FY11 FY12 CAGR %
Reported revenues ($m) 72 103 142 164 155 222 309 27.5%
Acquisition revenue ($m)
- SolvCentral.com 4
- Pivolis 2
- CG Smith Software 6
- Harita TVS 1
- Sparta Consulting 12 13
- In2Soft 2 2
- CPG 6 6
- SYSTIME 13
Organic revenues ($m) 67 97 142 163 143 201 289 27.6%
I norganic revenue growth (YoY%) 43% 38% 15% -6% 43% 40%
Organic revenue growth (YoY%) 45% 47% 15% -13% 41% 43%
1
4
F F F F F
14
Page 3 of 11
Figure 6 Revolo - key components
Significant room for sustained high growth
KPIT operates in three lines of businesses i) Integrated Enterprise Solutions
(Oracle practice), ii) auto and engineering and iii) SAP serving the
manufacturing, automotive and utilities verticals. Each of these segments has
grcwn at a COGR c %, 8% ano O.5% rspctivly. KPlT's rcnt acuisiticns,
Sparta and Systime, have also scaled up significantly.
Figure 4 Lines of business have scaled Figure 5 So have recently acquired entities
Investments in core business will drive growth: KPlT's investments in the
business in the past year and current year will ensure consistent high growth
going forward. The company invested in creating specific solutions to target
the SME & utilities markets in the US in the past year. The focus has also been
on increasing the maintenance revenues in the Sparta business, which were
c.5% of group revenue at the time of acquisition. It is already c.20% and is
likely to improve further. This not only improves the recurring business but
also helps aid margins. KPIT has also strengthened its geographic presence in
China, Korea, India, Japan, Korea and Brazil. The company appointed a
professional CEO in China and setup a subsidiary in The Netherlands last year.
KPlT's ky custcmrs alsc hav larg ERP rcll cuts that will drive growth in the
business. With over US$210m of deals bagged in the past year the company is
well positioned to drive growth. Moreover post the recent acquisitions the
average deal size for KPIT has risen.
Table 1 Key investments in personnel
Option value from Revelo not factored in estimates
Revelo is KPlT's atrmarkt scluticn that ccnvrts xisting oisl ano ptrcl
engines to hybrids. The solution promises to improve fuel efficiency by 35%
and reduce emissions by 30%. The company has entered into a 50:50 JV with
Bharat Forge to manufacture and market the solution. It is currently
undergoing trails in 200 vehicles and is likely to be launched in FY14. Revelo
costs between Rs65,000-70,000 at the lower end and Rs0.1-0.15m at the
upper end. The JV is targeting annual revenues of Rs3-5b annually from this
business. The JV plans to initially launch the solution in Mumbai and Pune.
KPIT is also in discussion with OEMs for factory fitted vehicles.
We currently do not factor in any value for Revelo as this is an altogether new
venture. However the company has filed for patents for key components and
there could be multiple monetization options.
$10
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FY10 FY11 FY12 FY13E
Sparta Systime
Appointment Individual Geograph Line of busine Remarks
Managing Director Mr. Guven Kivran Germany Automotive Founder of In2Soft - acquired by KPIT earlier
Vice President Mr. Toshimi Yamanoi Tokyo Automotive
To strengthen offerings for automotive OEM's
in Japan
Global Head of MarketingMs.Melissa Womack Global Marketing
Earlier chief marketing officer at CPG, a
consulting company acquired by KPIT.
Mandate to increase brand presence in US,
Europe & Asia Pac and drive a unified
customer experience across acquired entities
15
Page 4 of 11
Not without risks - management crucial
The complete payback for Systime would happen in FY16 only if Systime can
grow at 20% annually for the next three years with EBIDTA margins of 15%.
Systime reported revenue growth of 11% QoQ in Q1FY13 and has already
scaled up margins from 5% to 11%. Our checks indicate that the company is
already ahead of its business plan which gives us comfort.
Table 2 Systime - payback period of 5 years for goodwill of Rs1.7b
Earn-outs for Sparta and the cost of acquisition of the remaining stake in
Systime will see an outflow of US$48m over FY13 and FY14. The company
plans to fund these incremental outflows through debt and this will drive the
D/E ratio up from the current 0.3x tc O.4x. Mcrcvr KPlT's targt c
achieving US$1bn in revenues by FY17 could lead to further acquisitions going
forward, which would in turn increase debt on books.
KPIT will not shy from another acquisition but timing is crucial: Our analysis
suggests that th managmnt's track rccro ano win rats ar excellent. The
managmnt's ability tc uickly scal up margins cr th acuiro ntitis ano
time the next acquisition when the business is ready to digest another target
is crucial. KPIT has successfully done this in the past and has a very clear
acquisition philosophy, thereby driving our faith in the stock.
FY12 FY13E FY14E FY15E FY16E FY17E
Revenues ($m) 50 65 78 93 112 134
- growth % 29% 20% 20% 20% 20%
Revenues (I NR m) 2425 3501 3954 4651 5581 6698
EBI DTA (I NR m) 121 385 593 698 837 1005
EBIDTA% 5% 11% 15% 15% 15% 15%
Depreciation (I NR m) 49 70 79 93 112 134
PBT (I NR m) 73 315 514 605 726 871
Tax (I NR m) 22 95 154 181 218 261
ETR% 30% 30% 30% 30% 30% 30%
PAT (I NR m) 51 221 360 423 508 609
PAT % 2% 6% 9% 9% 9% 9%
Share of KPIT (INR m) 25 126 360 423 508 609
Add back depreciation (I NR m) 50 166 439 516 620 743
16
Page 5 of 11
Company Background
Started 1990, KPIT focuses on the manufacturing, automotive and utilities
verticals through its service offerings in SAP, Oracle and auto & engineering.
KPIT operates largely out of Pune and is the largest third party automotive
electronics vendor out of India.
KPIT has grown its revenues and PAT at a CAGR of 40% and 43% respectively
over the past 10 years. The company is highly acquisitive and has acquired 10
companies in the last 10 years.
KPIT derives 44% of its revenues from Integrated Enterprise Solutions (a suite
of Oracle based services), 24% from auto and engineering and 32% from SAP
based offerings. From a geographic perspective the company derives 76% of
its revenues from USA, 15% from Europe and 9% from RoW. Cummins is the
largest client contributing 21% to its revenues and is also a shareholder.
Figure 7 Geographical breakup of revenues Figure 8 Revenues and profitability trends
55%
60%
68% 69%
36%
30%
20% 19%
9% 10% 12% 12%
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75%
100%
FY09 FY10 FY11 FY12
North America Europe APAC
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20%
30%
40%
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4,000
6,000
8,000
10,000
12,000
14,000
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FY06 FY08 FY10 FY12
Sales (Rs bn) GPM (RHS) NPM (RHS)
17
Page 6 of 11
KPIT currently trades on a FY13E PER of 10.4 and a FY14E PER of 8.8. With an
EPS CAGR of 32% the current multiples are not demanding. Our key rationale
is as follows:
a) Consistently delivered over the past decade
b) Good visibility on growth from top clients and new deal pipelines
c) Acquired entities are delivering robust growth and are seeing
improving margin profiles
We initiate coverage on the stock with a BUY and a FV of Rs140 implying a
13% upside to the current market price.
Figure 9 DCF Summary Figure 10 Sensitivity of WACC to terminal growth
Figure 11 KPIT's FCFE Profile
Figure 12 Relative Valuation Chart
Category Value
COE 15.0%
Terminal Growth Rate 2.5%
PV of growth phase 7,234
PV of consolidation 5,916
PV of maturation 6,331
PV of terminal value 5,837
DCF of equity value 25,318
Net Cash
Total Equity Value 25,318
13.0% 14.0% 15.0% 16.0% 17.0%
0.5% 163 148 135 124 115
1.5% 167 151 137 126 116
2.5% 172 155 140 128 118
3.5% 178 159 143 130 119
4.5% 185 164 147 133 121
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FCFE Average ROE (RHS) COE (RHS)
Market cap Net Debt EV Sales CAGR EBITDA CAGR EPS CAGR
Company Mn Mn Mn FY12-14 FY12-14 FY12-14 2013E 2014E 2013E 2014E 2013E 2014E
Infosys Ltd. 1,447,919 (205,910) 1,242,009 13% 12% 11% 2.9 2.5 9.4 7.8 15.1 13.2
Tata Consultancy Services Ltd. 2,532,644 (88,275) 2,444,369 17% 17% 15% 3.8 3.5 12.6 11.7 18.4 17.5
Wipro Ltd. 938,041 (60,665) 877,376 12% 8% 11% 2.0 1.8 10.2 8.8 14.7 13.1
HCL Technologies Ltd. 400,233 (3,085) 397,148 18% 12% 15% 1.6 1.4 8.6 8.0 13.4 12.3
Average 15% 12% 13% 2.6x 2.3x 10.2x 9.1x 15.4x 14.0x
Other Indian IT Companies
Tech Mahindra + Satyam 123,956 7,243 131,199 13% 19% 12% 0.9 0.8 4.7 4.8 11.2 9.9
Hexaware Technologies Ltd. 36,060 (4,377) 31,683 25% 32% 16% 1.8 1.6 7.2 6.9 10.0 9.9
Polaris Financial Technology Ltd 12,964 14,600 27,564 18% 13% 13% 0.5 0.5 8.4 7.4 4.9 4.6
Persistent Systems Ltd. 17,094 (3,283) 13,811 18% 25% 18% 1.4 1.2 4.6 4.2 9.4 8.6
MphasiS Ltd. 84,514 (17,598) 66,917 6% 9% 2% 1.6 1.5 6.3 5.7 10.6 9.9
MindTree Ltd. 26,922 (3,103) 23,819 20% 27% 28% 1.1 1.0 5.5 5.0 8.5 7.8
KPIT Cummins Infosystems Ltd. 22,022 459 22,481 29% 36% 32% 1.0 0.9 6.4 5.6 10.5 8.9
Average 18% 23% 17% 1.2 1.1 6.1 5.7 9.3 8.5
P/Sales EV/EBITDA (x) P/E
18
Page 7 of 11
Risks to Fair Value
Any large acquisition by KPIT in the near term could be perceived
negatively as current goodwill is at 51% of its net worth.
Sharp deceleration in growth rates due to macro factors could alter
the payback period of Systime and lower profitability for the
company.
19
Page 8 of 11
Source: Espirito Santo Investment Bank Research estimates
Valuation Metrics 2009A 2010A 2011A 2012A 2013E 2014E
Recommendation: BUY P/E 34.1 26.2 23.7 15.4 10.4 8.8
Fair Value: INR 140 Reported P/E 34.1 26.2 23.7 15.4 10.4 8.8
EV / Sales 2.8 3.0 2.1 1.5 1.0 0.9
Share Price: INR 123 EV / EBITDA 12.0 13.5 13.7 10.4 6.2 5.3
Upside / Downside 14% EV / EBIT 15.7 16.7 18.7 13.0 7.1 6.1
FCF Yield 5.6% 4.8% 0.9% 1.2% 9.2% 8.7%
3 Month ADV ($m) 2 Dividend yield 0.5% 0.6% 0.6% 0.6% 0.6% 0.6%
Free Float 73.7%
52 Week High / Low INR 142 - 68
Key ratios 2009A 2010A 2011A 2012A 2013E 2014E
Bloomberg: KPIT IN
Model Published On: 01 October 2012 EBITDA margin 23.1% 22.1% 15.0% 14.5% 15.7% 16.0%
EBIT margin 17.6% 17.9% 11.0% 11.6% 13.6% 13.9%
Capex / Revenue 6.2% 3.3% 4.2% 4.1% 2.2% 2.0%
Shares In Issue (mm) 182 Capex / Depreciation 1.13 0.77 1.03 1.37 1.07 0.93
Market Cap ($mn) 408 Net Debt / EBITDA -0.3 -0.4 -1.1 0.1 -0.2 -0.3
Net Debt ($mn) 3 EBITDA / Net Interest 40.3 58.9 58.9 27.9 23.7 18.2
Enterprise Value ($mn) 411 ROE 39% 22% 16% 20% 24% 22%
P&L Summary 2009A 2010A 2011A 2012A 2013E 2014E
Revenue 7,932 7,316 10,120 15,000 22,379 25,106
% change 35.9% -7.8% 38.3% 48.2% 49.2% 12.2%
Espirito Santo Securities Analyst EBITDA 1,834 1,614 1,522 2,181 3,522 4,026
Nitin Padmanabhan % change 150.2% -12.0% -5.7% 43.3% 61.5% 14.3%
(91) 22 4315 6830 % margin 23.1% 22.1% 15.0% 14.5% 15.7% 16.0%
nitin.padmanabhan@execution-noble.com Depreciation & Amortisation -436 -308 -411 -445 -468 -536
EBIT 1,397 1,306 1,111 1,736 3,053 3,490
Soumitra Chatterjee % change 192.1% -6.5% -15.0% 56.3% 75.9% 14.3%
(91) 22 4315 6829 % margin 17.6% 17.9% 11.0% 11.6% 13.6% 13.9%
soumitra.chatterjee@execution-noble.com Interest expense -45 -27 -26 -78 -149 -221
Operating Profit 1,352 1,279 1,085 1,658 2,905 3,269
Forex gains/(losses) 0 0 0 0 0 0
Shareholding Pattern Other Income -574 -253 18 128 98 181
Pre Tax Profit 778 1,026 1,103 1,786 3,003 3,451
Income Tax Expense -120 -169 -155 -437 -785 -897
Minority Interests and Exceptionals 0 0 0 104 -62 -11
Net Income 659 857 948 1,454 2,156 2,543
Execution Net Income 659 857 948 1,454 2,156 2,543
Reported EPS 3.61 4.70 5.19 7.97 11.81 13.93
EPS 3.61 4.70 5.19 7.97 11.81 13.93
DPS 0.60 0.70 0.70 0.70 0.70 0.70
Payout Ratio 16.6% 14.9% 13.5% 8.8% 5.9% 5.0%
Shares In Issue (Less Treasury) 182 182 182 182 182 182
Cash Flow Summary 2009A 2010A 2011A 2012A 2013E 2014E
Revenue Breakdown EBITDA 1,834 1,614 1,522 2,181 3,522 4,026
Taxes Paid -120 -169 -155 -437 -785 -897
Interest Income -574 -253 18 128 98 181
Change in Working Capital 113 -169 -574 -870 -66 -480
Associate & Minority Dividends 0 0 0 0 0 0
Forex and Others -62 53 -168 2 -98 -181
Operating cash flow 1,191 1,076 643 1,005 2,670 2,649
Capital Expenditure -493 -238 -422 -609 -500 -500
Free Cash Flow 698 838 221 396 2,170 2,149
Acquisitions & Disposals 0 -668 -463 0 -1,166 -1,378
Dividends Paid To Shareholders -64 -55 -64 -72 -149 -149
Equity Raised / Bought Back 0 27 1,203 65 0 0
Other Financing Cash Flow 86 -670 145 -1,149 1,079 1,399
Net Cash Flow 720 -528 1,042 -760 1,934 2,020
Balance Sheet Summary 2009A 2010A 2011A 2012A 2013E 2014E
Operating Profit Breakdown
Cash & Equivalents 1,671 1,799 2,556 2,055 3,983 6,004
Tangible Fixed Assets 1,795 1,522 1,171 1,431 1,569 1,784
Goodwill & Intangibles 0 950 1,708 4,044 5,163 6,493
Investment in Equity Investee 0 0 0 0 0 0
Other Assets 2,518 2,065 3,651 5,832 6,918 7,889
Total Assets 5,984 6,336 9,087 13,363 17,634 22,169
Interest Bearing Debt 1,185 1,108 931 2,222 3,352 4,910
Other Liabilities 3,052 1,306 2,116 3,689 4,826 5,442
Total Liabilities 4,236 2,413 3,047 5,911 8,179 10,352
Shareholders' Equity 1,685 3,871 6,032 7,125 9,132 11,525
Minority Interests 63 51 9 326 326 326
Total Equity 1,748 3,922 6,041 7,451 9,458 11,851
Net Debt -487 -692 -1,626 167 -631 -1,094
KPIT Cummins
Promoter
26%
FII
23% DII
17%
Others
34%
IES
44%
SAP
32%
Auto and
Engeneeri
ng
24%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
FY10A FY11A FY12A FY13E FY14E
EBITDA PAT
20
FUNDAMENTAL INSIGHT
Polaris Software
Geared for growth
Polaris Software has always traded at massive discount to Tier-I and
Tier-II peers thanks to a lumpy products business and reliance on
Citi for revenues. It launched the products business in 2008, but due
to lack of new clients it took two years to build the retail banking
segment. But with marquee clients in the retail banking (now 60% of
product revenues), developing the wholesale banking should get
easier. Also with disclosure improving in the product segment the
large valuation discount should narrow. We have lowered our fair
value from Rs240 to Rs197, though we retain our BUY rating.
Can the license revenues grow on a consistent basis?
Despite a strong brand name and parent, Oracle Financial Software Services
(OFSS) is finding it difficult to grow its license revenues. In this business, until
the license revenue grows, implmntaticn ano /MC wcn't grcw. Sc can
Polaris grow its license revenues on a consistent basis? We believe it can.
Product margins are not as low as perceived: Polaris's product
margins are 25% which is blcw OFSS' prcouct margins c 43%.
However, this includes R&D expenses which are 21% of product
revenues. Grossing up, this gives EBITDA margins of 47%. In FY05,
OFSS was spending c.13% of its product revenues on R&D and
Temenos today spends 5.5-6% of its revenues on development and an
additional 2.5-3% on research. Given that both are now mature
products, OFSS' R&D expenses should have reduced to 9% of product
revenues meaning EBITDA margins of 51% ex-R&D, offering margin
upside of 10% over 7-O yars in Pclaris' prcoucts sgmnt.
Services margins expected to expand to 12% in near term: Polaris's
services margins are c. 10% which is much lower than peers, largely
due to high costs of employees who are skewed towards laterals with
high levels of experience. Polaris is targeting increasing margins in the
services business to 12% in the near term by broadening the pyramid
by hiring more freshers and increasing the offshore mix.
10% USD growth reasonable given deal wins and order flows: With
two recent large deals in the services segment, we estimate revenues
will grow 10% in USD. In the product segment, we think 10% growth is
also reasonable, as Polaris has recently won 5 deals in which the
implementation should start from Q2FY13 onwards. We expect
margins to remain flat as the margin improvement in the product
business is offset by lower margins in services. We only expect
margin improvement in services to start only from H2FY13.
Valuations: improving visibility gives valuation comfort
While the services segment operates at low double digit margins, the product
segment has margins of 25% which will enable Polaris to address structural
issues like: a) wage pressure which grew at 8-10% over the last two years, b)
higher Visa charges and rejection rates. Polaris has significantly improved
investor disclosure levels in Q1FY13 and we expect more efforts to improve
disclosure on the products business. We expect Polaris to record revenue and
EBITDA CAGR of 18% and 13% over FY12-14E. Given this growth we find PERs
of 4.9x FY13E and 4.6x FY14E compelling. Reiterate BUY.
Accounting & corporate governance AMBER
Franchise Strength AMBER
BUY
51% upside
Fair Value Rs197.00
Bloomberg ticker POL IN
Free Float 71%
INR m Y/E 31-Mar 2011A 2012A 2013E 2014E
Revenue 15863 20527 25137 28353
EBITDA 2139 2906 3296 3730
EBIT 1802 2434 2771 3184
Pre Tax Profit 2386 2835 3357 3548
Net Income 2029 2207 2656 2807
EPS 20.3 22.1 26.6 28.1
DPS 4.5 5.0 5.0 5.0
Free Cash Flow 181 (1143) 1575 978
Y/E 31-Mar 2011A 2012A 2013E 2014E
P/E 6.4 5.9 4.9 4.6
EV / Sales 0.7 0.5 0.4 0.4
EV / EBITDA 5.0 3.7 3.2 2.8
EV / EBIT 5.9 4.4 3.8 3.3
FCF Yield -3% -12% 8% 5%
Data, Bloomberg
60
80
100
120
140
POL IN vs BSE500 Index
Analysts
Soumitra Chatterjee
+91 22 4315 6829
soumitra.chatterjee@execution -noble.com
Execution Noble Ltd
Nitin Padmanabhan
+91 (0) 22 4315 6830
nitin.padmanabhan@execution -noble.com
Execution Noble Ltd
21
Page 2 of 10
Product business has grown 38% CAGR in last 3 years
Polaris's product business has grown much faster than peers, due to a smaller
base and also positioning in the right geographies. While Polaris previously
oion't giv sparat details of license, implementation and AMC revenues, it
has now started to disclose these, in line with best practice. As shown in the
table below, Polaris has grown its product revenues at a CAGR of 18% over
last 5 years and 38% in last 3 years as it gets almost 2/3
rd
of its product
revenues from emerging economies which have an appetite for software
banking products.
Figure 1 Last 3,5,10 yrs revenue CAGR Figure 2 Geographical split of product revenues
Product margins are better than Temenos but lower than OFSS
Polaris's prcouct margins ar 25% which is blcw OFSS' prcouct margins c
43%. However, this includes R&D expenses which are 21% of product revenues.
Grossing up, this gives EBITDA margins of 47%. While margins are better than
Temenos, they are lower than OFSS, as Polaris started by selling smaller
modules of banking product, where price often becomes a competing factor,
but is slowly moving to core banking solutions which have higher margins.
Tmncs' margins hav bn ao|usto cr ovlcpmnt ccsts as it capitalizes
development cost whereas Polaris and OFSS expense it.
Figure 3 Product segment margins
Focus would be to improve margins in services business
While products have margins of c.25%, services margins are only c.10%. While
this has happened due to high costs of laterals with more than 6-8 years of
experience, Polaris plans to address this by hiring freshers and improving the
offshore mix, which should take margins in the services segment to 12% in the
near term.
Last 10 years Last 5 years Last 3 years
Temenos 17% 9% 13%
License 17% 0% 8%
Maintenance 24% 27% 30%
Services 12% 6% 1%
OFSS 22% 8% 10%
License 6% -6% -8%
Maintenance 29% 8% 11%
Services 27% 20% 19%
Polaris FT NA 18% 38%
Temenos OFSS Polaris
Americas 10% 26% 13%
Europe 40% 36% 21%
ROW 51% 37% 66%
-60%
-40%
-20%
0%
20%
40%
60%
FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
Temenos OFSS Polaris FT
22
Page 3 of 10
Company Snapshot
Polaris Software Lab was incorporated in 1993. It was one of the first vendors
that Citigroup chose to partner with, when it entered India. Simultaneously,
Citigroup started its own company called Citibank Overseas Software Ltd,
(COSL) to leverage its Indian operations. COSL was later renamed Orbitech,
and was merged with Polaris in 2003. Polaris is thus an amalgamation of these
two organizations. Through this merger, Polaris acquired 57 IPRs of Orbitech
and rearchitected them into a J2EE-based SOA platform and rebranded as
Intellect in 2005. In the last five years, PSL has grown its revenues and
earnings at CAGRs of 14% and 57% respectively.
Figure 4 Geography wise revenue Breakup Figure 5 License, Implementation and AMC Figure 6 Revenues, EBITDA and Net margins
Source: Espirito Santo Investment Bank, Company Data Source: Espirito Santo Investment Bank, Company Data Source: Espirito Santo Investment Bank, Company Data
Change in forecasts
Our revenue estimates have gone up by 11% and 4% for FY13 and FY14 due to
change in currency assumption from Rs49.5/$1 to Rs55/$1. However, EBITDA
has not increased as we moderated our margin assumptions due to lower
margins in services and a more moderate improvement in products than
previously expected.
Table 1 Old versus New estimates
ESIB vs. consensus
Our revenues estimates for FY13 and FY14 are 2% higher than consensus as we
factor in higher growth in the products segment. However, EBITDA is lower by
3% and 5% for FY13E and FY14E, as we think recurring R&D expenses will keep
margin improvement under check.
Table 2 US versus Consensus
88.7% 88.8% 91.0% 92.6% 94.8%
11.3% 11.2% 9.0% 7.4% 5.2%
0%
25%
50%
75%
100%
FY07 FY08 FY09 FY10 FY11
BFSI Other
License
18%
Service
46%
Maintena
nce
28%
SI
8%
0%
10%
20%
30%
0
4,000
8,000
12,000
16,000
FY06 FY08 FY10 FY12
Revenue EBITDA Net Profit
Sales Old New Change
FY13 22,650 25,137 11%
FY14 27,238 28,353 4%
EBITDA
FY13 3,252 3,296 1%
FY14 3,914 3,730 -5%
PAT
FY13 25 27 5%
FY14 29 28 -3%
Sales US Cons Change
CY12 25,137 24,535 2%
CY13 28,353 27,876 2%
EBITDA
CY12 3,296 3,410 -3%
CY13 3,730 3,916 -5%
PAT
CY12 27 24 12%
CY13 28 27 4%
23
Page 4 of 10
Figure 7 Percentage of broker's upgrading and price performance Figure 8 Percentage of earnings upgrade and price performance
Source: Espirito Santo Investment Bank, Factset Estimates Source: Espirito Santo Investment Bank, Factset Estimates
Figure 9 One year forward PE Band
0
50
100
150
200
250
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-20%
0%
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40%
60%
80%
100%
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Rolling 12M forward EPS growth forecasts Price (RHS)
0.0
5.0
10.0
15.0
20.0
25.0
Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12
PE Std Dev(-2) Std Dev(-1)
Mean Std Dev(+1) Std Dev(+2)
24
Page 5 of 10
Polaris is amongst the few Tier-II IT companies which should be able to
improve margins due to a decent product portfolio. While the services
segment operates at low double digit margins, the product segment has
margins of 23% which will enable Polaris to address structural issues like: a)
wage pressure which has been growing at 13-15% over the last five years and
b) reducing concentration away from Citi which contributes to >40% of
revenue. We expect Polaris to record revenue and EBITDA CAGR of 20% and
22% over FY11-14E. We have lowered our FV from Rs240 to Rs197 due to
increasing working capital requirement as Days Sales Outstanding (DSOs)
have gone up from 93 days to 118 days since our initiation. Though we factor
DSOs to revert to mean to 100-105 days but that would be over a period of 4
to 6 quarters.
Figure 10 Polaris' estimated FCFE profile
Figure 11 DCF Summary Figure 12 Sensitivity to terminal growth and cost of capital
Figure 13 Relative Valuation Table
Category Value
COE 15.0%
Net Cash
13.0% 14.0% 15.0% 16.0% 17.0%
0.5% 233 209 189 172 158
1.5% 239 214 193 175 160
2.5% 247 219 197 178 162
3.5% 256 226 202 182 165
4.5% 267 234 208 186 168
T
e
r
m
i
n
a
l

G
r
o
w
t
Infosys Ltd. 1,447,919 (205,910) 1,242,009 13% 12% 11% 2.9 2.5 9.4 7.8 15.1 13.2
Wipro Ltd. 938,041 (60,665) 877,376 12% 8% 11% 2.0 1.8 10.2 8.8 14.7 13.1
Average 15% 12% 13% 2.6x 2.3x 10.2x 9.1x 15.4x 14.0x
MphasiS Ltd. 84,514 (17,598) 66,917 6% 9% 2% 1.6 1.5 6.3 5.7 10.6 9.9
MindTree Ltd. 26,922 (3,103) 23,819 20% 27% 28% 1.1 1.0 5.5 5.0 8.5 7.8
Average 18% 23% 17% 1.2 1.1 6.1 5.7 9.3 8.5
25
Page 6 of 10
Risks to Fair Value
Our fair value of Rs197 is at risk if
1. Services margins don't improve: We build in 200bps improvement in
margins in services business over the next two years. If not for it our
fair value would have been Rs165.
2. Slow ramp-up in product revenues: Any slower than expected ramp-
up in product business puts our fair value at risk.
26
Page 7 of 10
Source: Company data and Espirito Santo Investment Bank Research estimates
Valuation Metrics 2010A 2011A 2012A 2013E 2014E
Recommendation: BUY P/E 8.5 6.4 5.9 4.9 4.6
Fair Value: INR 197 Reported P/E 8.5 6.4 5.9 4.9 4.6
EV / Sales 0.8 0.7 0.5 0.4 0.4
Share Price: INR 130 EV / EBITDA 4.8 5.0 3.7 3.2 2.8
Upside / Downside 51.0% EV / EBIT 5.7 5.9 4.4 3.8 3.3
FCF Yield 17.7% -3.1% -12.0% 7.7% 4.8%
3 Month ADV ($m) 2 Dividend yield 1.3% 3.5% 3.8% 3.8% 3.8%
Free Float 71.0%
Key ratios 2010A 2011A 2012A 2013E 2014E
Bloomberg: POL IN
Model Published On: 01 October 2012 EBITDA margin 16.4% 13.5% 14.2% 13.1% 13.2%
EBIT margin 13.8% 11.4% 11.9% 11.0% 11.2%
Capex / Revenue 2.5% 5.2% 5.9% 2.6% 2.8%
Shares In Issue (mm) 99 Capex / Depreciation 0.97 2.44 2.57 1.24 1.47
Market Cap (Rs mn) 12,880 Net Debt / EBITDA -2.3 -2.4 -1.0 -0.9 -1.0
Net Debt (Rs mn) -2,257 EBITDA / Net Interest 243.7 186.2 100.7 109.2 123.6
Enterprise Value (Rs mn) 10,622 ROE 18% 20% 18% 20% 18%
P&L Summary 2010A 2011A 2012A 2013E 2014E
Revenue 13,538 15,863 20,527 25,137 28,353
% change -1.8% 17.2% 29.4% 22.5% 12.8%
Espirito Santo Securities Analyst EBITDA 2,220 2,139 2,906 3,296 3,730
Soumitra Chatterjee % change -4.9% -3.7% 35.9% 13.4% 13.2%
(91) 22 4315 6829 % margin 16.4% 13.5% 14.2% 13.1% 13.2%
soumitra.chatterjee@execution-noble.com Depreciation & Amortisation -350 -337 -472 -525 -546
EBIT 1,870 1,802 2,434 2,771 3,184
Nitin Padmanabhan % change 2.2% -3.6% 35.1% 13.8% 14.9%
(91) 22 4315 6830 % margin 13.8% 11.4% 11.9% 11.0% 11.2%
nitin.padmanabhan@execution-noble.com Associates 0 0 0 0 0
Operating Profit 1,870 1,802 2,434 2,771 3,184
Interest Expenses -9 -11 -29 -30 -30
Shareholding Pattern Other Income -73 595 429 617 395
Pre Tax Profit 1,788 2,386 2,835 3,357 3,548
Income Tax Expense -255 -359 -630 -707 -747
Minority Interests -4 2 3 6 6
Net Income 1,529 2,029 2,207 2,656 2,807
Execution Net Income 1,529 2,029 2,207 2,656 2,807
Reported EPS 15.34 20.28 22.11 26.61 28.12
EPS 15.34 20.28 22.11 26.61 28.12
DPS 1.75 4.50 5.00 5.00 5.00
Payout Ratio 11.4% 22.2% 22.6% 18.8% 17.8%
Shares In Issue (Less Treasury) 99 99 99 99 99
Cash Flow Summary 2010A 2011A 2012A 2013E 2014E
Revenue Breakdown EBITDA 2,220 2,139 2,906 3,296 3,730
Taxes Paid -255 -359 -630 -707 -747
Interest Paid / Received -82 583 401 587 365
Change in Working Capital 829 -971 -2,173 -384 -1,180
Associate & Minority Dividends 0 0 0 0 0
Other Operating Cash Flow -170 -389 -432 -565 -389
Operating cash flow 2,542 1,003 71 2,227 1,778
Capital Expenditure -339 -822 -1,214 -652 -800
Free Cash Flow 2,203 181 -1,143 1,575 978
Acquisitions & Disposals -347 -189 -1,016 0 0
Dividends Paid To Shareholders -346 -202 -749 -580 -580
Equity Raised / Bought Back 24 20 1 0 0
Other Financing Cash Flow -1,375 344 2,741 446 395
Net Cash Flow 159 154 -165 1,440 793
Balance Sheet Summary 2010A 2011A 2012A 2013E 2014E
Cash & Equivalents 5,134 5,265 4,027 4,155 4,948
Tangible Fixed Assets 2,271 2,937 3,987 4,097 4,351
Goodwill & Intangibles 506 644 1,994 1,815 1,815
Investment in Equity Investee 0 0 0 0 0
Other Assets 3,894 5,389 8,306 10,712 12,638
Total Assets 11,805 14,235 18,315 20,779 23,751
Interest Bearing Debt 25 57 1,238 1,161 1,161
Other Liabilities 3,056 3,827 4,530 6,301 7,046
Total Liabilities 3,081 3,885 5,768 7,462 8,208
Shareholders' Equity 8,725 10,325 12,524 13,296 15,523
Minority Interests 0 25 22 21 21
Total Equity 8,725 10,351 12,547 13,317 15,544
Net Debt -5,109 -5,208 -2,789 -2,994 -3,787
Polaris Software Lab
Promoter
29%
FII
26%
DII
15%
Others
30%
Services
77%
Products
23%
Services
48%
Products
52%
27
FUNDAMENTAL INSIGHT
MphasiS
From tepid to reasonable growth
MphasiS has underperformed the BSE-IT index by c.10% in last year
due to muted quarterly results. Nevertheless, on an absolute basis
the stock is up 6% as free cash accretion remains strong (now 33%
of market cap). With the HP channel now reaching about 50% of
revenues as against 70% two years ago, margins stabilising due to
cost control, HP's service business growing after six quarters and
Direct channel growth expected to continue, FY13 looks better to us
than FY12. Having raised our fair value to Rs433 from Rs414, we
remain Buyers, though upside is limited in our view.
HP Services business has grown after 6 quarters
The HP business for MphasiS has been declining for some time. To some
extent this decline has been offset by growth in the direct channel which now
contributes c.42% of total revenues. The stock benefits from the backstop of a
large cash base (c.33% of market cap) and with the HP and direct channel
slowly reaching 50-50, FY13E growth looks stronger than FY12.
HP's Services business has grown after 6 quarters: HP's Srvics
business was in decline for the last 6 quarters as it was in
restructuring mode, growth turning positive only in Q3FY12. Similarly,
MphasiS's revenues from HP have also declined from 70% to 55% in
the last 8 quarters. In FY09, the go to market model with HP was 30%
of total revenue and HP contributed 70% tc MphasiS's revenues. That
has reduced to 6% c tctal rvnus ano HP's shar has alln tc 55%
due to market share loss of HP. The remaining business was stable.
With HP services business growth turning positive, the market share
loss should reduce and MphasiS' rvnus rcm HP should stabilize.
Direct channel growth encouraging in tough environment: MphasiS's
direct channel has grown 10% in FY11 and is expected to grow 60% in
FY12. If not for this, MphasiS revenue would have declined 10% in
FY12. Investors were concerned that the direct channel was small so
can't rally ccmplain abcut declining growth in the HP channel. With
the direct channel slowly approaching 50% share, we estimate that
MphasiS growth, which has was flat in FY11, should deliver a 7.5%
CAGR till FY14E.
Free cash generation best amongst peers: In the Tier-II IT space, we
focus more on cash generation than PAT. Despite tepid growth in the
last two years, MphasiS continued to trade at c.10x P/E. One key
reason was strong free cash generation, ahead of peers. MphasiS is
generating free cash at Rs600m per month and even if it does an
acquisition (upto $50m) the cash could be replenished with a year.
Valuation
MphasiS was in a long downgrade cycle as the HP business started to decline.
However, with smaller inroads in other verticals within HP and growth in the
direct channel, the revenue decline has to a great extent been arrested. While
HP continues to lose market share (recent lost the world bank and US Navy
contract) the pace of loss has come down and this should help stabilise the go
to market channel with HP in the next few quarters. We expect 6% revenue
CAGR and 2% earnings CAGR over FY12-14E. Reiterate BUY.
Earnings Momentum AMBER
BUY
11% upside
Fair Value Rs433.00
Bloomberg ticker MPHL IN
Free Float 39%
INR m Y/E 31-Oct 2010A 2011A 2012E 2013E
Revenue 50364 50980 54107 57762
EBITDA 12647 9847 10693 11656
EBIT 11010 8297 8936 9803
Pre Tax Profit 12098 10049 10415 11243
Net Income 10906 8222 7975 8545
EPS 52.0 39.1 38.0 40.7
DPS 4.0 6.5 7.0 7.5
Free Cash Flow 7465 5778 6806 5915
Y/E 31-Oct 2010A 2011A 2012E 2013E
P/E 6.6 8.8 9.0 8.4
EV / Sales 1.6 1.6 1.5 1.3
EV / EBITDA 6.4 8.3 7.5 6.4
EV / EBIT 7.3 9.9 9.0 7.6
FCF Yield 7% 4% 6% 5%
Data, Bloomberg
80
90
100
110
120
130
MPHL IN vs BSE500 Index
Analysts
Soumitra Chatterjee
+91 22 4315 6829
Execution Noble Ltd
Nitin Padmanabhan
+91 (0) 22 4315 6830
Execution Noble Ltd
28
Page 2 of 9
MphasiS has managed to reduce concentration from HP
MphasiS has managed to reduce its HP concentration. While this meant
revenue growth stalled for a year or so, it also meant MphasiS managed to
reduce risk without a meaningful decline in revenues.
Figure 1 Breakup of HP revenues into different Segments (FY09) Figure 2 Breakup of HP revenues into different Segments (Now)
Consensus has started to upgrade MphasiS
After a lull of almost one and half years, consensus has started to upgrade
MphasiS as the risk of revenues and earnings volatility has reduced.
Additionally, superior cash accretion has lent support to the stock.
Figure 3 Percenage of broker's upgrading and price performance Figure 4 Percentage of earnings upgrade and price performance
Source: Espirito Santo Investment Bank Research, Factset Estimates Source: Espirito Santo Investment Bank Research, Factset Estimates
Change in forecasts
V havn't chango cur stimats matrially cr FY2 as MphasiS's actual
performance has been in line with our estimates. For FY13 while our EBITDA
estimates have remained unchanged, EPS has still increased by 10% as
depreciation expenses as come down resulting in 6% upgrade in EBIT. The rest
of the upgrade has come due to higher other income.
5%
15%
30%
Internal Migration Go To Market
70%
30%
HP Non-HP
5%
5%
15% 30%
Non HPES Internal
55%
45%
HP Non-HP
0
100
200
300
400
500
600
700
800
-40%
-30%
-20%
-10%
0%
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M
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0
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-4%
-2%
0%
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4%
6%
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10%
M
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M
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29
Page 3 of 9
Table 1 Old versus New Estimates
ESIB vs. consensus
Our estimates for FY12 are largely in line with consensus but our estimates for
FY13 and 4% higher due to changes in depreciation estimates.
Figure 5 Us versus Consensus
FY12 53,154 54,107 2%
FY13 57,762 57,762 0%
EBITDA
FY12 11,122 10,693 -4%
FY13 11,656 11,656 0%
EPS
FY12 37 38 3%
FY13 37 41 10%
FY12 54,107 54,369 0%
FY13 57,762 57,221 1%
EBITDA
FY12 10,693 10,586 1%
FY13 11,656 11,042 6%
PAT
FY12 38 37 2%
FY13 41 39 4%
30
Page 4 of 9
With the downgrade cycle coming to an end and cash generation remaining,
MphasiS is expected to find support from higher growth in direct channel and
a decline in the pace of slowdown in HP revenues. We continue to value
MphasiS on a DCF basis with a fair value of Rs433, up from our previous FV of
Rs414 due to superior operating and free cash generation. Expect 6% revenue
CAGR and 2% earnings CAGR over FY12-14E. Reiterate BUY
Figure 6 MphasiS' estimated FCFE profile
0%
5%
10%
15%
20%
25%
30%
0.0
5.0
10.0
15.0
20.0
25.0
F
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6
I
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R
s
.

B
n
Category Value
COE 15.0%
Net Cash
13.0% 14.0% 15.0% 16.0% 17.0%
0.5% 500 455 417 385 357
1.5% 513 465 424 390 361
2.5% 528 476 433 397 366
3.5% 547 490 443 404 372
4.5% 569 506 455 413 379 T
e
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m
i
n
a
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G
r
o
w
t
Infosys Ltd. 1,447,919 (205,910) 1,242,009 13% 12% 11% 2.9 2.5 9.4 7.8 15.1 13.2
Wipro Ltd. 938,041 (60,665) 877,376 12% 8% 11% 2.0 1.8 10.2 8.8 14.7 13.1
Average 15% 12% 13% 2.6x 2.3x 10.2x 9.1x 15.4x 14.0x
MphasiS Ltd. 84,514 (17,598) 66,917 6% 9% 2% 1.6 1.5 6.3 5.7 10.6 9.9
MindTree Ltd. 26,922 (3,103) 23,819 20% 27% 28% 1.1 1.0 5.5 5.0 8.5 7.8
Average 18% 23% 17% 1.2 1.1 6.1 5.7 9.3 8.5
31
Page 5 of 9
Risks to Fair Value
Our Fair Value of Rs433 is at risk if there is:
Contracts being renegotiated at significantly lower price points: The
MSA with HP is due for renewal. Any massive discount in price could
result in lower revenues and lower margins.
Lower growth in direct channel: MphasiS's direct channel has grown
>10% since re-organization. Low growth in direct channel puts our
revenue and earnings estimates at risk.
Company Snapshot
BFL Software was started in Bangalore in 1992 as an IT services company and
went public in July 1993 by offering 6m shares at par. MphasiS Corporation
was formed in 1998 by Mr Jaitirth Rao and Jereon Tas. It has three key lines of
Business.
Applications (62% of FY11 revenues): In the service line MphasiS
executes contracts won either through its own sales channel (22% of
FY09 revenues) or the projects won via HP (47% of FY09 revenues).
On own contracts won, MphasiS invoices clients directly, while on
contract won via HP, MphasiS invoices HP. On payment, HP retains a
share of it and passes the balance to MphasiS.
BPO (23% of FY11 revenues): In BPO, MphasiS provides both voice
and non-vcic srvics. Sinc th EDS acuisiticn, MphasiS's revenue
mix has changed from 80% voice based operations (in FY06) to 50%
(in FY09). MphasiS currently gets 50% of its BPO revenues via HP.
That said, BPO revenue growth of 12.5% FY07-09 CAGR has lagged
the overall revenue growth of 27%.
lTO (5% c FY sals): MphasiS's ITO revenues are entirely via HP.
However, HP driven revenues are likely to fall to 90% due to
MphasiS's acquisition of Fortify Systems in April 2010. The revenues
from this segment have grown at a CAGR of 74% from $31m in FY07
to $164m in FY09.
Figure 10 HP and Direct Channel Figure 11 APPS, ITO and BPO Revenues Figure 12 Revenues, Gross and Net margins
Source: Espirito Santo Investment Bank, Company Data Source: Espirito Santo Investment Bank, Company Data Source: Espirito Santo Investment Bank, Company Data
4%
54%
62%
70% 68% 66% 64%
96%
46%
38%
30% 32% 34% 36%
0%
25%
50%
75%
100%
FY07 FY09 FY11 FY13
HP/EDS Direct
65% 64%
67%
63% 62% 62%
22%
18% 13%
15%
11% 11%
12%
18% 20% 22%
26% 26%
0%
25%
50%
75%
100%
FY08 FY09 FY10 FY11 FY12 FY13
Apps BPO ITO
0%
10%
20%
30%
40%
0
15
30
45
60
FY05 FY07 FY09 FY11E FY13E
R
s

B
n
Revenue GPM NPM
32
Page 6 of 9
[Source: Company data and Espirito Santo Investment Bank Research estimates
Valuation Metrics 2009A 2010A 2011A 2012E 2013E
Recommendation: BUY P/E 9.0 6.6 8.8 9.0 8.4
Fair Value: INR 433 Reported P/E 9.0 7.5 10.0 10.3 9.6
EV / Sales 1.9 1.6 1.6 1.5 1.3
Share Price: INR 390 EV / EBITDA 7.1 6.4 8.3 7.5 6.4
Upside / Downside 11% EV / EBIT 8.7 7.3 9.9 9.0 7.6
FCF Yield 9.7% 7.1% 4.5% 5.9% 5.0%
3 Month ADV ($m) 2 Dividend yield 0.5% 1.0% 1.7% 1.8% 1.9%
Free Float 40.0%
Key ratios 2009A 2010A 2011A 2012E 2013E
Bloomberg: MPHL IN
Model Published On: 01 October 2012 EBITDA margin 26.4% 25.1% 19.3% 19.8% 20.2%
EBIT margin 21.7% 21.9% 16.3% 16.5% 17.0%
Capex / Revenue 3.2% 1.8% 3.9% 3.7% 3.5%
Shares In Issue (mm) 210 Capex / Depreciation 0.68 0.54 1.27 1.14 1.08
Market Cap ($mn) 1,640 Net Debt / EBITDA -0.2 -0.1 0.0 -0.1 -0.6
Net Debt ($mn) -409 EBITDA / Net Interest -403.7 -1,529.8 447.6 61.8 69.4
Enterprise Value ($mn) 1,231 ROE 43% 33% 21% 17% 16%
Forthcoming Catalysts P&L Summary 2009A 2010A 2011A 2012E 2013E
Fourth quarter results Mid November Revenue 42,639 50,364 50,980 54,107 57,762
% change 123.6% 18.1% 1.2% 6.1% 6.8%
EBITDA 11,275 12,647 9,847 10,693 11,656
% change 190.3% 12.2% -22.1% 8.6% 9.0%
% margin 26.4% 25.1% 19.3% 19.8% 20.2%
Depreciation & Amortisation -2,022 -1,637 -1,550 -1,757 -1,853
Espirito Santo Securities Analyst EBIT 9,253 11,010 8,297 8,936 9,803
Soumitra Chatterjee % change 221.4% 19.0% -24.6% 7.7% 9.7%
(91) 22 4315 6829 % margin 21.7% 21.9% 16.3% 16.5% 17.0%
soumitra.chatterjee@execution-noble.com Associates 0 0 0 0 0
Operating Profit 9,253 11,010 8,297 8,936 9,803
Interest Expenses 28 8 -22 -173 -168
Shareholding Pattern Other Income 447 1,080 1,774 1,652 1,608
Pre Tax Profit 9,728 12,098 10,049 10,415 11,243
Income Tax Expense 238 -1,192 -1,827 -2,441 -2,698
Net Income 9,966 10,906 8,222 7,975 8,545
Execution Net Income 9,966 10,906 8,222 7,975 8,545
Reported EPS 43.45 52.04 39.15 37.99 40.71
EPS 43.45 52.04 39.15 37.99 40.71
DPS 2.0 4.0 6.5 7.0 7.5
Payout Ratio 4.6% 7.7% 16.6% 18.4% 18.4%
Shares In Issue (Less Treasury) 210 210 210 210 210
Cash Flow Summary 2009A 2010A 2011A 2012E 2013E
Revenue Breakdown EBITDA 11,275 12,647 9,847 10,693 11,656
Taxes Paid 238 -1,192 -1,827 -2,441 -2,698
Interest Paid / Received 475 1,088 1,752 1,479 1,440
Change in Working Capital 621 -3,068 -482 -555 -874
Associate & Minority Dividends 0 0 0 0 0
Other Operating Cash Flow -2,040 -1,120 -1,543 -370 -1,608
Operating cash flow 10,569 8,355 7,746 8,806 7,915
Capital Expenditure -1,375 -890 -1,969 -2,000 -2,000
Free Cash Flow 9,194 7,465 5,778 6,806 5,915
Acquisitions & Disposals 0 0 0 0 0
Dividends Paid To Shareholders -486 -858 -980 -2,567 -1,715
Equity Raised / Bought Back 0 0 0 0 0
Other Financing Cash Flow -7,677 -6,525 -3,665 -2,429 1,608
Net Cash Flow 1,031 81 1,133 1,810 5,808
Balance Sheet Summary 2009A 2010A 2011A 2012E 2013E
Margin Trends
Cash & Equivalents 1,786 1,784 2,897 4,789 10,597
Tangible Fixed Assets 3,291 2,512 2,946 2,898 3,045
Goodwill & Intangibles 2,946 3,886 8,698 9,929 9,929
Investment in Equity Investee 7,612 14,600 17,765 22,077 22,077
Other Assets 17,001 22,256 23,689 21,573 23,523
Total Assets 32,635 45,038 55,994 61,265 69,171
Interest Bearing Debt 33 454 2,923 3,339 3,339
Other Liabilities 9,156 11,598 14,190 11,550 12,625
Total Liabilities 9,189 12,052 17,114 14,889 15,964
Shareholders' Equity 23,446 32,986 38,881 46,377 53,207
Total Equity 23,446 32,986 38,881 46,377 53,207
Net Debt -1,752 -1,330 27 -1,450 -7,258
MphasiS
Promoter
61%
FII
20%
DII
6%
Others
13%
Applicatio
n
63%
ITO
22%
BPO
15%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
FY09A FY10A FY11A FY12E FY13E
EBITDA PAT
33
FUNDAMENTAL INSIGHT
India | Technology | 1-October-2012
MindTree
Too close for comfort
MindTree has managed to come out of its misstep in the mobile
handset business in FY09 fairly well and has grown its revenues and
earnings at CAGRs of 16% and 45% since then. Renewed focus on IT
services led to deal wins which increased the pace of growth.
However, sluggishness in Product Engineering Services (PES) will
restrict overall revenue growth to max 10% in FY13E, leaving margin
improvement difficult from hereon. We initiate with a fair value of
Rs710 and a NEUTRAL rating.
Business risks cannot be ignored
MindTree started the year on an upbeat mood aiming to beat the NASSCOM
target of 11-14% growth in FY13. However, owing to weakness in the PES
segment it has tempered growth optimism and now aims to meet the
NASSCOM estimates. We see FY12 and FY13 as years of earnings growth
driven by margin expansion. Can this be sustained? We think not.
A large competitor has made inroads into a large client: A large IT
vendor recently made inroads into one of MindTr's largr clints.
Investors are concerned that Mindtree could be prone to vendor
consolidation risk, as the services provided by MindTree to this client
are routine RIM and ADM services. Our checks further indicate that
this competitor could end up signing a couple of more deals which
could make him the preferred vendor of that client. However,
MindTree has not lost any large client to vendor consolidation so far.
Moreover it has a seven year relationship with this client, which could
limit such risk, although it cannot completely rule it out.
Renewed focus required in driving growth in PES segment:
MinoTr's PES sgmnt has grcwn at a C/GR c 5% in last 3 yars,
which is lower when compared to the company average of 14% during
the same period. While MindTree has now moderated its growth
expectations for FY13, citing weakness in this segment, our
conversations with listed and unlisted pure-play PES players suggest
that this segment can grow at 15% over the next 3 years, which is
contrary tc MinoTr's xpctaticns. Givn its crigins in the PES
segment, it is hard to believe this forecast of sluggish growth.
Margins have peaked, not much room for upside: MindTree EBIT
margins declined to 10% in FY09 as it had to write-off investments
made in white label handset business. Since then, driven by
operational efficiencies and currency benefit, margins have recovered
to 18%. However, with growth coming down and the cost base at
optimal levels, further improvements in gross margins are difficult.
Moreover lower growth rates make it difficult to broaden the pyramid
and leverage SG&A to offset annual wage hikes.
Valuations
MindTree scores at par with Tier-I IT companies on quarterly and annual
disclosure levels and had maintained consistency in disclosures. However, with
growth expectations coming down we expect earnings CAGR of 11% over
FY12-14E. This makes the stock expensive at 8.5x FY13E EPS of Rs78 given
lower growth and earnings profile than peers. Initiate with NEUTRAL.
NEUTRAL
7% upside
Fair Value Rs710.00
Bloomberg ticker MTCL IN
Free Float 80%
INR m Y/E 31-Mar 2011A 2012A 2013E 2014E
Revenue 15091 19152 23783 27453
EBITDA 1777 2930 4329 4747
EBIT 1065 2235 3716 4060
Pre Tax Profit 1307 2552 4113 4492
Net Income 1018 2122 3204 3497
EPS 25 52 78 85
Free Cash Flow (404) 1581 1652 1656
Y/E 31-Mar 2011A 2012A 2013E 2014E
P/E 26.8 12.8 8.5 7.8
EV / Sales 1.7 1.2 0.9 0.7
EV / EBITDA 14.5 8.1 5.1 4.3
EV / EBIT 24.2 10.6 5.9 5.0
FCF Yield (0.0) 0.0 0.0 0.0
Dividend yield 0.0 0.0 0.0 0.0
Data, Bloomberg
80
100
120
140
160
180
200
220
MTCL IN vs BSE500 Index
Analysts
Nitin Padmanabhan
+91 (0) 22 4315 6830
Execution Noble Ltd
Soumitra Chatterjee
+91 22 4315 6829
Execution Noble Ltd
34
Page 2 of 9
Historic growth has struggled due to PES segment
MinoTr's crganic grcwth has bn hlo back ou tc its lumpy PES sgmnt
which contributes to 33% of revenues. Over the last 3 years, the IT services
revenues (67% of revenues) have grown at 34% CAGR while the PES business
has grown by a meagre 5% CAGR. We find this surprising as Persistent, which
operates in the same segment and counts MindTree as a competitor, has
grown its revenues at a CAGR of 18% over the same period. Our conversations
with a few unlisted companies also indicate that growth has been in high
double digits. Vhil a ma|cr part c MinoTr's PES businss ccms rcm the
telecom vertical, Persistent too gets c.25% of its revenues from telecom and
that share has not decreased.
Figure 1 Persistent's revenue and MindTree's PES revenues
Why has this happened?
MinoTr's prcmctr, Ashok Soota, was the vice-chairman of Wipro where he
ovlcpo Viprc's Prcouct Enginring Srvics sgmnt. Vhn MinoTr
was formed, the focus was in the PES segment which grew from nil to $40m
in 7 yars' tim. Vhil it has wcn a few deals in the PES segment in Q1FY13
and PES should start growing in H2FY13, even to achieve FY12 PES revenues
of $139m calls for a CQGR of 5% over the next three quarters, which we think
is a challenging task.
IT Services business has grown at a strong pace
While the IT Services business has grown at 34% CAGR, led by some large
deal wins, in our view the business has to be looked at on a portfolio basis and
if the PES segment remains flat in FY13, the IT Services business has to grow
6.5% tc mt th lcwr no c N/SSCOM's stimats. If our fears regarding
tier-I competitors making inroads into two of the key clients of MindTree were
to play out either in part or in full, then in order to drive incremental growth in
IT Services, MindTree would have to bid and win some large deals. This again
we think would be a challenge.
0
50
100
150
200
250
FY10 FY11 FY12
MindTree Persistent
35
Page 3 of 9
Company snapshot
Started in 1999 MindTree is structured into two business units that focus on
software development - IT Services and R&D Service. It offers a range of IT
services such as application development and maintenance (ADM), consulting,
package implementation, independent testing and infrastructure management
services to focused industry verticals like banking, financial services and
insurance (BFSI), manufacturing and travel/transportation. In FY12 MindTree
recorded revenue of $403m growing at 42% CAGR over last 10 years
(including Aztecsoft and 21% organically). Some of its key clients include Avis
Budget Group, Microsoft, Unilever, Volvo, United Technologies, Symantec,
KPN, eBay, Texas Instruments amongst others.
Figure 2 Segment wise revenue breakup Figure 3 Geography wise revenue breakup Figure 4 Revenue, EBITDA and PAT margins
Source: Espirito Santo Investment Bank Research, Company Data Source: Espirito Santo Investment Bank Research, Company Data Source: Espirito Santo Investment Bank Research, Company Data
54%
58%
66%
46%
42%
34%
0%
20%
40%
60%
80%
100%
FY10 FY11 FY12
IT Services PES
65%
62%
58%
20%
19% 26%
6%
8%
8%
9% 10%
8%
0%
20%
40%
60%
80%
100%
FY10 FY11 FY12
US Europe India APAC
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
0
5,000
10,000
15,000
20,000
25,000
FY09 FY10 FY11 FY12
Revenue EBITDA (%) RHS PAT (%) RHS
36
Page 4 of 9
MindTree scores at par with Tier-I IT companies on quarterly and annual
disclosure levels and has maintained consistency in disclosures. However, with
growth expectations coming down we expect revenue CAGR of 11% over
FY12-14E. This allows little in the way of upside given the stock trades at 8.5x
FY13E EPS of Rs78, especially given the lower growth and earnings profile
than peers. We initiate with a fair value of Rs710 and a NEUTRAL rating.
Figure 5 DCF Summary Figure 6 Sensitivity of WACC and terminal growth rate
Figure 7 MindTree's FCFE Profile
Figure 8 Relative Valuation Chart
Category Value
COE 15.0%
Net Cash
13.0% 14.0% 15.0% 16.0% 17.0%
0.5% 726 702 682 665 651
1.5% 732 707 686 668 653
2.5% 740 712 710 671 655
3.5% 749 719 695 675 658
4.5% 760 727 701 679 661
T
e
r
m
i
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a
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G
r
o
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t
0%
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15%
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25%
30%
0.0
1.0
2.0
3.0
4.0
5.0
6.0
F
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1
3
F
Y
1
5
F
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1
7
F
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7
I
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s
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B
n
Infosys Ltd. 1,447,919 (205,910) 1,242,009 13% 12% 11% 2.9 2.5 9.4 7.8 15.1 13.2
Wipro Ltd. 938,041 (60,665) 877,376 12% 8% 11% 2.0 1.8 10.2 8.8 14.7 13.1
Average 15% 12% 13% 2.6x 2.3x 10.2x 9.1x 15.4x 14.0x
MphasiS Ltd. 84,514 (17,598) 66,917 6% 9% 2% 1.6 1.5 6.3 5.7 10.6 9.9
MindTree Ltd. 26,922 (3,103) 23,819 20% 27% 28% 1.1 1.0 5.5 5.0 8.5 7.8
Average 18% 23% 17% 1.2 1.1 6.1 5.7 9.3 8.5
37
Page 5 of 9
Risks to Fair Value
Our fair value of Rs710 is at risk:
a) On the upside: Although employee pyramid expansion is positively
co-related to growth, if MindTree is able to broaden the pyramid
significantly and extract margins then our fair value of Rs710 is at risk.
b) On the downside: While MindTree has not lost clients yet to any
vendor consolidation exercise, if it loses this time around as few
vendors have made inroads into larger clients the our fair value is at
risk.
38
Page 6 of 9
Valuation Metrics 2009A 2010A 2011A 2012A 2013E 2014E
Recommendation: NEUTRAL P/E 39.0 11.4 26.8 12.8 8.5 7.8
EV / Sales 2.2 2.0 1.7 1.2 0.9 0.7
Upside / Downside 7% EV / EBIT 41.9 14.1 24.2 10.6 5.9 5.0
FCF Yield 4.8% 6.4% -1.8% 4.5% 4.3% 4.5%
Free Float 80.2%
Key ratios 2009A 2010A 2011A 2012A 2013E 2014E
Bloomberg: MTCL IN
Model Published On: 01 October 2012 EBITDA margin 9.9% 18.9% 11.8% 15.3% 18.2% 17.3%
EBIT margin 5.3% 13.9% 7.1% 11.7% 15.6% 14.8%
Capex / Revenue 3.0% 3.5% 5.5% 2.5% 1.1% 0.7%
Shares In Issue (mm) 41 Capex / Depreciation 0.65 0.69 1.17 0.69 0.42 0.29
Market Cap ($mn) 495 Net Debt / EBITDA 0.0 -0.7 -0.9 -1.2 -1.2 -1.5
Net Debt ($mn) 6 EBITDA / Net Interest NA -3.6 -11.4 -86.2 -50.3 NA
P&L Summary 2009A 2010A 2011A 2012A 2013E 2014E
Revenue 12,375 12,960 15,091 19,152 23,783 27,453
% change 67.3% 4.7% 16.4% 26.9% 24.2% 15.4%
Espirito Santo Securities Analyst EBITDA 1,220 2,456 1,777 2,930 4,329 4,747
Nitin Padmanabhan % change -2.7% 101.3% -27.7% 64.9% 47.7% 9.7%
(91) 22 4315 6830 % margin 9.9% 18.9% 11.8% 15.3% 18.2% 17.3%
nitin.padmanabhan@execution-noble.com Depreciation & Amortisation -570 -652 -712 -695 -613 -686
EBIT 651 1,804 1,065 2,235 3,716 4,060
Soumitra Chatterjee % change -27.5% 177.2% -41.0% 109.9% 66.3% 9.3%
(91) 22 4315 6829 % margin 5.3% 13.9% 7.1% 11.7% 15.6% 14.8%
soumitra.chatterjee@execution-noble.com Associates 0 0 0 0 0 0
Operating Profit 651 1,804 1,065 2,235 3,716 4,060
Forex gains/(losses) 0 673 156 34 86 0
Shareholding Pattern Other Income 115 96 86 351 484 432
Pre Tax Profit 766 2,574 1,307 2,552 4,113 4,492
Income Tax Expense -67 -398 -289 -430 -909 -995
Minority Interests and Exceptionals 0 224 0 0 0 0
Net Income 699 2,399 1,018 2,122 3,204 3,497
Execution Net Income 699 2,399 1,018 2,122 3,204 3,497
Reported EPS 16.96 58.26 24.73 51.52 77.79 84.90
EPS 16.96 58.26 24.73 51.52 77.79 84.90
DPS 1.00 3.00 2.50 4.00 6.00 7.00
Payout Ratio 5.9% 5.1% 10.1% 7.8% 7.7% 8.2%
Cash Flow Summary 2009A 2010A 2011A 2012A 2013E 2014E
Revenue Breakdown EBITDA 1,220 2,456 1,777 2,930 4,329 4,747
Taxes Paid -67 -398 -289 -430 -909 -995
Interest Income 115 96 86 351 484 432
Change in Working Capital -955 237 -1,377 -1,076 -1,500 -1,883
Forex and Others 1,485 -89 235 288 -496 -445
Operating cash flow 1,798 2,302 432 2,063 1,907 1,855
Capital Expenditure -369 -452 -836 -482 -255 -198
Free Cash Flow 1,429 1,849 -404 1,581 1,652 1,656
Acquisitions & Disposals -2,920 -216 0 0 0 0
Dividends Paid To Shareholders -90 -46 -150 -176 -291 -341
Equity Raised / Bought Back 6 94 139 144 0 0
Other Financing Cash Flow 310 -1,390 13 397 0 0
Net Cash Flow -1,265 292 -402 1,946 1,360 1,315
Balance Sheet Summary 2009A 2010A 2011A 2012A 2013E 2014E
Goodwill & Intangibles 1,460 154 0 0 0 0
Other Assets 4,502 4,482 5,567 6,986 8,941 11,500
Total Assets 10,316 9,340 10,145 13,346 16,623 20,290
Interest Bearing Debt 1,394 31 41 37 37 37
Total Equity 5,840 6,706 7,762 9,572 12,426 15,451
Net Debt 1 -1,814 -1,530 -3,647 -5,326 -6,923
MindTree
Promoter
20%
FII
22%
DII
11%
Others
47%
PES
33%
MFG
16%
BFSI
21%
T&T
13%
Others
17%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
20.0%
FY10A FY11A FY12A FY13A FY14A
EBITDA PAT
39

FUNDAMENTAL INSIGHT


Not a bull for three reasons

Hexawares stock now trades at a 10x one year forward P/E and has
outperformed the BSE-IT index by 55% YTD. Our reverse DCF
suggests that the stock price is factoring in growth of 16%, margins
of 20% and ROE of 22% based on the current 50% dividend payout.
Performance was driven first by acquisition speculation, then as that
died down it was supported by a 5% dividend yield, but for this
dividend to be maintained FCF has to improve substantially from
current levels or the cash balance is headed south. We estimate 15%
revenue growth in CY13 and only one of the three growth drivers
intact, hence we see more negatives than positives. Reiterate SELL,
albeit on a revised fair value of Rs100, slightly up from Rs90.

Expectations stretched and valuations pricey
Hexaware has had a phenomenal run in the last two years as revenue started
to grow and margins expanded, with the added kicker of acquisition talk in Q1
CY12. YTD the stock has outperformed the BSE-IT index by 55% and it is the
most expensive Tier-II IT stock (see figure 11). The street expects revenue
growth of 18%, 20% margins and earnings CAGR of 20% with dividend payout
of 50% over CY12-14. Are these expectations stretched? We think so.
Two out of three growth buckets yet to be filled: Hexawares growth
drivers can be divided into three. First, growth from large deal wins,
second, from existing large clients and third, smaller deals or new clients.
The recent large deal won in Q2CY12 we think could add up to 8%
revenue growth in CY13. However, incremental revenue analysis suggests
that large clients ex-large deal wins have stagnated and revenue
contribution outside of top-10 clients has been consistently heading south.
With two Tier-II IT firms already moderating the streets growth
expectations, we see 15% growth as the best case in CY13E.
Margins tied to revenue growth: Hexawares current 23% EBITDA margins
have improved as revenues increased 33% in CY11 and are likely to
increase 20% in CY12. Our simulation model suggests that margins sustain
or improve if growth remains over 20% on a constant currency basis, but
if were to fall below 20% then margins decline 70bps annually in constant
currency. Consensus estimates suggest that margins are expected to
remain constant at 22.3% in CY13 and decline only 30bps for CY14, which
on <15% revenue CAGR over CY12-14 (consensus) looks stretched.
Dividend not sustainable at current cash generation rate: For the current
valuation to persist the dividend of Rs1.5/share/quarter has to be
maintained, implying an annual cash outflow of Rs2.03bn when FCF
generation is under Rs400m per quarter. This FCF generation is at a time
when DSOs are at life-time low of 45 days and margins an all-time high of
23% and if they were to revert to the mean (55-60 days), then FCF
generation would be far lower (we estimate cash could deplete in 2 yrs).
Valuations: most expensive Tier-II IT stock (fig.11)
With an optimal cost structure already, a 25% revenue CAGR over CY11-14E
will translate into only a 16% earnings CAGR. We retain our SELL stance. The
much admired current dividend alone wont support the stock, and the payout
requires growth of 30% in free cash generation to be sustained.

Earnings Momentum AMBER

SELL
17% downside
Fair Value Rs100.00

Bloomberg ticker HEXW IN
Free Float 72%

INR m Y/E 31-Dec 2010A 2011A 2012E 2013E
Revenue 10545 14505 19814 22723
EBITDA 938 2646 4419 4595
EBIT 696 2398 4109 4249
Pre Tax Profit 945 3075 4505 4670
Net Income 1077 2668 3596 3642
EPS 7.6 9.2 12.2 12.3
DPS 3.0 4.0 6.0 6.0
FCF 714 983 1209 1838

Y/E 31-Dec 2010A 2011A 2012E 2013E
P/E 15.7 13.1 9.8 9.8
EV / Sales 3.2 2.4 1.8 1.5
EV / EBITDA 36.4 12.9 7.9 7.7
EV / EBIT 49.0 14.2 8.5 8.3
FCF Yield 1% 2% 2% 4%

Data, Bloomberg

80
100
120
140
160
180
HEXW IN vs BSE500 Index
Analysts

Soumitra Chatterjee
+91 22 4315 6829
Execution Noble Ltd

Nitin Padmanabhan
+91 (0) 22 4315 6830
Execution Noble Ltd

Page 2 of 9
Why we think the current dividend is unsustainable
Having first been excited by the possibility of acquisition, the street then got
excited about the increase in quarterly dividend. However, in the last three
years the annual dividend payment has exceeded the net free cash generation
(including interest and dividend income) and Hexawares cash balance has
been depleting on a YoY basis for last 3 years. Now with an annual dividend
payment of Rs2.1bn, the net free cash generation would not be enough to
meet the cash outflow for dividend. Additionally, the quarterly expense run
rate has increased from Rs2.1bn to Rs3.0bn in the last three years and this is
expected to further increase to Rs5.2bn in next three years, which only
increases the event specific risks if the current payout were to be maintained.
Remember that Hexaware has had a very volatile history, where EBITDA
margins have moved from 20% to low single digits (even negative in Q4CY07)
twice in last 6 years and it should conserve cash in case the macro situation
were to deteriorate further.
Table 1 Cash generation profile

Change in forecasts
Our revenue estimates have gone up by 13% and 17% for CY12E and CY13E due
to change in currency assumption from Rs49.5/$1 to Rs55/$1. Our EBITDA
estimates have gone up by 27% and 32% for CY12 and CY13 due to upgrades
in revenue estimates (driven by currency) which have consequently driven the
margins assumption, as a 1% depreciation in currency impacts margins by c.
50bps. Our PAT estimates have gone up by 29% and 24% dues to upgrade in
revenues and EBITDA. Excluding currency, our estimates would have moved in
very low single digits.
Table 2 Old versus new estimates (largely driven by change in currency assumption)

ESIB vs. consensus
Our revenues estimates for CY12 and CY13 are largely in line with consensus
estimates. However, our EBITDA estimate for CY13 is 7% lower than consensus
as we build in a margin decline of 200bps due to wage hike (250bps) and
currency assumption (100bps). There is a positive impact of 150bps on
margins due to growth giving a net negative impact of 200bps.
CY09 CY10 CY11 CY12E CY13E CY14E
Operating cash flow 1,511 123 1,413 1,485 2,070 1,986
Interest Income 222 243 326 425 426 427
Dividend Income 19 37 76 - - -
Capex (252) (340) (633) (672) (600) (600)
Free cash flow 1,500 63 1,181 1,238 1,896 1,814
Dividend Payout (including tax) (244) (522) (1,376) (2,064) (2,064) (2,064)
Net cash flow 1,256 (459) (195) (826) (168) (250)
Cash balance 4,118 4,753 4,606 3,784 3,620 3,373
Quarterly expense run rate 2,091 2,402 2,965 3,849 4,564 5,246
CY12 17,482 19,814 13%
CY13 19,357 22,723 17%
EBITDA
CY12 3,489 4,419 27%
CY13 3,491 4,595 32%
PAT
CY12 2,797 3,596 29%
CY13 2,931 3,642 24%

Page 3 of 9
Table 3 ESIB versus consensus

Figure 1 Percenage of broker's upgrading and price performance Figure 2 Percentage of earnings upgrade and price performance

Figure 3 One year forward PE Band Figure 4 FCF, Dividend Payout, cash balance and expense runrate


CY12 19,814 19,359 2%
CY13 22,723 22,340 2%
EBITDA
CY12 4,419 4,346 2%
CY13 4,595 4,928 -7%
PAT
CY12 3,596 3,431 5%
CY13 3,642 3,845 -5%
0
20
40
60
80
100
120
140
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
M
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-8%
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M
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0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12
PE Std Dev(-2) Std Dev(-1)
Mean Std Dev(+1) Std Dev(+2)
0
1,000
2,000
3,000
4,000
5,000
6,000
(2,500)
(2,000)
(1,500)
(1,000)
(500)
-
500
1,000
1,500
2,000
2,500
CY09 CY10 CY11 CY12E CY13E CY14E
Free cash flow Dividend Payout (including tax)
Net cash flow Cash balance
Quarterly expense run rate

Page 4 of 9

Hexaware currently trades at a 16% premium to Tier-II IT companies like
Polaris, NIIT Tech, MindTree, Persistent and MphasiS. In its favour the stock has
a dividend yield of 5%. But on balance we retain our SELL stance for two key
reasons: 1) the existing valuation is likely to be sustained only if margins
remain stable, which already at 23% looks challenging to us and 2) the current
dividend payout implies a growth of 30% in free cash generations.
Figure 5 Hexaware estimated FCFE profile




0%
5%
10%
15%
20%
25%
30%
0.0
0.5
1.0
1.5
2.0
2.5
C
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1
2
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4
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n

R
s
.

B
n
FCF Average ROE (RHS) WACC (RHS)
Category Value
COE 15.0%
Net Cash
13.0% 14.0% 15.0% 16.0% 17.0%
0.5% 116 105 96 89 82
1.5% 119 108 98 90 83
2.5% 123 111 100 92 84
3.5% 128 114 103 94 86
4.5% 133 118 106 96 87
T
e
r
m
i
n
a
l

G
r
o
w
t
Infosys Ltd. 1,447,919 (205,910) 1,242,009 13% 12% 11% 2.9 2.5 9.4 7.8 15.1 13.2
Wipro Ltd. 938,041 (60,665) 877,376 12% 8% 11% 2.0 1.8 10.2 8.8 14.7 13.1
Average 15% 12% 13% 2.6x 2.3x 10.2x 9.1x 15.4x 14.0x
MphasiS Ltd. 84,514 (17,598) 66,917 6% 9% 2% 1.6 1.5 6.3 5.7 10.6 9.9
MindTree Ltd. 26,922 (3,103) 23,819 20% 27% 28% 1.1 1.0 5.5 5.0 8.5 7.8
Average 18% 23% 17% 1.2 1.1 6.1 5.7 9.3 8.5

Page 5 of 9
Risks to Fair Value

Our fair value of Rs100 is at risk if:
Hexaware win deals outside: Whilst it has won a couple of deals
outside its top 10 accounts, they are small in size ($4-5m) and too
insignificant to make any difference. The two large deals, $110m and
$177m are from existing clients. If Hexaware wins deals outside of its
top 10 accounts then the client concentration metric may not worsen
and pricing pressure should ease.
Company snapshot
Hexaware Technologies was incorporated in November 1992 under the name
Aptech Information Systems Ltd' and was promoted by Atul K. Nishar, Dr.
(Mrs.) Alka Nishar and Dr. K. K. Anand. It had two divisions, namely IT Services
and IT Training. In 2001, Aptechs IT Training and IT Services division was
demerged and in 2002 the IT Services division was renamed Hexaware
Technologies. The IT Training division was separately listed as Aptech Limited
(APTR IN) and Hexaware (HEXW IN) was separately listed. Hexaware is a Tier-
II IT vendor with an employee base of >8150 professionals. It specialises in
PeopleSoft HRMS implementation practice in addition to other IT services. It
gets 60% of its revenues from the BFSI (37%) and Travel & Transportation
(23%) verticals which are largely in the US (67% of revenues). In 2010, it won a
$110m deal from an existing client and in 2011 it won a $177m deal which is its
largest deal to date.
Figure 9 Geography wise revenue breakup Figure 10 Vertical wise revenue breakup

Figure 11 Revenue, EBITDA and PAT margins

Source: Espirito Santo Investment Bank Source: Espirito Santo Investment Bank Source: Espirito Santo Investment Bank

69.3%
66.7% 64.9% 65.8% 67.9%
65.4%
25.8%
26.7% 28.9% 27.5%
26.6%
28.1%
4.9% 6.6% 6.2% 6.7% 5.6% 6.5%
0%
25%
50%
75%
100%
CY06 CY07 CY08 CY09 CY10 CY10
Americas Europe RoW
44.8%
41.1% 41.6%
37.1%
32.4%
18.9%
16.4% 17.5%
22.7%
23.2%
22.0%
28.8%
29.4%
40.2%
39.9%
14.3% 13.7% 11.5%
4.5%
0%
25%
50%
75%
100%
BFSI TTHL Emerg. Seg Others
0%
10%
20%
30%
0
2,000
4,000
6,000
8,000
10,000
12,000
CY06 CY08 CY10
Revenues EBITDA PAT

Page 6 of 9


Valuation Metrics 2009A 2010A 2011A 2012E 2013E 2014E
Recommendation: SELL P/E 12.8 15.7 13.1 9.8 9.8 9.8
EV / Sales 3.3 3.2 2.4 1.8 1.5 1.4
Upside / Downside -17% EV / EBIT 19.8 49.0 14.2 8.5 8.3 8.3
FCF Yield 5.3% 1.2% 1.7% 2.0% 3.7% 3.3%
Free Float 71.8%
Key ratios 2009A 2010A 2011A 2012E 2013E 2014E
Bloomberg: HEXW IN
Model Published On: 08 November 2011 EBITDA margin 19.5% 8.9% 18.2% 22.3% 20.2% 18.4%
EBIT margin 16.9% 6.6% 16.5% 20.7% 18.7% 16.9%
Capex / Revenue 0.8% -5.1% 4.3% 3.4% 2.6% 2.4%
Shares In Issue (mm) 294 Capex / Depreciation 0.30 -2.24 2.54 2.17 1.73 1.60
Market Cap ($mn) 704 Net Debt / EBITDA -2.0 -4.9 -1.7 -0.9 -0.8 -0.7
Net Debt ($mn) -78 EBITDA / Net Interest 3.3 3.8 -10.7 -152.4 NA NA
P&L Summary 2009A 2010A 2011A 2012E 2013E 2014E
Revenue 10,386 10,545 14,505 19,814 22,723 25,402
% change -9.8% 1.5% 37.6% 36.6% 14.7% 11.8%
Espirito Santo Securities Analyst EBITDA 2,023 938 2,646 4,419 4,595 4,674
Soumitra Chatterjee % change 64.9% -53.6% 182.1% 67.0% 4.0% 1.7%
(91) 22 4315 6829 % margin 19.5% 8.9% 18.2% 22.3% 20.2% 18.4%
soumitra.chatterjee@execution-noble.com Depreciation & Amortisation -270 -242 -248 -310 -346 -374
EBIT 1,753 696 2,398 4,109 4,249 4,300
Nitin Padmanabhan % change 85.9% -60.3% 244.5% 71.3% 3.4% 1.2%
(91) 22 4315 6830 % margin 16.9% 6.6% 16.5% 20.7% 18.7% 16.9%
nitin.padmanabhan@execution-noble.com Associates 0 0 0 0 0 0
Operating Profit 1,753 696 2,398 4,109 4,249 4,300
Forex gains/(losses) -617 -248 248 29 0 0
Shareholding Pattern Other Income 310 497 429 425 421 420
Pre Tax Profit 1,446 945 3,075 4,505 4,670 4,719
Income Tax Expense -103 -92 -407 -909 -1,027 -1,085
Minority Interests and Exceptionals 0 224 0 0 0 0
Net Income 1,343 1,077 2,668 3,596 3,642 3,634
Execution Net Income 1,343 1,077 2,668 3,596 3,642 3,634
Reported EPS 9.34 7.62 9.18 12.21 12.30 12.27
EPS 9.34 7.62 9.18 12.21 12.30 12.27
DPS 1.40 3.00 4.00 6.00 6.00 6.00
Payout Ratio 15.0% 39.4% 43.6% 49.2% 48.8% 48.9%
Cash Flow Summary 2009A 2010A 2011A 2012E 2013E 2014E
Revenue Breakdown EBITDA 2,023 938 2,646 4,419 4,595 4,674
Taxes Paid -103 -92 -407 -909 -1,027 -1,085
Interest Income 222 243 326 425 421 420
Change in Working Capital 201 -563 -578 -2,053 -1,551 -1,699
Forex and Others -1 -354 -374 0 0 0
Operating cash flow 2,342 172 1,612 1,881 2,438 2,309
Capital Expenditure -82 542 -629 -672 -600 -600
Free Cash Flow 2,261 714 983 1,209 1,838 1,709
Acquisitions & Disposals 0 0 0 0 0 0
Dividends Paid To Shareholders -183 -233 -1,243 -2,060 -2,060 -2,060
Equity Raised / Bought Back 2 32 37 0 0 0
Other Financing Cash Flow -2,013 1,017 21 29 0 0
Net Cash Flow 67 1,530 -202 -822 -223 -352
Balance Sheet Summary 2009A 2010A 2011A 2012E 2013E 2014E
Goodwill & Intangibles 1,207 1,160 1,377 1,377 1,377 1,377
Other Assets 2,903 3,733 5,134 6,209 7,697 9,335
Total Assets 11,379 12,564 14,525 15,140 16,659 18,171
Interest Bearing Debt 163 112 0 0 0 0
Total Equity 8,497 9,655 10,163 11,757 13,339 14,912
Net Debt -3,955 -4,641 -4,606 -3,784 -3,561 -3,209
Promoter
28%
FII
43%
DII
7%
Others
22%
BFSI
37%
TTHL
23%
Emerging
segments
40%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
CY09A CY10A CY11E CY12E CY13E
EBITDA EBIT
Page 7 of 9
MphasiS MPHL IN
Report date Recommendation Fair value Share price
2011 September 21 Buy Rs414.00 Rs342.00
March 1 Buy Rs501.00 Rs431.00
February 2 Buy Rs740.00 Rs660.00
2010 July 29 Buy Rs721.00 Rs610.00
Source: Bloomberg, Espirito Santo Investment Bank Research
B
B
B
B
250
350
450
550
650
750
Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12
Buy Trading Buy Neutral Trading Sell Sell Restricted Dropped Coverage
46
Page 7 of 9
MindTree MTCL IN
Recommendation history is not available
300
350
400
450
500
550
600
650
700
750
Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12
47
Page 9 of 11
KPIT Cummins KPIT IN
Recommendation history is not available
0
20
40
60
80
100
120
140
48
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Polaris Software POL IN
2011 July 22 Buy Rs240.00 Rs173.00
B
100
120
140
160
180
200
220
240
Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12
49
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Hexaware Technologies HEXW IN
2012 February 15 Sell Rs90.00 Rs111.00
2011 November 9 Sell Rs69.00 Rs89.00
S
S
0
20
40
60
80
100
120
140
50
Page 8 of 9
IMPORTANT DISCLOSURES
240912
This report was prepared by Esprito Santo Investment Bank Research, a global brand name for the equity research teams of Banco Esprito Santo de Investimento, S.A., with headquarter
in Lisbon, Portugal, of its Branches in Spain and Poland and of its affiliates BES Securities do Brasil, S.A - Corretora de Cmbio e Valores Mobilirios, in Brazil, and Execution Noble
Limited, in the United Kingdom, all authorized to engage in securities activities according to each domestic legislation. All of these entities are included within the perimeter of the
Financial Grcup ccntrcllo by Espiritc Santc Financial Grcup S./. (Pancc Espiritc Santc Grcup').
Analyst Certification
Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this
report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; the issuers were not previously informed about the content of the
recommendation included in this research report and the assumptions were not validated by the issuers; (2) no part of his or her compensation is directly or indirectly related to: (a) the
specific recommendations or views expressed by that research analyst in the research report; and/or (b) any services provided or to be provided by Banco Esprito Santo de
Investimento, S.A. and/or by any of its affiliates to the issuer of the securities under recommendation. Moreover, each of the analysts hereby certifies that he or she has no economic or
financial interest whatsoever in the companies subject to his or her opinion and does not own or trade any securities issued by the latter.
Ratings Distribution
Espirito Santo Investment Bank Research hereby provides the distribution of the equity research ratings in relation to the total Issuers covered and to the investment banking
clients as of end of June 2012.
Explanation of Rating System Ratings Distribution
12-MONTH RATING DEFINITION
BUY Analyst expects at least 10% upside potential to fair
value, which should be realized in the next 12 months
NEUTRAL Analyst expects upside/downside potential of between
+10% and -10% to fair value, which should be realized in
the next 12 months
SELL Analyst expects at least 10% downside potential to fair
value, which should be realized in the next 12 months
As at end June 2012 Total ESIB Research
Total Investment Banking Clients
(IBC)
Recommendation Count % of Total Count % of IBC % of Total
12 Month Rating:
Buy 232 48.0% 29 67.4% 6.0%
Neutral 172 35.6% 8 18.6% 1.7%
Sell 72 14.9% 2 4.7% 0.4%
Restricted 5 1.0% 4 9.3% 0.8%
Under Review 0 0.0% 0 0.0% 0.0%
TRADING RATING DEFINITION
TRADING BUY Analyst expects a positive short-term movement in the
share price (max duration 2 months from the time Trading
Buy is announced) and may move out of line with the fair
value estimate during that period
TRADING SELL Analyst expects a negative short-term movement in the
share price (max duration 2 months from time Trading
Sell is announced) and may move out of line with the fair
value estimate during that period
Trading Rating:
Trading Buy 0 0.0% 0 0.0% 0.0%
Trading Sell 2 0.4% 0 0.0% 0.0%
Total recommendations 483 100% 43 100% 8.9%
Fcr urthr incrmaticn cn Rating Systm plas s Diniticns ano oistributicn c ratings' cn: http://www.espiritosantoib-research.com.
Share Prices
Share prices are as at the close of business on the day preceding publication, unless otherwise specified.
Coverage Policy
Esprito Santo Investment Bank Research reserves the right to choose the securities it expresses opinions on. The main criteria to choose such securities are: 1) markets in which they
trade 2) market capitalisation 3) liquidity, 4) sector suitability. Esprito Santo Investment Bank Research has no specific policy regarding the frequency in which opinions and investment
recommendations are released.
Representation to Investors
Esprito Santo Investment Bank Research has issued this report for information purposes only. This material constitutes "investment research" for the purposes of the Markets in Financial
Instruments Directive and as such contains an objective or independent explanation of the matters contained in the material.
Any recommendations contained in this document must not be relied upon as investment advice based on the recipient's personal circumstances. This report is not, and should not be
construed as an offer or a solicitation to buy or sell any securities or related financial instruments. The investment discussed or recommended in this report may be unsuitable for
investors depending on their specific investment objectives and financial position. The material in this research report is general information intended for recipients who understand the
risks associated with investment. It does not take account of whether an investment, course of action, or associated risks are suitable for the recipient. This research report does not
purport to be comprehensive or to contain all the information on which a prospective investor may need in order to make an investment decision and the recipient of this report must
make its own independent assessment and decisions regarding any securities or financial instruments mentioned herein. In the event that further clarification is required on the words or
phrases used in this material, the recipient is strongly recommended to seek independent legal or financial advice. Where an investment is denominated in a currency other than the
invstcr's currncy, changs in rats c xchange may have an adverse effect on the value, price of, or income derived from the investment. Past performance is not necessarily a guide to
future performance. Income from investments may fluctuate. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the
interest of investors. Any recommendation and opinion contained in this report may become outdated as a consequence of changes in the environment in which the issuer of the
securities under analysis operates, in addition to changes in the estimates and forecasts, assumptions and valuation methodology used herein. The securities mentioned in this publication
may not be eligible for sale in some states or countries.
All the information contained herein is based upon information available to the public and has been obtained from sources believed to be reliable. However, Esprito Santo Investment
Bank Research does not guarantee the accuracy or completeness of the information contained in this report. The opinions expressed herein are Esprito Santo Investment Bank Research
present opinions only, and are subject to change without prior notice. Esprito Santo Investment Bank Research is not under any obligation to update or keep current the information and
the opinions expressed herein nor to provide the recipient with access to any additional information.
Esprito Santo Investment Bank Research has not entered into any agreement with the issuer relating to production of this report. Esprito Santo Investment Bank Research does not
accept any form of liability for losses or damages which may arise from the use of this report or its contents.
Ownership and Material Conflicts of Interest
Banco Esprito Santo de Investimento, S.A. and/or its Affiliates (including all entities within Esprito Santo Investment Bank Research) and/or their directors, officers and employees, may
have, or have had, interests or qualified holdings on issuers mentioned in this report. Banco Esprito Santo de Investimento, S.A. and/or its Affiliates may have, or have had, business
relationships with the companies mentioned in this report.
For a complete list of the covered Issuers in which Banco Esprito Santo de Investimento, S.A. or its Affiliates hold stakes in excess of 1% and for information on possible material conflicts
of interest arising from investment banking activities please see Disclosures on Ownership and Material Conflicts of Interest on http://www.espiritosantoib-research.com.
Market Making UK
Execution Noble Limited is a Market Maker in companies covered and may sell to or buy from customers as principal in certain financial instruments listed or admitted to listing on the
London Stcck Exchang. Fcr incrmaticn cn Ccmpanis tc which Excuticn Ncbl Limito is a Markt Makr plas s UK Markt Making' on http://www.espiritosantoib-research.com.
Confidentiality
51
Page 9 of 9
This report cannct b rprcouco, in whcl cr in part, in any crm cr by any mans, withcut Espiritc Santc lnvstmnt Pank Rsarch's spcific written authorization. This report is
confidential and is intended solely for the designated addressee. Therefore any disclosure, replication, distribution or any action taken in reliance on it, is prohibited and unlawful. Receipt
and/or review of this research report constitutes your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this
report (including any investment recommendations, estimates or price targets without first obtaining express permission from an authorized officer of Banco Esprito Santo de
Investimento, S.A.
Regulatory Authorities
For information on the identity of the Regulatory Authorities that supervise the entities included within Esprito Santo Investment Bank Research please see http://www.espiritosantoib-
research.com.
IMPORTANT DISCLOSURES FOR U.S. PERSONS
This report was prepared by Esprito Santo Investment Bank Research, a global brand name for the equity research teams of Banco Esprito Santo de Investimento, S.A., with headquarter
in Lisbon, Portugal, of its Branches in Spain and Poland and of its affiliates BES Securities do Brasil, S.A - Corretora de Cmbio e Valores Mobilirios, in Brazil, and Execution Noble
Limited, in the United Kingdom, all authorized to engage in securities activities according to each domestic legislation. Neither Banco Esprito Santo de Investimento, S.A. nor these
affiliates are registered as a broker-dealer in the United States and therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence of research
analysts. This report is provided for distribution to U.S. institutional investors in reliance upon the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act
of 1934, as amended.
This report is confidential and not intended for distribution to, or use by, persons other than the addressee and its employees, agents and advisors.
E.S. Financial Services, Inc. is the U.S. distributor of this report. E.S. Financial Services, Inc. accepts responsibility for the contents of this report, subject to the terms set out below, to the
extent that it is delivered to a U.S. person other than a major U.S. institutional investor. Any U.S. person receiving this report and wishing to effect securities transactions in any security
discussed in the report should do so only through E.S. Financial Services, Inc.
Contact Information
Garreth Hodgson Senior Managing Director /Head of Sales (212) 351-6054 ghodgson@esinvestment.com
Eva Gendell Vice President (212) 351-6058 egendell@esinvestment.com
James Kaloudis Executive Director (212) 351-6065 jkaloudis@esinvestment.com
Joy Bejasa Vice President (212) 351-6055 jbejasa@esinvestment.com
Lisa Gottardo Executive Director (212) 351-6060 lgottardo@esinvestment.com
Mike Williams Vice President (212) 351-6052 mwilliams@esinvestment.com
Pedro Marques Vice President (212) 351-6051 pmarques@esinvestment.com
Poorva Upadhyaya Assistant Vice President (212) 351-6056 pupadhyaya@esinvestment.com
E.S. Financial Services, Inc.
New York Branch
340 Madison Avenue, 12th Floor
New York, N.Y. 10173
Each analyst whose name appears in this report certifies the following, with respect to each security or issuer that the analyst covers in this report: (1) that all of the views expressed in
this report accurately reflect the personal views of the analyst about those securities and issuers; and (2) that no part of the compensation of the analyst was, is, or will be, directly or
indirectly, related to the specific recommendations or views expressed by the analyst in this report.
The analysts whose names appear in this report are not registered or qualified as research analysts with the Financial Industry Regulatory Authority ("FINRA") and may not be associated
persons of E.S. Financial Services, Inc. and therefore may not be subject to the applicable restrictions under FINRA Rules on communications with a subject company, public appearances
and trading securities held by a research analyst account.
Ownership and Material Conflicts of Interest
Banco Esprito Santo de Investimento, S.A. and/or its Affiliates and/or their directors, officers and employees, may have, or have had, interests or qualified holdings on issuers mentioned
in this report. Banco Esprito Santo de Investimento, S.A. and/or its Affiliates may have, or have had, business relationships with the companies mentioned in this report.
For a complete list of the covered Issuers in which Banco Esprito Santo de Investimento, S.A. or its Affiliates hold stakes in excess of 1% and for information on possible material conflicts
c intrst arising rcm invstmnt banking activitis plas s lmpcrtant oisclcsurs cr US prscns' cn http://www.espiritosantoib-research.com.
Receipt of Compensation
Fcr incrmaticn cn Rcipt c Ccmpnsaticn rcm sub|ct lssurs plas s lmpcrtant oisclcsurs cr US prscns' cn http://www.espiritosantoib-research.com.
Representation to Investors
Esprito Santo Investment Bank Research has issued this report for information purposes only. All the information contained therein is based upon information available to the public and
has been obtained from sources believed to be reliable. However, Esprito Santo Investment Bank Research does not guarantee the accuracy or completeness of the information
contained in this report. The opinions expressed herein are our present opinions only, and are subject to change without prior notice. Esprito Santo Investment Bank Research is not
under any obligation to update or keep current the information and the opinions expressed herein. This report is not, and should not be construed as an offer or a solicitation to buy or sell
any securities or related financial instruments. The investment discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives
and financial position. Where an investment is denominated in a currency other than the investcr's currncy, changs in rats c xchang may hav an aovrs ct cn th valu, pric
of, or income derived from the investment. Past performance is not necessarily a guide to future performance. Income from investments may fluctuate. The price or value of the
investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. Any recommendation and opinion contained in this report may
become outdated as a consequence of changes in the environment in which the issuer of the securities under analysis operates, in addition to changes in the estimates and forecasts,
assumptions and valuation methodology used herein. The securities mentioned in this publication may not be eligible for sale in some states or countries. Esprito Santo Investment Bank
Research does not accept any form of liability for losses or damages which may arise from the use of this report. Please note that investing in any non-U.S. securities or related financial
instruments discussed in this research report may present certain risks. The securities of non-U.S. issuers may not be registered with the U.S. Securities and Exchange Commission or
subject to regulation in the United States. Information on such non-U.S. securities or related financial instruments may be limited. Foreign companies may not be subject to audit and
reporting standards and regulatory requirements comparable to those in the United States.
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