For Q2’09, Tech Mahindra’s (TM) revenue grew by 4.3% q-o-q to Rs11.6 billion, owing to a robust growth in the emerging markets (up 40% sequentially). The EBITDA margin advanced significantly by 230 bps due to an improved SG&A leverage and a decreased cost of revenues.
The company currently maintains a healthy order book of around $3 billion, including $2 billion from BT, which gives revenue visibility for the next 3–5 years.
In our view, the ramp-ups in certain deals will be relatively slow and might witness an increase the transition periods. For an order book of $2 billion, we have assumed that the company will generate approximately 10% of this revenue in each quarter for the next 10 quarters. Besides, the $350 million deal, which generated around $32 million in Q2’09 ($25 million in Q1’09), is expected to generate around 8% in each quarter.
Tech Mahindra recently won a $700 million deal from BT, which is expected to start contributing to the Company’s revenues from Q1’10. We have assumed a slow ramp-up in this deal at around 4% initially.
However, this should increase to around 6% within a year. As a consequence, revenues are expected to grow at 11.3% and 6.1% for FY09 and FY10, respectively, in the USD terms.
We have reduced our EBITDA margin estimates by 2% to 21% for FY09 and 2.7% to 20.1% for FY10, largely on account of the increasing transition periods and slow ramp-ups in the large deals, as the company witnessed a delay in the ramp-up of the recently won $700 million deal.
The utilization rate is expected to dip by around 100 bps for FY09 due to recruitment of freshers in H2’09. Other than this, we believe that the increase in employee and SG&A costs will also strain the margin.
At the current market of Rs325.20, the stock trades at a 27% discount to the industry average multiple of 8.5x for FY09, which provides a significant value proposition to TM’s shareholders.
Based on DCF valuation, we have arrived at a target price of Rs433 for the stock, assuming an 8.0% Rf, a 5% terminal growth rate, and a 17.4% WACC. This provides an upside of 31.3% from the current price. We maintain our BUY rating.