Tech Mahindra Ltd reported decent results under difficult conditions for the September quarter. While revenues from BT Group Plc continued to be sluggish, the non-BT business grew smartly. Revenues from BT fell below 50% of total revenues (49.8%, to be precise) for the first time.

Reported revenues grew by 2.6% to Rs1,141.8 crore, and operating profit increased by 4.3% to Rs292.5 crore.

The improvement in profit margins was primarily because of a sharp increase in employee utilization to 75%, compared with 71% in the June quarter. This, coupled with favourable currency movements, helped the company overcome the pressures of falling price realizations on its work. In the preceding two fiscal years, the company has operated at a utilization rate of 68-70%, which indicates that there’s little or no scope to increase productivity further from last quarter’s high levels.

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With BT bargaining hard for price discounts last quarter in exchange for committed volumes, margins could come under pressure in the next few quarters, especially with limited scope for improvement in employee utilization. Tech Mahindra gave details of the BT deal restructuring in an earnings conference call with analysts, adding that the impact of the price discounts is visible in last quarter’s results. BT has been going slow on IT outsourcing work in the past few quarters, to such an extent that it wasn’t even providing committed volumes on a long-term project titled “Barcelona".

Graphics: Yogesh Kumar / Mint

The two firms have now restructured the deal, whereby normal outsourcing work from BT and work under the “Barcelona" deal will be clubbed. BT has given a new commitment on such combined revenues, in exchange for price discounts.

While the company is taking the posture that it has managed to arrest the drop in volumes from BT, one sceptical analyst with a domestic institutional brokerage says that the net takeaway from the restructuring is that BT has got further price discounts. And as far as the committed volumes go, the analyst points out that one should take it with a pinch of salt since BT just reneged on committed volumes related to “Barcelona".

With half of the company’s overall business expected to be flat at best from current levels, the growth outlook for the company isn’t bright. The non-BT business would have to grow at double the industry growth rates just for the company to be able to match the average industry growth rate. That seems like a tall order.

In that backdrop, Tech Mahindra seems to trade at rather rich valuations, having risen by 287% from its lows in March. A large part of this is due to its investment in Mahindra Satyam Ltd. With Satyam’s shares doing well in the recent rally, even Tech Mahindra’s shares got re-rated. There is a near consensus that Satyam’s shares are overvalued, and any correction in them would lead to a drop in Tech Mahindra’s shares as well. The Satyam stake accounts for 35% of Tech Mahindra’s total valuation, assuming a holding company discount of 30%.

Excluding this, Tech Mahindra’s core business gets a valuation of 15.6 times estimated earnings for the year ended March 2011. This is based on earnings estimates of India Infoline’s institutional equities division, IIFL.

Apart from rich valuations, what works against investors is the continued uncertainty about Satyam’s financial condition.