Mindtree’s revenues rose just 0.8% sequentially in Q1, slower than most analysts’ estimates
Profit margins contracted from around 14% in the year-ago June quarter to 10% last quarter
How has Mindtree Ltd fared in the immediate aftermath of its takeover by Larsen and Toubro Ltd (L&T) and the resultant churn? It unexpectedly reported record deal wins worth $324 million in the June quarter, giving the impression that it has come out unaffected. However, this alone is unlikely to soothe investors’ nerves as there is visible strain on execution.
Revenue growth slowed across key business verticals. Total revenue rose just 0.8% from March quarter in dollar terms, slower than most analysts’ estimates. On a year-on-year basis, revenue is up 9.4%, slower than the 15-20% growth the company clocked in the preceding four quarters.
The banking, financial services (BFS), hi-tech and media segments, which together generate more than 60% of Mindtree’s revenue, saw a marked slowdown in revenue growth.
The bad news does not end there. Employee payouts to commemorate the company’s 20th anniversary and visa costs impacted profitability. Profit margins contracted four percentage points from around 14% in the year-ago June quarter to 10% last quarter. Add to this a rise in other operating expenses and the impact from a change in accounting norms, and profit in rupee terms slumped 41% from the year-ago quarter.
Analysts at worst were expecting a one percentage point year-on-year contraction in margins. As such, both the pressure on profitability and slowdown in revenue growth are higher than Street estimates. Prima facie, the change in ownership at the company is taking its toll.
It is not that investors weren’t prepared. The Mindtree stock has lost about 16% in the last two weeks after the resignation of top management personnel after the takeover by L&T. Rising employee churn amid management change can slow down business momentum, warned an analyst at a brokerage firm. This is especially true of Mindtree, which is highly dependent on discretionary spends and requires greater customer engagement. Note that employee attrition rate crossed 15% on a trailing 12-month basis.
The need of the hour is for L&T to move quickly to limit the damage. Apart from containing attrition, it needs to simultaneously decide on Mindtree’s future. As of now L&T maintains that it plans to run Mindtree independently, rather than merge it with its IT services subsidiary. However, as analysts pointed out, there is limited merit in keeping the two IT companies separate. Combining them will bring economies of scale and better management focus.
However, the current state of flux can continue to weigh on the Mindtree stock, whose valuations are not cheap. “The Mindtree story has many uncertainties on integration, attrition, continuation of independent growth charter and potential consolidation with the IT services arm of L&T. This is in addition to standard industry-wide concerns on pricing pressure, talent constraint in the US and risk of slowdown in BFS. Against this backdrop, valuations of 15.5X FY2021E earnings are fair and do not have scope for upside," analysts at Kotak Institutional Equities said in a note last week.