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Mphasis – Playing on technology tailwind


Company Name – Mpahsis Limited (Mphasis)


Current Share Price – INR 2,029 (January 11, 2023)


Market Cap – INR 38,211 cr


 

1. What is interesting about the stock?

Pass the parcel is a classic British party game in which a parcel is passed from one person to another. Mphasis is like that parcel that has changed hands multiple times – directly or indirectly:

  • Founded in 1998 by Jerry Rao and Jeroen Tas

  • Acquired BFL Software in 2000

  • Electronic Data Systems Corporation (EDS) acquired Mphasis in 2006

  • Hewlett-Packard (HP) bought EDS in 2008 and renamed EDS as HP Enterprise Services

  • HP sold Mphasis to Blackstone, a private equity fund, in September 2016

  • Blackstone rolled over the investment to a new global fund and Asia fund along with co-investment by ADIA, GIC, and UC Investments (manages retirement and endowment assets of the University of California)

Mphasis is a global Information Technology (IT) solutions provider specializing in providing cloud and cognitive services, applying next-generation technology to help enterprises transform businesses globally. Company provides IT/ ITeS/ BPO services to clients in the banking and capital markets, emerging industries, IT, communication and entertainment, and insurance sectors. The Company derives its revenues primarily from software services and projects, licensing arrangements and application services, as well as infrastructure outsourcing services. The company is present across North America, Europe, South Asia, and Asia Pacific.


Mphasis standalone business stagnated after the EDS acquisition. Under its deal with HP, Mphasis not only worked with HP as a client but was also effectively a sub-contractor, getting business with HP clients and having a negotiated rate card. At the end of FY10, the HP channel accounted for about 70% of Mphasis’s revenue. It also impacted Company’s business development capabilities. When Blackstone acquired the Company in 2016, they negotiated a minimum revenue commitment (USD 990 million over 5 years) to alleviate the complete loss of business from HP and get some time to restart the business development activities. Since then the Company has been able to increase the non-HP (or direct business) to ~95% in Q2FY23.


Sector-wise revenue breakup in Q2FY23 was:

  • Banking & Financial Services – 54%

  • Telecom, Media, and Technology (TMT) – 13%

  • Logistics and Transportation – 13%

  • Insurance – 8%

  • Others – 12%

Geography-wise revenue break-up in Q2FY23 was:

  • Americas – 82%

  • EMEA – 10%

  • Rest of the world – 8%

Mphasis serves marquee customers across the globe including six top global banks, 11 out of 15 top mortgage lenders, and three top global insurance companies. Dependence on the mortgage players in the US has exposed the Company to risk in the current environment when interest rates are rising, leading to a nosedive in the US housing market and mortgage market.


Given the Blackstone Group’s parentage and Blackstone’s fresh commitment of 5-7 years, Mphasis has access to its investment portfolio and the company has leveraged the same since its acquisition. With Blackstone expanding its assets under management across verticals and geographies, new opportunities for client wins shall continue for Mphasis. Further, Mphasis is the only IT services company in Blackstone’s entire global portfolio, positioning it quite uniquely.

With Abu Dhabi Investment Authority (ADIA), GIC (sovereign wealth fund of Singapore), and University of California (UC) Investments recently picking up a stake in Mphasis, the company is likely to gain access to the investment portfolio of these investors as well.


Why invest in Mphasis?

  • Established a position in the industry with a credible track record

  • Access to Blackstone portfolio companies

  • Strong financial position – high ROCE/ROE and a cash balance of ~ INR 2,800 cr

2. Key Historical Financials


  • Company revenue and net profit have grown 15% and 12% respectively over the last 5 years

  • EBITDA margin has been around 18-19% which is lower than Tier 1 players like TCS and Infosys

  • Cash flow conversion (CFO/EBITDA) has been healthy at ~80%

  • ROCE and ROE also have been strong

3. What is my view on company valuation?


Share price has increased 2.5x in the last 5 years vs. a 1.8x increase in the net profit implying multiple expansions.


Company trades at P/E (TTM) multiple of 24x vs a 5-year average P/E ratio of 17x. Mphasis trades at a discount compared to other mid-tier IT players like Persistent Systems (37x) and Coforge (32x) and large IT players like TCS (30x) and Infosys (27x). Over the last 3 years, the discount of mid-tier IT companies vs the large-cap players has come down significantly!


Increasing IT spending is lifting all the boats globally. However, the stock looks expensive in the challenging macro backdrop in the US.


4. What are the risks to the investment analysis?


Risks to the analysis are:

  • Company has high geographical, sector, and customer risk

  • Low pricing power

  • Exposed to exchange rate risks

 

About the Author


I have over 17 years of experience in venture capital, private equity, and investment banking in India and the Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in the Middle East, to look after investments, M&A, and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB), and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.


I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).


I am an Insignificant Investor in the public market and co-founder of SocInvest.


Disclosure


I have had no stock, option, or similar derivative position in any of the companies mentioned in the last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.


I am not a SEBI registered advisor. This article is purely for educational purposes and is not to be construed as investment advice. Please consult your financial advisor before acting on it.


I have used publicly available information while writing this article.

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