Mphasis: Cashing in on Hewlett-Packard

Mphasis Limited is a 61% subsidiary of EDS (“Electronic Data Systems Corp”). EDS acquired a controlling stake in Mphasis in 2006. In 2008 Hewlett-Packard Co. bought EDS for $13.9 billion and later merged its Indian operations in ‘EDS India’ with Mphasis to increase its holding to the present 61%. As EDS is a 100 per cent subsidiary of Hewlett-Packard, Hewlett-Packard is the ultimate parent of Mphasis.

Mphasis is an IT company which offers Application Services, Business Process Outsourcing Services and Infrastructure Technology Outsourcing Services. Mphasis offers solutions to industries such as banking and financial services, logistics, technology and retail. Mphasis has operations in India, USA, Europe, Asia Pacific, Japan and the Middle East. Nearly 45 per cent of the revenue is contributed through EDS-HP.

Mphasis has issued bonus share for three consecutive years (2003 to 2005) at the ratio of 1:1. During the quarter ended 31st January 2009, Mphasis added nine new clients including six relationships through HP. This includes clients in Manufacturing, Retail, Pharma & Healthcare, Banking & Financial Services, Logistics and Airline & Transportation.

The EDS-HP revenue is about 45 per cent of Mphasis’ total revenues (~$90 million), which is just 1 per cent of HP total services revenue.

Baring Private Equity Partners has increased its stake in Mphasis by 3.6 per cent to 12.2 per cent. Baring bought 7.6 Million shares in a bulk deal from Merrill Lynch Capital Markets. Baring had earlier sold 34.73 per cent stake in Mphasis to EDS in 2006, when EDS acquired a controlling stake in Mphasis.

In the 1st Quarter ended July 2009, Mphasis reported impressive results showing top-line & bottom-line growth of 42% & 128% respectively in spite of the rupee appreciation. HP – EDS still remains a large part of overall business, showing a contribution this quarter of about 10-12%. Seven clients were added in that quarter.

In Q1 E 09, there was the acquisition of AIG’s captive unit in October 09. The AIG acquisition showed some promise in Q1FY10. Going forward, the acquisition will allow greater access to the AIG business, which will also ensure some assured revenue from the previous parent. It also ensures better penetration in the insurance vertical. BFSI is an important vertical for the company which brings in ~40% revenues in this quarter. Since BFSI is the most affected vertical during the past one year, significant growth can be sought from it in revival. Mphasis seems to be well placed to pounce on this opportunity as it unfolds.

In Q4 09, top-line grew by 26% compared to Oct 08 and bottom line grew by 34% as compared to the same period.

The operating margins show a difference of almost 10% when compared to last year’s average, with current year’s margin at 26%. Some high value contracts which have been generated on Mphasis’ own merit as well as due to the association with HP appear to have contributed to the increase in margins. 16 new contracts were signed out of which 13 were on account of the HP relationship.

64% of Mphasis’ revenues came from the US while 20% came from the EU. The Middle East contributed to 16% of the revenues. Mphasis added 771 employees this quarter, primarily on account of the acquisition of AIG’s captive unit in October 09. The total employee addition this year was 4,721 which takes the count to 33,524.

HP is also one of Mphasis’ clients which contributes to 12% of revenues. This business is not a growth business since it caters to HP’s internal IT requirement and the parent is consolidating its IT expenses to rationalize its IT spend. The work farmed out to Mphasis is a small percentage of HP’s total requirement and so if that is increased, Mphasis’ profits will also increase.

It is clear Mphasis is benefiting from strong brand-equity of HP and EDS as it added several new clients through HP during the quarter. The only question is whether the shift in revenue and EPS for Mphasis was one-time or can be expected to continue.

The stock is not cheap, at about 16 times FY 10 earnings. However, leveraging its association with HP and EDS, Mphasis can be expected to do good business flows for all the verticals. Besides, with improving economic indicators all over the world, the volume growth can be expected to improve.

Key takeaways of Mphasis

(i) The Operating Profit for Q4FY09 grew by 43.37% over Q4FY08.The EBDITA margin showed a consistent growth quarter-on-quarter and stood at 27.97% for the Q4FY10. Consolidated net profit growth of 6.9% compared to the quarter ending 31 July 2009. Revenues for the same period grew by 2.4%.

(ii) In Q1FY09, the Group added 16 new clients, 13 being from the HP channel.

(iii) Banking & Financial services, Telecom, Logistics and transportation witnessed positive growth, while technology and manufacturing and retail was flat. Healthcare and Pharma witnessed dip in revenue QoQ basis. Contribution from BFSI 41% to the revenues (up by 1% QoQ). Revenue share of technology and healthcare was down to 22% and 7% from 23% and 8% QoQ.

(iv) The revenue contribution from US increased 14.27% at Rs 719 crore (66% of revenues), Europe increased 32.55% at Rs 225.6 Cr (20% of revenues), APAC grew 145.66% YoY at Rs 96.3 crore (6% of revenues) and India & Middle East dipped 20.45% at Rs 80 crore (8% of revenues). This growth is attributed to strong linkage of the company with EDS-HP. The revenue from these geographies may be expected to grow though at a slower pace.