The Hindu Business Line : MphasiS BFL: Buy

Though the stock has run-up by 10 per cent in the homestretch to the earnings announcement on January 10, improvement in fundamentals and greater predictability — both in IT services and BPO — raise confidence in the stock.

The company also appears to be on track to meeting its earnings guidance of 30 per cent in 2005-06. At the current price levels, the stock trades at a price-earnings multiple of 15 times its expected per share earnings for FY-06.

The improvement in performance/margins in IT services in the second quarter of 2005-06, good showing expected in voice-based BPO in the coming quarters and focus on non-voice-based platform BPO as an engine of future growth are positive drivers of the stock. With Barings India Private Equity, one of the biggest shareholders in the company, deciding to retain its equity stake after putting its 35.6 per cent holding on the block, the relatively turbulent phase is behind MphasiS.

As consolidation in the mid-cap space is likely to continue for a while, the possibility of acquisition-related upsides in the stock should not be ignored.

Recently, the company proposed a buyback of up to 10 per cent of the equity after April 10, 2006.

While the mode of buyback and the price would be decided closer to the D.date, this move signals confidence and can act as a cushion for the stock price in the coming months.

On the flip side, however, the company is still refining its business model, especially on the BPO side. Its ability to sustain the volume growth in IT services holds the key to topline growth.

As the operating profit margins have improved by four percentage points in the latest quarter, maintaining the margins at these levels will be critical to overall earnings growth. This will be watched closely as domestic BPO business from Bharti start contributing to the top and bottomline.

Based on the performance in the first half and the latest quarter of 2005-06, the factors that will be closely watched in the two key segments are:

IT Services: The revenues from this segment rose by about 5.5 per cent on a sequential basis, while the segmental profits improved sharply by 19 per cent, on account of rationalisation of costs under different heads.

The segment profit margins also improved by nearly four percentage points on a sequential basis. The volume growth in the IT services business has been encouraging, with revenues from the top client rising to 17 per cent.

The number of $1-million clients has also increased to 27 from 25 in the previous quarter. The offshore contribution has improved by two percentage points to 42 per cent.

BPO: The BPO revenue growth remained sluggish, with a 0.7 per cent decline on a sequential basis. The sluggishness was evident from the contribution of the top client that declined to 17 per cent from 20 per cent the previous quarter.

The number of $5-million clients has also dipped in the latest quarter. In marked contrast, the employee addition remained robust at over 1200 in this quarter, with another 1,500 to be added in the second half

of 2005-06. As the domestic BPO business is likely to start contributing to the topline in the next two quarters, the revenue growth is expected to look up. Besides this, contribution from a North American bank is also expected to ramp up in the coming quarter.

The company plans to focus on platform-based solutions in the area of tax return management, mortgage loans and insurance claims. In the latest quarter, MphasiS has got access to a platform from a large financial

institution in the UK, which is focussed on risk management. Using this, the company plans to develop niche solutions in several areas.

The developments on this front will be watched closely, as the intellectual property developed using the platform can offer greater flexibility in client pricing and contribute to higher margins in the medium term.

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