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Investors see Tech Mahindra shares gaining momentum

LiveMint logoLiveMint 08-03-2017 Mobis Philipose

Tech Mahindra Ltd has made another acquisition with the aim to cross-sell its services to a new set of clients. It said on Monday it has acquired CJS Solutions Group Llc, a US-based healthcare information technology consulting firm that does business as the HCI Group.

The enterprise value of $110 million seems reasonable, given HCI’s trailing 12-month revenue of $114 million. Besides, the US-based firm has grown by as much as 28% annually in the past two years. Of course, operating margin is low at high single-digit levels, but this is typical of US-based tech firms. And it seems unlikely that Tech Mahindra can bring about a meaningful improvement in margins, considering that HCI’s work is mostly done on site.

Analysts at Jefferies India Pvt. Ltd said in a note to clients, “We believe that the nature of work that HCI does in the US provides limited opportunity for offshorability. While some margin benefits might still be realized on the back of cost cutting and other efficiencies, the major benefit due to offshoring will not materialize.”

The big idea behind the acquisition then appears to be the ability to cross-sell Tech Mahindra’s services to a new set of clients. The company has almost no exposure to the healthcare provider space, and the acquisition will give access to 30 new clients. Overall, the healthcare and life sciences vertical contributes less than 5% to its revenues.

Jefferies’ analysts point out that the acquisition is on the same lines as two previous acquisitions in 2016—Target and Bio Agency—where a specific expertise was acquired with the cross-sell of existing services being the major incremental positive.

Alongside the company’s penchant for mergers and acquisitions, the performance of its organic business has also picked up in the past two quarters. In turn, this has got investors excited. Since it announced Q2 results in end-October, Tech Mahindra’s shares have risen by around 20%, far higher than the 7% gain in the Nifty IT index.

In the process, its valuations have risen to 15.6 times estimated fiscal year 2017 earnings, only slightly lower than Infosys Ltd’s 16.2 times valuation. While the better-than-expected growth in the past quarters suggests Tech Mahindra is firmly on the recovery path, not everyone is convinced. Analysts at Nomura Research said in a note to clients, “We see the telecom (~47% of revenues) segment to be stable but not in a material rebound scenario, with likely near-term headwinds from LCC (Lightbridge Communications Corp.) restructuring and non-recurrence of milestone payments (which aided growth in Q3)... Overall, we look for 8% EPS CAGR over FY17-19F (after a 3% decline in FY17).” EPS is short for earnings per share and CAGR stands for compound annual growth rate.

If earnings growth ends up being in single digits, as Nomura expects, the mid-teens price-earnings multiple looks overdone.

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