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INSTITUTIONAL EQUITY RESEARCH Page | 1 | PHILLIPCAPITAL INDIA RESEARCH Please see penultimate page for additional important disclosures. PhillipCapital (India) Private Limited. (“PHILLIPCAP”) is a foreign broker-dealer unregistered in the USA. PHILLIPCAP research is prepared by research analysts who are not registered in the USA. PHILLIPCAP research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities Inc, an SEC registered and FINRA-member broker-dealer. IT Services LTI & MTCL – Buy the next IT behemoth in its infancy INDIA | IT SERVICES | Sector Update 18 June 2020 M&A in IT Services – we predicted it FIVE years ago! Five years ago, we had predicted heightened M&A activity in the IT midcap space (read here). In December 2019, we doubled down on the thesis (read here), and predicted the merger of Mindtree with LTI. We pat ourselves for having foreseen this highly hypothetical scenario well ahead. Over the last five years, multiple midcap IT companies (iGate, GSSL, Polaris, KPIT, Mphasis, Mindtree) have seen M&A activity; LTI and MTCL’s merger is now an inevitability (read here). L&T Infotech + Mindtree – creating a Rs 700bn IT behemoth with 53% returns over next 2 years We see LTI+MTCL breaking into the top-5 club of the Indian IT sector over the next two years. In the last decade, only TechM has managed to break into the club – and that was driven by its merger with Satyam. LTI+MTCL will lead to the formation of $3.5bn IT Services Company by FY24, with a significantly superior profile to TechM – higher growth, higher margins, higher ROEs. In fact, LTI+MTCL have the highest revenue CAGR in the industry over FY19-22 and the second- highest ROE. While the combined entity currently is only half of TechM’s revenue, it already is at 97% of its market-cap. Our base-case scenario assumes LTI+MTCL to report 12% USD revenue CAGR over FY22-24, and 16% EBIT margins in FY24. If it is valued at 18x FY24 PE in FY22 (currently LTI/MTCL are trading at 18x/17x two-year forward PE), it would have a market-cap of Rs 700bn (currently Rs 466bn) – translating into whopping 46% returns over the next two years. A perfect merger with little overlap – dream combination for any management LTI+MTCL is a dream merger for any management. The two companies have a highly complementary profile with very little business overlap. LTI has a very strong base in BFSI (44% of revenue) while MTCL is very strong in Retail (20%). Hi-tech/Media remains very strong for both companies. After merging, the entity would have a diversified revenue profile – across BFSI, Manufacturing, Retail and Hitech – very similar to large-caps. LTI+MTCL would also have minimal client overlap. Among their top-25 clients, we found only one in common; all others were mutually exclusive, giving the entity a highly exhaustive coverage of all verticals. The merger will also address the issue of client concentration – top-client share of the merged entity will fall to 9% of revenues (currently 22%/13% for MTCL/LTI). LTI and MTCL also have very similar employee metrics and profiles: (1) both hire candidates from the same colleges for equivalent profiles, (2) have similar salary levels (only 4% variance), (3) have matching revenue productivity (only 2% variance), and (4) have comparable onsite/offshore mix. Merger synergies can be HUGE – leading to much better financials than expected LTI has been the fastest growing IT company for the last two years and likely to remain in the leader’s quadrant for next two, while MTCL should see significant margin expansion over the next two years, with multiple margin levers. LTI / MTCL both have very strong profiles in Hi- tech/Media – forming 11% / 43% of their revenues. Both have a coveted list of clients, with almost no overlap. Technology domain is likely to be one of the biggest beneficiaries in a post- Covid world, which augurs very well for LTI+MTCL, with their strong presence in this domain. We foresee highly smooth integration of the two workforces with synergies from: (1) lower G&A expenses, (2) redistribution of sales/marketing teams, (3) lower bench strength requirement, and (4) lower subcontracting costs. We find LTI has a relatively efficient cost structure, with employees cost as % of revenue being 500bps lower than MTCL – an area in which the merged entity could expand its margins. Even with location of delivery centres, LTI+MTCL have an amazingly complementary profile, with only 4 common locations in the US (6/4 in EU/ROW). Own the next IT behemoth in its infancy – can play through either LTI or Mindtree We recommend investors seize this opportunity and own the next IT behemoth in its infancy to make handsome returns over the next two years. They can choose to play this theme through either LTI or MTCL, as both are trading at similar valuations (LTI 18x, MTCL 17x FY22 PE) and hence offer a similar investment return path. We upgrade our target multiple for LTI to 20x (18x earlier) and MTCL to 19x (18x earlier). Maintain BUY on both the name. We also upgrade our target multiple and price targets slightly, for all largecaps (excl TechM). Companies L&T Infotech Buy CMP 1880 TP (↑) 2120 MindTree Buy CMP 909 TP (↑) 1050 TCS Buy CMP 2036 TP (↑) 2420 Infosys Buy CMP 713 TP (↑) 870 Wipro Neutral CMP 218 TP (↑) 220 HCL Tech Buy CMP 578 TP (↑) 640 Tech Mahindra Sell CMP 536 TP (↔) 440 L&T Technology Services Neutral CMP 133 TP (↔) 1140 Cyient Sell CMP 217 TP (↔) 165 NIIT Technologies Neutral CMP 1372 TP (↔) 1315 Persistent Systems Neutral CMP 584 TP (↔) 500 Mphasis Buy CMP 859 TP (↔) 970 Hexaware Neutral CMP 323 TP (↔) 330 Vibhor Singhal, Research Analyst (+ 9122 6246 4109) [email protected] Karan Uppal, Research Analyst (+ 9122 6246 4106) [email protected]

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  • INSTITUTIONAL EQUITY RESEARCH

    Page | 1 | PHILLIPCAPITAL INDIA RESEARCH Please see penultimate page for additional important disclosures. PhillipCapital (India) Private Limited. (“PHILLIPCAP”) is a foreign broker-dealer unregistered in the USA. PHILLIPCAP research is prepared by research analysts who are not registered in the USA. PHILLIPCAP research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities Inc, an SEC registered and FINRA-member broker-dealer.

    IT Services LTI & MTCL – Buy the next IT behemoth in its infancy

    INDIA | IT SERVICES | Sector Update

    18 June 2020

    M&A in IT Services – we predicted it FIVE years ago! Five years ago, we had predicted heightened M&A activity in the IT midcap space (read here). In December 2019, we doubled down on the thesis (read here), and predicted the merger of Mindtree with LTI. We pat ourselves for having foreseen this highly hypothetical scenario well ahead. Over the last five years, multiple midcap IT companies (iGate, GSSL, Polaris, KPIT, Mphasis, Mindtree) have seen M&A activity; LTI and MTCL’s merger is now an inevitability (read here).

    L&T Infotech + Mindtree – creating a Rs 700bn IT behemoth with 53% returns over next 2 years We see LTI+MTCL breaking into the top-5 club of the Indian IT sector over the next two years. In the last decade, only TechM has managed to break into the club – and that was driven by its merger with Satyam. LTI+MTCL will lead to the formation of $3.5bn IT Services Company by FY24, with a significantly superior profile to TechM – higher growth, higher margins, higher ROEs. In fact, LTI+MTCL have the highest revenue CAGR in the industry over FY19-22 and the second-highest ROE. While the combined entity currently is only half of TechM’s revenue, it already is at 97% of its market-cap.

    Our base-case scenario assumes LTI+MTCL to report 12% USD revenue CAGR over FY22-24, and 16% EBIT margins in FY24. If it is valued at 18x FY24 PE in FY22 (currently LTI/MTCL are trading at 18x/17x two-year forward PE), it would have a market-cap of Rs 700bn (currently Rs 466bn) – translating into whopping 46% returns over the next two years.

    A perfect merger with little overlap – dream combination for any management LTI+MTCL is a dream merger for any management. The two companies have a highly complementary profile with very little business overlap. LTI has a very strong base in BFSI (44% of revenue) while MTCL is very strong in Retail (20%). Hi-tech/Media remains very strong for both companies. After merging, the entity would have a diversified revenue profile – across BFSI, Manufacturing, Retail and Hitech – very similar to large-caps.

    LTI+MTCL would also have minimal client overlap. Among their top-25 clients, we found only one in common; all others were mutually exclusive, giving the entity a highly exhaustive coverage of all verticals. The merger will also address the issue of client concentration – top-client share of the merged entity will fall to 9% of revenues (currently 22%/13% for MTCL/LTI). LTI and MTCL also have very similar employee metrics and profiles: (1) both hire candidates from the same colleges for equivalent profiles, (2) have similar salary levels (only 4% variance), (3) have matching revenue productivity (only 2% variance), and (4) have comparable onsite/offshore mix.

    Merger synergies can be HUGE – leading to much better financials than expected LTI has been the fastest growing IT company for the last two years and likely to remain in the leader’s quadrant for next two, while MTCL should see significant margin expansion over the next two years, with multiple margin levers. LTI / MTCL both have very strong profiles in Hi-tech/Media – forming 11% / 43% of their revenues. Both have a coveted list of clients, with almost no overlap. Technology domain is likely to be one of the biggest beneficiaries in a post-Covid world, which augurs very well for LTI+MTCL, with their strong presence in this domain.

    We foresee highly smooth integration of the two workforces with synergies from: (1) lower G&A expenses, (2) redistribution of sales/marketing teams, (3) lower bench strength requirement, and (4) lower subcontracting costs. We find LTI has a relatively efficient cost structure, with employees cost as % of revenue being 500bps lower than MTCL – an area in which the merged entity could expand its margins. Even with location of delivery centres, LTI+MTCL have an amazingly complementary profile, with only 4 common locations in the US (6/4 in EU/ROW).

    Own the next IT behemoth in its infancy – can play through either LTI or Mindtree

    We recommend investors seize this opportunity and own the next IT behemoth in its infancy to

    make handsome returns over the next two years. They can choose to play this theme through

    either LTI or MTCL, as both are trading at similar valuations (LTI 18x, MTCL 17x FY22 PE) and

    hence offer a similar investment return path. We upgrade our target multiple for LTI to 20x (18x

    earlier) and MTCL to 19x (18x earlier). Maintain BUY on both the name. We also upgrade our

    target multiple and price targets slightly, for all largecaps (excl TechM).

    Companies L&T Infotech Buy CMP 1880 TP (↑) 2120

    MindTree Buy CMP 909 TP (↑) 1050

    TCS Buy CMP 2036 TP (↑) 2420

    Infosys Buy CMP 713 TP (↑) 870

    Wipro Neutral CMP 218 TP (↑) 220

    HCL Tech Buy CMP 578 TP (↑) 640

    Tech Mahindra Sell CMP 536 TP (↔) 440

    L&T Technology Services Neutral CMP 133 TP (↔) 1140

    Cyient Sell CMP 217 TP (↔) 165

    NIIT Technologies Neutral CMP 1372 TP (↔) 1315

    Persistent Systems Neutral CMP 584 TP (↔) 500

    Mphasis Buy

    CMP 859

    TP (↔) 970

    Hexaware Neutral CMP 323 TP (↔) 330 Vibhor Singhal, Research Analyst (+ 9122 6246 4109) [email protected] Karan Uppal, Research Analyst (+ 9122 6246 4106) [email protected]

    http://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Midcaps_Sector_Update_-_Sept_2014_20140925172452.pdfhttp://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Sector_Report_-_Dec_2019_-_Midcap_20191212124503.pdfhttps://www.business-standard.com/article/companies/l-t-plans-to-become-asset-light-reduce-debt-by-rs-30-000-crore-120030500078_1.htmlmailto:[email protected]:[email protected]

  • Page | 2 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    M&A in IT Services – we predicted it FIVE years ago! Five years ago, we published a report (read here) where we highlighted that most midcap IT companies will find it difficult to withstand competition in the rapidly evolving technology landscape and (hence) might look to sell themselves out over the next few years. We had also hypothesized that IF one or more of these midcap IT companies could be merged (perhaps facilitated by PE owners), it could lead to the formation of a formidable IT company that could perform much better than its individual components, and would also command a valuation premium. We had analysed this by taking five niche midcap IT companies with significant PE presence. We then created four hypothetical Integrated Entities (IEs), merging three different midcap companies from this set, and then analysed the overall profile of these IEs with respect to clients, revenue diversification, and operating margins. Our analysis had revealed that the hypothetical integration would have led to the formation of well-diversified full-service IT companies with a sizeable revenue base; ones that were capable of maintaining their competitive edges in niche domains. Their profiles would have been very similar to the profiles of the top-5 players, which would have led to them being significantly rerated.

    We predicted M&A activity in the IT midcap space in 2014

    Source: PhillipCapital India Research We give ourselves a little pat for having predicted this highly hypothetical scenario five years ago (well ahead) accurately. Over the last few quarters, promoters of multiple midcap companies (Mindtree, NIIT Tech, KPIT) have exited their businesses. In fact, over the last four years, multiple midcap IT companies have either merged with larger IT companies (iGate, Geometric, Polaris, KPIT, Syntel) or have sold significant promoter stake to PE investors (Hexaware, Mphasis, Zensar). In December 2019, we doubled down on this thesis, and released the second part of our “One + One = Eleven” report (read here). In that report, we highlighted our expectations of further M&A activity in the sector, and predicted mergers of LTI with Mindtree, and Hexaware with NIIT Tech. True to our thesis, the CEO of L&T group, Mr. S.N.Subramanaiam, talked about an eventual merger of the two entities in a year or two years (read here). We have long maintained the merger of LTI and MTCL to be an inevitability. In this report, we highlight how we believe this merger could pave way for the formation of an IT behemoth, which could soon displace underperforming largecaps (like Wipro, TechM) from the “Top 5” category, and in the process, would generate handsome returns for investors.

    HEXW,13.9

    NITEC,8.2

    KPIT,9.4

    POL,9.1

    Cyient,12

    INFO,16.1

    TCS,19.3

    HCLT,14.5

    Wipro,13.9

    TechM,15.6

    KNP,11.5

    HKN,14.7

    HKC,14.4

    NPC,12.5

    P/E

    (x)

    Top 5 client concentration (%)

    Low

    High

    LowHigh

    Our report One + One = Eleven (Part 2)

    Our report One + One = Eleven (Part 1)

    http://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Midcaps_Sector_Update_-_Sept_2014_20140925172452.pdfhttp://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Sector_Report_-_Dec_2019_-_Midcap_20191212124503.pdfhttps://www.business-standard.com/article/companies/l-t-plans-to-become-asset-light-reduce-debt-by-rs-30-000-crore-120030500078_1.html#:~:text=L%26T%20plans%20to%20become%20asset%20light%2C%20reduce%20debt%20by%20Rs%2030%2C000%20crore,-Amritha%20Pillay%20%http://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Sector_Report_-_Dec_2019_-_Midcap_20191212124503.pdfhttp://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Midcaps_Sector_Update_-_Sept_2014_20140925172452.pdfhttp://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Sector_Report_-_Dec_2019_-_Midcap_20191212124503.pdfhttp://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Midcaps_Sector_Update_-_Sept_2014_20140925172452.pdfhttp://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Sector_Report_-_Dec_2019_-_Midcap_20191212124503.pdfhttp://backoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_IT_Midcaps_Sector_Update_-_Sept_2014_20140925172452.pdf

  • Page | 3 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Mergers creating value Indian IT companies have typically been averse to making large acquisition. Part of it stems from their risk aversion, but majorly from the confidence in their intrinsic ability to keep growing organically. Overseas IT companies on the other hand (Accenture, CapGemini, Cognizant, DXC, etc,) have been more ‘adventurous’ and have made multiple large acquisitions.

    Recent M&A transactions in Europe Capgemini – Altran Tieto - EVRY DXC - Luxoft

    Date of Announcement June 24, 2019 June 18, 2019 January 7, 2019

    Expected completion December 2019 December 2019 June 2019

    Acquirer Capgemini Tieto Corp DXC Technology

    Sales € 13.2bn € 1.6bn $ 20.7bn

    EBIT Margins 12.1% 9.7% 8.3%

    Employees 211,000 15,000 130,000

    HQ France Finland US

    Target Altran Technologies EVRY Luxoft Holding

    Sales € 2.9bn € 1.3bn $ 907mn

    EBIT Margins 12.1% 7.9% 6.6%

    Employees 47,000 8,800 13,000

    HQ France Norway Switzerland

    Consideration € 14 per Altran share 0.12 shares in Tieto and NOK 5.28 in cash $59 per Luxoft share

    EV € 5.0bn (incl Debt of € 1.4bn) € 1.38bn (incl cash consideration of € 0.2bn) $2bn

    EV/Sales 1.7x 1.1x 2.2x

    Source: Companies, PhillipCapital India Research In the last decade, there have only been two large mergers (or acquisitions) in the Indian IT services sector. And both the events led to the formation of strong entities that turned out to be much more successful than the acquiring companies.

    Tech Mahindra = Tech Mahindra + Satyam Tech Mahindra’s transition from a midcap telecom solutions vendor to one among the top-5 (listed) IT companies in India was a result of its merger with Satyam. Before the merger, TechM had strong vertical and client concentration, which was a major cause of its sluggish growth over FY10-11. Telecom, its single largest vertical, accounted for 97% of its revenues, and BT, its largest client, for 45%. The company had reported only 9% revenue CAGR over FY10-12, with an EBITDA-margin contraction of 770bps.

    TechM: Clear indication of re-rating after merger with Satyam

    Source: Bloomberg, PhillipCapital India Research

    6x

    12x

    18x

    24x

    0

    100

    200

    300

    400

    500

    600

    700

    800

    900

    Jan

    -07

    Jan

    -08

    Jan

    -09

    Jan

    -10

    Jan

    -11

    Jan

    -12

    Jan

    -13

    Jan

    -14

    (Rs) Pre- Satyam Post- Satyam

  • Page | 4 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Its merger with Satyam in 2013 led to a dilution of its clientele and vertical concentration, thereby reducing its business risks. The evolution of TechM from a telecom services vendor to a fully equipped end-to-end service provider resulted in strong revenue CQGR of 4.2% over Q1FY13-Q1FY15. Its focus verticals – telecom, BFSI, manufacturing, and retail – all saw above-industry-average growth in this period. Its margins, too, improved by a robust 450bps after the merger. Satyam’s acquisition led to the belief that TechM would now be able to bag large deals across verticals, leveraging its expertise in telecom along with Satyam’s enterprise-level outsourcing capabilities. The belief also led to the traditional ‘Top-4’ bracket in the Indian IT services space expanding to ‘Top-5’. The markets, too, rewarded the company with a significant rerating in multiple, from 6-8x pre acquisition to touch 15-16x post acquisition.

    Birlasoft = Birlasoft + KPIT (IT Services) In January 2018, KPIT Technologies and Birlasoft announced their plans to merge their IT Services businesses – to create two separately listed entities:

    KPIT’s engineering business ($220mn)

    Merged entity comprising of KPIT’s IT Services ($350mn) and Birlasoft ($125mn) KPIT’s IT Services business (mainly comprising of SAP/Oracle implementation) and Birlasoft’s IT business (primarily BFSI and healthcare) were struggling independently. While KPIT’s engineering business continued to prosper, its SAP/Enterprise business was continuously dragging overall growth. At the same time, Birlasoft, due to its small size, was not able to capitalize on large deals and customers. A demerger of the engineering business from KPIT meant that the management could focus on the engineering business. At the same time, the merger of Birlasoft with KPIT’s IT Services business provided Birlasoft the scale (combined entity revenue of $500mn vs. earlier revenue of $125mn) that it needed for it to grow in that domain.

    The merger-demerger process of KPIT Tech and Birlasoft (FY18 numbers)

    Source: Companies, PhillipCapital India Research Post this merger-demerger both new entities – KPIT and Birlasoft – have been doing really well. While KPIT reported strong FY20 with 14% yoy in CC growth in revenues, Birlasoft bagged its largest deal ever (at $240mn), paving the way for strong growth in the future.

  • Page | 5 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    L&T Infotech + Mindtree – Creating an IT behemoth In March 2019, the L&T group – in a surprising but not entirely unexpected move – entered into a share-purchase agreement with V.G. Siddhartha and Coffee Day Group to acquire their 20.15% stake in Mindtree. It raised its stake further through open-market purchases and open offer, acquiring 60.55% of Mindtree’s total equity.

    In our December 2019 report, we had highlighted LTI + Mindtree as a “highly likely” merger, with the synergies between the two being too large to ignore. Initially, L&T’s management (as well as LTI and MTCL’s managements) had indicated that MTCL would remain an independent listed entity and ruled out any merger between the two. However, our stand was validated by the L&T Group CEO & MD, Mr. S N Subrahmanyan, a few months after our report. In an interview, he said “ultimately, the plan is to merge Mindtree and L&T Infotech once the new management settles down, but the merger is still one or two years away,”. Read it here.

    A Rs 700bn IT behemoth, by FY22 – on conservative estimates We believe that the LTI and MTCL merger, which we expect will happen sooner than everyone anticipates, will lead to the formation of a $3.5bn IT Services company – on conservative estimates. This $3.5bn entity, if it continues to command the current multiple enjoyed by its constituents, would easily achieve a market-cap of Rs 700bn.

    LTI + MTCL merger in numbers

    LTI + MTCL merger in numbers Company Particulars ($mn/Rsmn) FY20 FY21E FY22E FY23E FY24E

    LTI USD Rev 1,525 1,525 1,708 1,913 2,142

    Yoy Growth 13.0 -0.0 12.0 12.0 12.0

    EBIT 17,561 17,637 21,398

    EBIT Margins (%) 16.1 15.4 16.5

    PAT 15,199 15,241 18,453

    MTCL USD Rev 1,089 1,052 1,158 1,296 1,452

    Yoy Growth 8.7 -3.4 10.0 12.0 12.0

    EBIT 7,869 9,003 11,116

    EBIT Margins (%) 10.1 11.4 12.6

    PAT 6,309 7,178 9,091

    LTI + MTCL USD Rev 2,613 2,577 2,865 3,209 3,594

    Yoy Growth 11.2 -1.4 11.2 12.0 12.0

    EBIT 25,430 26,640 32,514 38,304 44,859

    EBIT Margins (%) 13.6 13.8 14.9 15.5 16.0

    PAT 21,508 22,419 27,543 32,201 37,813

    Market Cap (Rs bn) 466 681 PE (x) 18x FY22 PE (implied) 18x FY24 PE (target)

    Source: PhillipCapital India Research (*Our USD-INR assumption of 75/76/77/78 for FY21/22/23/24)

    https://www.business-standard.com/article/companies/l-t-plans-to-become-asset-light-reduce-debt-by-rs-30-000-crore-120030500078_1.html

  • Page | 6 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Indian IT Services – a skewed landscape The Indian IT services sector appears to be a skewed landscape right now with six “mega” companies with revenues in $5bn-20bn range and a plethora of “mid-cap” companies in the $500mn-1bn range. The mega companies have typically dominated the big-ticket enterprise deals, while the midcaps have been focussing on smaller, complex deals in niche domains. Over the last decade, only one company has managed to migrate from one “band” to the other – TechM. And that too was driven by its acquisition of Satyam – a company much larger than its own size. Now, we have another IT company, with revenues approaching $3bn aspiring to break into the “mega” companies’ club – the combined entity of LTI and Mindtree.

    Skewed landscape of Indian IT services

    Source: PhillipCapital India Research

    The Nifty paradox – what is the substitute for Wipro? Currently, the weightage of the IT sector in Nifty is 14.7%, comprising Infosys (6.4%), TCS (5.2%), HCL Tech (1.5%), Wipro (0.8%), and TechM (0.8%). Wipro has been a laggard for many years now, significantly underperforming all its largecap peers in stock returns as well as growth. If investors wish to remain underweight in Wipro, there is no substitute as most midcap companies (including LTI and MTCL individually) are quite small, and have high revenue concentration risk. LTI + MTCL offers a much larger business, without the traditional risks associated with IT midcaps. In that sense, it offers a lucrative alternative for investors as a substitute to Wipro.

    IT sector holds 14.7% weight in Nifty, dominated by Infosys and TCS

    Source: PhillipCapital India Research

    TCS

    CTSH

    Infosys

    HCLT

    Wipro

    TechM

    LTI

    Mphasis Hexaware

    LTTS

    Cyient

    NIIT Tech

    Persistent

    MindTree LTI+MTCL

    0

    5

    10

    15

    20

    25

    400 4,000

    PE

    (x)

    USD revenue ($ mn) - 700 3,000 8,000 20,000

    Financials , 33.3%

    IT, 14.7%

    Oil & Gas, 14.3%

    FMCG, 10.6% Auto, 5.6%

    Industrials, 4.1%

    TCS, 5.2% Infosys, 6.4%

    HCL Tech, 1.5% Wipro, 0.8%

    Tech Mahindra, 0.8%

    Nifty

    IT

    Industrials Telecom/Media Pharma DiscretionaryMetals & Mining Power Cements Agri Chemicals

    Nifty IT break-up

  • Page | 7 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Wipro has significantly underperformed its largecap peers Company Stock returns USD Revenue CAGR

    3 year 5 year 10 year 3 year 5 year 10 year

    TCS 68% 62% 462% 8% 7% 13%

    Infosys 51% 41% 117% 8% 8% 10%

    Wipro 8% 3% 68% 1% 2% 5%

    HCL Tech 34% 23% 531% 13% 11% 14%

    Tech Mahindra 53% 6% 230% 6% 7% 18%

    Set to enter the ‘Top – 5’ club The combined LTI + MTCL entity – while currently half of TechM’s revenue – is already at 97% of the latter’s market cap. This huge divergence is attributable to the former’s significantly superior profile in terms of higher growth, margins, and ROEs, leading to a higher multiple. In fact, LTI + MTCL has the highest revenue CAGR over FY19-22 in the industry and the second highest ROE (second only to TCS).

    LTI + MTCL is already almost touching the “Top-5” Company USD Revenue ($ mn) PAT (Rs mn) Rev CAGR ROE Mcap

    FY20 FY20 FY19-22 FY20 Current (Rs mn)

    TCS 22,032 3,23,400 3.0% 38% 7,635

    Infosys 12,781 1,67,640 4.7% 25% 3,101

    Wipro 8,256 97,234 1.4% 17% 1,310

    HCL Tech 9,936 1,10,940 7.9% 21% 1,568

    Tech Mahindra 5,182 40,330 2.5% 18% 500

    LTI 1,525 15,199 8.2% 28% 327

    MindTree 1,089 6,309 4.9% 20% 149

    LTI + Mindtree 2,613 21,508 6.8% 25% 476

    % of TechM 50% 53% - - 97%

    Source: PhillipCapital India Research

    Historically, companies have grown rapidly post $2.5bn While we propose our thesis of LTI + MTCL becoming one of the Top-5 by FY24, we do foresee it happening much earlier. And the primary reason for that is the strong growth companies are able to report once they hit the critical $2.5bn revenue mark. Historically, IT Services companies have taken, on an average, four years to double their revenues from $2.5bn to touch $5bn. The fastest amongst them was TCS (only 2 years) but this can be attributed to lower outsourcing penetration in those years. Infosys and Wipro got delayed by the GFC crisis. TechM took the longest time (7 years) as it struggled to manage its LCC acquisition. Even on a quarterly basis, companies have taken only 13 quarters (on an average) to reach $1.25bn (the run-rate required for $5bn annual revenues) from the current revenue base of LTI+MTCL ($700mn).

    Time taken to double revenue from $2.5b to $5.0bn (Annual and quarterly) Revenue $2.5bn $5.0bn No of years $700mn $1250mn No of qurtrs CQGR

    TCS FY06 FY08 2.0 3QFY06 1QFY08 6.0 10.1%

    Infosys FY07 FY11 4.0 2QFY07 4QFY10 14.0 4.2%

    Wipro FY08 FY11 3.0 1QFY11 1QFY14 12.0 5.0%

    HCL Tech FY10 FY14 4.0 1QFY08 2QFY11 13.0 4.6%

    TechM FY13 FY20 7.0 1QFY14 3QFY19 22.0 2.7%

    Average

    4.0 13.4 5.3%

    Source: PhillipCapital India Research

    Hence, on an average, companies have taken only four years to double their revenue – from $2.5 to $5bn – translating into a CAGR of 26%. We attribute this strong growth, to the size opening up doors for these companies, as they get invited to larger deals. While it might not be easy for LTI+MTCL to replicate the same, because of relatively higher penetration of outsourcing now – we do expect the size to provide significant boost to its growth rate, over and above our assumed 12% CAGR.

  • Page | 8 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Sensitivity analysis We believe the merger can create significant value over the next two years. Our base case scenario is of the LTI+MTCL entity reporting 12% revenue CAGR over FY22-24, and 16% margins in FY24, with the entity getting 18x FY24 PE in FY22 (current PE of LTI/MTCL is 18.0x/17.5x two-year forward). In this scenario, the merged entity will command a marketcap of Rs 681bn – translating into a whopping 46% returns over the next two years. To prove that, and also calculate its dependency on various variables, we conducted a two-step sensitivity analysis. In our sensitivity analysis, we tried to measure the impact on the FY22 market cap of the combined entity of LTI + MTCL. We base our sensitivity analysis on three variables – revenue growth, margins and the PE multiple. In our first sensitivity analysis, we assume 16% EBIT margins in FY24 for the combined entity (easily achievable in our opinion) – and vary the revenue growth and PE multiple. We find that the merged entity can achieve a market-cap of Rs 549-793bn – translating into 18%-70% returns over the next two years from current levels.

    Sensitivity analysis 1 leads to likelihood of mcap of Rs 549bn-793bn in two years Mcap (Rs bn) Rev CAGR (FY22-24)

    466 10% 11% 12% 13% 15%

    Mu

    ltip

    le

    (FY2

    4 P

    E) 15 549 558 567 576 595

    16 586 595 605 615 634

    17 623 633 643 653 674

    18 659 670 681 691 714

    20 732 744 756 768 793

    Sensitivity analysis 1 leads to likelihood of 18%-70% returns over next two years Returns Rev CAGR (FY22-24)

    10% 11% 12% 13% 15%

    Mu

    ltip

    le

    (FY2

    4 P

    E) 15 18% 20% 22% 24% 28%

    16 26% 28% 30% 32% 36%

    17 34% 36% 38% 40% 45%

    18 42% 44% 46% 49% 53%

    20 57% 60% 62% 65% 70%

    Source: PhillipCapital India Research (Assumption: FY24 EBIT Margins = 16%)

    In our second sensitivity analysis, we assume 18x FY24 PE, in March 2022 for the combined entity (current multiple of 18.0x/17.5x FY22 PE for LTI/MTCL) and vary the revenue growth and EBIT margins. We find that the merged entity can achieve a market-cap of Rs 550-753bn – translating into 18-62% returns over the next two years.

    Sensitivity analysis 2 leads to likelihood of mcap of Rs 550bn-753bn in two years Mcap (Rs bn) Rev CAGR (FY22-24)

    466 10% 11% 12% 13% 15%

    FY2

    2

    EBIT

    Mar

    gin

    s

    13% 550 558 567 576 594

    14% 586 596 605 614 634

    15% 623 633 643 653 674

    16% 659 670 681 691 714

    17% 696 707 718 730 753

    Sensitivity analysis 2 leads to likelihood of 18%-62% returns over next two years Returns Rev CAGR

    10% 11% 12% 13% 15%

    FY2

    2

    EBIT

    Mar

    gin

    s 13% 18% 20% 22% 24% 28%

    14% 26% 28% 30% 32% 36%

    15% 34% 36% 38% 40% 45%

    16% 42% 44% 46% 49% 53%

    17% 49% 52% 54% 57% 62%

    Source: PhillipCapital India Research (Assumption: PE Multiple = 18x FY24 PE)

    Sensitivity analysis # 1 is dependent on Revenue CAGR and FY24 PE Multiple in FY22. Here we assume FY24 EBIT margins constant at 16%

    Sensitivity analysis # 2 is dependent on Revenue CAGR and FY24 EBIT margins. Here we assume PE Multiple in FY22 at 18x FY24 PE

  • Page | 9 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    A perfect merger with little overlap The merger of L&T Infotech and Mindtree is a dream merger for any management. The two companies have highly complementary profile with very little business or client overlap. LTI has a very strong base in BFSI segment (44% of its revenue) while MTCL is very strong in the Retail (20%) segment. While Hi-tech/Media remain very strong for both companies, the kind of clients the two service are completely different.

    L&T Infotech + Mindtree will have a highly diversified revenue profile (FY20) LTI MTCL LTI + MTCL Rev share

    Top line (USD mn) 1,525 1,089 2,613 EBIT margin (%) 16.3% 10.1% 13.8%

    Key verticals

    BFSI 691 231 922 35%

    Manf 257 - 257 10%

    E&U/TTL 173 181 354 14%

    Retail 171 231 402 15%

    Hitech – Media 172 446 618 24%

    Others 60 - 60 2%

    Geographies

    US 1,051 814 1,865 71% EU 240 184 424 16% India 125 44 169 6%

    ROW 108 47 155 6%

    Horizontals

    ADM 551 132 683 26%

    IMS 176 270 446 17%

    Enterprise 445 - 445 17%

    Digital 310 416 726 28%

    Platforms 43 73 116 4%

    Testing - 198 198 8%

    Source: PhillipCapital India Research (FY20 numbers)

    L&T Infotech + Mindtree will have a highly diversified revenue profile

    On merger, the LTI+MTCL entity will have a revenue profile similar to largecaps, with highest exposure to BFSI (35%) – though still lower than the parent LTI (44%). The revenue base will be well-diversified across Manufacturing, Retail, and Hitech.

    Vertical exposure comparison (FY20) BFSI Telecom HiTech Manf Retail Healthcare TTL E&U Others US Europe ROW

    Infosys 32% 13% 8% 10% 15% 6% - 13% 3% 61% 24% 15% TCS 30% 7% 9% 10% 15% 8% - - 21% 52% 31% 17% HCL 21% 8% 16% 20% 10% 13% - 11% - 65% 27% 7% Wipro 31% 6% 13% 8% 16% 13% - 13% - 59% 24% 17% TechM 14% 42% 8% 18% 7% - - - 12% 48% 27% 25%

    LTI + MTCL 35% - 24% 10% 15% - 7% 7% 2% 71% 16% 12%

    Source: PhillipCapital India Research (FY20 numbers)

    35%

    21%

    45%

    10%

    0%

    17%

    14%

    17%

    11%

    15%

    21%

    11%

    24%

    41%

    11%

    2%

    0%

    4%

    0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

    LTI + MTCL

    MTCL

    LTI

    BFSI Manf E&U/TTL Retail Hitech - Media Others

  • Page | 10 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Client profile – highly mutually exclusive The best thing about the inevitable merger of LTI and Mindtree is the minimal client overlap. Amongst the top-25 clients of both LTI and Mindtree, we found only one common client – P&G. Apart from that, almost all the clients are mutually exclusive, which gives the combined entity a highly exhaustive coverage of almost all verticals.

    Top clients’ profile of LTI & MTCL: Highly diversified with little overlap

    Source: Media reports, PhillipCapital India Research

    The client list reveals one common strong point for the two companies – their strong presence in Hi-tech/Media segment. Put together, the two companies have the who’s who of the technology sector as their clients – including the likes of Microsoft, Google, Cisco, Philips, Viacom etc. And the most interesting part is that there is virtually no overlap in that segment too; almost all the clients of the two companies, even in the Hi-Tech/Media segment are mutually exclusive.

    Client concentration will reduce significantly The merger will also address the issue of client concentration. Currently, the top client forms 22% of MTCL’s while ~13% of LTI’s revenue (no longer disclosed). This leads to concentration risk with the two companies. However, with the merger, the share of the top client in the combined revenue will drop to 9%, thus derisking the overall revenue profile to a large extent. The revenue share of all the buckets – top-5, top-10 and top-20 – will all fall significantly, thereby broadening the revenue base.

    Client concentration risk reduces in the merged entity

    Client concentration comparison with Top 5 Top Client Top 5 Top 10 Top 20 Non Top 20

    Infosys 3% 19% 34% 66% HCL 16% 23% 33% 67% Wipro 3% 13% 20% 80% TechM 22% 31% 43% 57%

    LTI + MTCL 9% 24% 33% 67%

    Source: Companies, PhillipCapital India Research

    7

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    BFSI Manufacturing Retail Hitech/media TTL/EU

    No

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    LTI Mindtree

    13% 22%

    9%

    19% 13%

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    14% 10%

    9%

    54% 55% 67%

    0%

    20%

    40%

    60%

    80%

    100%

    LTI MTCL LTI + MTCL

    Top client Top 2-5 clients Top 6-10 clients Non Top-10

  • Page | 11 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Employee metrics – as identical as they could have been Integration of any two companies is an arduous task and it takes even experienced companies decades to realise the synergies of a merger. However, we believe that integrating LTI and MTCL might not be as difficult a task as it is for other companies because of the very similar employee metrics and profile of the two companies. 1. Similar employee profile: Both LTI and MTCL hire candidates from the same

    engineering colleges with similar profiles. They are put through similar training programs on various platforms, and are readily/frequently transferred across projects and platforms.

    2. Similar employee revenue productivity: This was a surprise for us too. The revenue productivity of LTI and MTCL are as close as they could have been – with a difference of just 2% between them. This leaves little to be differentiated in terms of productivity and redeployment in the merged entity.

    Less than 2% variance in the employee productivity of the two companies Employees LTI MTCL LTI + MTCL

    Software Professionals 29,683 20,817 50,500

    Sales & Support 1,754 1,174 2,928

    Total 31,437 21,911 53,348

    Rev productivity (US$ ‘000 / emp) 51,363 52,303 51,750

    Source: Companies, PhillipCapital India Research (FY20 numbers)

    3. Similar salary levels: Our analysis of the salary levels at these companies reveals

    that they are very similar even at different hierarchies. The onsite salaries for the technology staff remain amazingly same at various levels; offshore salary levels, while very similar, show a bit of variation at higher levels.

    Salary levels are similar across hierarchies (less than 4% avg variance)

    Source: Glassdoor.com, PhillipCapital India Research

    4. Onsite/Offshore mix: LTI and MTCL operate at similar onsite: offshore levels

    with onsite forming 20-22%. The ratio couldn’t have been more similar for the two companies. This ensures smooth integration of the workforce, and continuity of the onsite/offshore mix, in the merged entity.

    LTI and MTCL operate at similar effort mix Onsite effort share 1QFY20 2QFY20 3QFY20 4QFY20

    LTI 22.0% 22.0% 21.9% 21.5%

    MTCL 22.0% 21.6% 21.2% 21.1%

    Utilization 1QFY20 2QFY20 3QFY20 4QFY20

    LTI 80.5% 78.9% 79.2% 79.3%

    MTCL 77.2% 77.0% 77.0% 76.5%

    Attrition 1QFY20 2QFY20 3QFY20 4QFY20

    LTI 18.3% 18.4% 17.7% 16.5%

    MTCL 15.1% 13.0% 17.2% 17.4%

    Source: Companies, PhillipCapital India Research

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    There is less than 2% variance in the employee revenue productivity

    There is less than 4% variation in the average salary levels, across hierarchies

    Onsite/Offshore mix could not have been more similar Scope of improvement in utilization for Mindtree Scope of improvement in attrition for both LTI & MTCL

  • Page | 12 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Merger synergies can be HUGE Highly complementary profiles of LTI and MTCL mean that there will be minimum overlap between the two. But significantly greater than that, we see merger synergies in this creation of the IT behemoth.

    LTI chasing growth – Mindtree expanding margins LTI and MTCL are a perfect combination of companies likely to report industry leading growth and profitability. LTI has been the fastest growing IT company (across largecaps and midcaps) for last two years and in a covid-impacted FY21, too, it appears to be the only company that could report positive yoy USD revenue growth. Its deal-wins, current momentum, and a highly aggressive sales team make it highly likely that LTI would remain in the leader’s quadrant in terms of growth.

    LTI has grown significantly ahead of the industry average

    On the other hand, MTCL is expected to report significant margin expansion over the next two years. In fact, our whole thesis of upgrading MTCL (in November 2019) was based on margin expansion by Q4FY20 – which has played out to perfection.

    Mindtree had reported average EBIT margins of 17.5% over FY13-15.

    However, as growth decelerated in FY17-18, margins fell to 10%.

    In FY19, as growth rebounded, it was able to expand margins by 240bps.

    Yet again, in FY20, as the L&T group took over MTCL, the transition led to margins sliding by 270bps – though margins were back in Q4FY20 to Q4FY19 levels.

    We see significant margin expansion levers for MTCL over next 2-3 years, including utilization, employee pyramid, lowering of SG&A, and subcontracting expenses.

    Mindtree margins fell sharply in 1HFY20 – and can rebound in the same manner

    Source: Companies, PhillipCapital India Research

    -5

    0

    5

    10

    15

    20

    FY16 FY17 FY18 FY19 FY20 FY21E FY22E

    US$

    Rev

    enu

    e gr

    ow

    th (

    % y

    oy)

    LTI Largecap Midcap Industry

    14.0

    9.7

    10.4

    12.8

    10.1

    11.4

    12.6

    8

    9

    10

    11

    12

    13

    14

    15

    FY16 FY17 FY18 FY19 FY20 FY21E FY22E

    Annual EBIT Margins

    11.6

    13.1 13.6

    12.9

    6.4

    9.3

    12.0 12.5

    6

    7

    8

    9

    10

    11

    12

    13

    14

    1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20

    Quarterly EBIT Margins

  • Page | 13 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    A formidable force in Hi-tech / Media vertical LTI and MTCL both have a very strong profile in Hi-tech / Media segment – forming 11% and 43% of their revenues respectively. Both the companies have a coveted list of clients in the segment, though Mindtree appears to have a slight upper hand. Interestingly though, there is literally no client overlap between the two companies. While MTCL has Microsoft, Google and Philips as its top clients, LTI boasts of Cisco and Viacom as few of its top clients.

    LTI+MTCL has grown the fastest in Hi-tech/Media versus peers Hitech share FY20 % yoy Last 3 years cagr

    Infosys 8% 12% 11% TCS 9% 3% 12% HCL 16% 2% 15% Wipro 13% -4% -3% TechM 8% 10% 11%

    LTI + MTCL 24% 12% 17%

    Source: Company, PhillipCapital India Research

    In a post-covid world, we expect hi-tech companies like Microsoft, Google and Amazon to benefit the most because of the increasing adoption of cloud-based platforms/applications and virtual meeting platforms, especially on the enterprise side. Technology domain is expected to be one of the biggest beneficiaries of this pandemic, and this augurs well for the LTI+MTCL entity with its strong presence in this domain.

    LTI strong in BFSI – Mindtree in Retail While both LTI and MTCL are strong in Hi-tech/Media, the two companies have different verticals as their strengths which are highly complementary. LTI has an exceptionally strong presence in BFSI, with Citigroup being its largest client, and a host of other marquee clients. The segment contributes 44% to its revenues and remains a key vertical, boosting its growth. On the other hand, MTCL has traditionally been very strong in Retail/CPG, with all large names as in its clientele. The vertical forms 20% of its revenues. Together, the BFSI and Retail/CPG verticals would enable the LTI+MTCL entity to diversify its revenue base while maintaining a strong position in both verticals with global majors as its clients.

    LTI+MTCL have outperformed all largecaps in BFSI and Retail BFSI Retail

    Rev share FY20 % yoy Last 3 years

    cagr Rev share FY20 % yoy Last 3 years

    cagr

    Infosys 32% 7% 6% 15% 2% 6% TCS 30% 4% 5% 15% 4% 14% HCL 21% 10% 8% 10% 17% 14% Wipro 31% 2% 9% 16% 6% 4% TechM 14% 6% 9% 7% 12% 6%

    LTI + MTCL 35% 7% 12% 15% 12% 15%

    Source: Company, PhillipCapital India Research

  • Page | 14 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Workforce rationalization can provide significant tailwind to margins In any merger across industries, the biggest source of synergies is saving on operational costs. IT Services is a people’s business, so the biggest source of saving operational costs is via workforce rationalization. As detailed in an earlier section, the two companies have highly similar workforces – hired from the same colleges, given the same training, and the salary levels are quite similar. Hence, we foresee a highly smooth integration of the two workforces with lots of synergies. We expect the synergies to come from: 1) Reduction of support staff such as HR, admin, etc., which would lower G&A

    expenses. 2) Redistribution/realignment of sales and marketing teams, eliminating overlaps

    and multiplicity of efforts. 3) Lower bench strength (as % of total workforce) as beyond a number the %

    number becoming irrelevant. 4) Lower subcontracting costs, as both companies would be able to address the

    demand-supply mismatch with a much larger workforce at their disposal. As we compare the cost structure of LTI and MTCL, we find that LTI has a highly efficient cost structure with “cost of employees” (as % of revenue) 500bps lower than MTCL. This is one area in which the merged entity could expand its margins.

    Total SG&A expenses are almost the same at 22.2% / 21.9% for the two.

    Subcontracting costs, too, are almost the same at 7.7% / 7.5%.

    Utilization and attrition also remain the same for the two companies.

    Cost structure analysis of LTI & MTCL (FY19) MTCL % of rev LTI % of rev

    Revenue 70,215

    94,458 Employee Benefit Expenses

    Salaries and Wages 40,985 58.4% 50,627 53.6%

    Provident and Other Funds 2,829 4.0% 3,270 3.5% Employee Stock Based Compensation 162 0.2% 281 0.3%

    Staff Welfare Expenses 236 0.3% 490 0.5%

    Total 44,212 63.0% 54,668 57.9%

    Other Expenses

    Travel Expenses 3,006 4.3% 3,270 3.5%

    Communication Expenses 793 1.1% 522 0.6%

    Subcontractor Charges 5,281 7.5% 7,256 7.7%

    Computer Consumables 919 1.3% 3,639 3.9%

    Legal and Professional Charges 452 0.6% - 0.0%

    Power and Fuel 302 0.4% 310 0.3% Lease Rentals 1,223 1.7% 1,941 2.1%

    Repairs and Maintenance 163 0.2% 885 0.9%

    Insurance 76 0.1% 63 0.1% Rates and Taxes 266 0.4% 294 0.3% Other Expenses 2,877 4.1% 2,777 2.9%

    Total 15,358 21.9% 20,957 22.2%

    Workforce rationalization can provide significant boost to margins

    54%

    58% 58%

    63%

    48%

    50%

    52%

    54%

    56%

    58%

    60%

    62%

    64%

    Salaries and Wages Total Employee expense

    LTI MTCL

    3%

    8%

    4%

    2%

    4%

    8%

    1% 2%

    0%

    1%

    2%

    3%

    4%

    5%

    6%

    7%

    8%

    Travel Expenses SubcontractorCharges

    ComputerConsumables

    Lease Rentals

    LTI MTCL

    We have compared the FY19 cost structure because that offers a normalized comparison. MTCL FY20 numbers were impacted by exceptional bonuses/salary hikes awarded post its acquisition

  • Page | 15 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Location synergies are just too good to be true Even with the location of delivery centres, LTI+MTCL have an amazingly complementary profile, with only four common locations in the US (total 26 locations, 71% of the combined entity’s revenues). However, EU/APAC appear to have more common locations than expected.

    Very little overlap in development centre locations – even in their largest geography, US

    Source: Company, PhillipCapital India Research

    LTI is great in marketing – Mindtree has strong delivery LTI and MTCL are complementary, not just in terms of their client/business profile – but also in the manner in which they conduct their business. LTI is exceptionally strong in marketing, visible in its deal-wins and various partnerships forged with leading platform providers (like SAP, Oracle, MS, Cisco, IBM and AWS), which are a testimony to its strong marketing capabilities (along with delivery) and have translated into strong deal-wins for the company. This has, in turn, driven its industry-leading revenue growth for two consecutive years.

    LTI enjoys high-tiered partnerships with most firms

    Source: Company, PhillipCapital India Research

    MTCL, on the other hand, is famous for being exceptionally strong in delivery. “Born digital”, MTCL, even under its previous management, was always considered the

    Schaumburg, IL

    Hartford, CT

    Glendale, WI

    Tampa, FL

    Jupiter, FL

    Plano, TX

    Irving, TX

    Houston, TX

    Cincinnati, OH

    Pleasanton, CA

    Ontario – Canada

    Alpharetta, GA

    Bellevue, WA

    Chicago, IL

    Cleveland, OH

    Dallas, TX

    San Jose, CA

    Scottsdale, AZ

    Redmond, WA

    Gainesville, FL

    Minneapolis, MN

    Amsterdam, Netherland

    Belfast, N.Ireland

    Madrid, Spain

    Espoo, Finland

    Oslo, Norway

    Brussels, BelgiumCopenhagen, Denmark

    Cologne,

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    Netherlands

    Munich, GermanyDublin, Ireland

    London, UKWarsaw, Poland

    Stockholm, SwedenParis, France

    New JerseyLos Angeles, CANew York, NY

    Toronto, Canada

    KuwaitSaudi ArabiaQatarAbu DhabiMoroccoJohannesburg

    Dubai

    Sydney, AusSingapore

    Tokyo, JapanShanghai,

    China

    Cape Town, South Africa

    Makati City, PhilippinesHong KongPerth, Aus

    Kuala Lumpur, Malaysia

    Beijing, ChinaMelbourne, Aus

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  • Page | 16 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    benchmark for delivery among midcaps (like TCS is among largecaps). MTCL’s repeat clients and renewals from its existing clients, and its high ranking in industry surveys, is a testament to its strong delivery capabilities.

    Size will open doors for new accounts and large deals One of the biggest benefits of the LTI-MTCL merger would be the giant size of the company, and its ability, thereafter, to win large deals. The LTI+MTCL entity is a $2.5bn entity now and is likely to be $3bn by FY22 (conservatively). This size will open many new doors for the merged entity, as it becomes eligible to bid for many large deals and gets invited to the RFPs. It would be able to challenge the likes of TCS, Accenture, Infosys and CapGemini in large deals – based on its strengths in marketing (LTI) and delivery (MTCL), and even outbid them in many such deals.

    Large deal announcements by largecaps in the last few months Time Geo Client USD mn Years Details of the deal

    Apr’20 US Walgreen Boots Alliance 1500 10 TCS will modernize applications and cloud-enabled technology

    operations

    TCS

    Jan ‘18 EU M&G Prudential 690 10 To support 4mn policies of Prudential; 1,100 incumbent supplier's

    employees to move to TCS with 700 new roles in India

    Sep ‘19 US General Motors NA 5

    TCS will acquire certain assets of GM – India (along with 1,300

    employees) and support GM’s global vehicles programs with

    engineering design services

    Jan ‘18 US Transamerica 2500 10

    TCS will simplify the service of more than 10mn policies into a single

    integrated modern platform and drive greater sustainable growth

    opportunities through superior customer experiences; 2,200

    Transamerica employees will join TCS

    Dec ‘17 US Nielsen Holdings 2250 10

    ADM, BPO, KPO and Analytics. Assured of US$ 320mn business every

    year from 2017-2020, US$ 186mn every year from 2021-2024, and US$

    139.5mn in 2025. The deal will incrementally add US$ 70-80mn annually

    Jan ‘18 UK Marks & Spencer NA 5 Digital Transformation; 250 employees to be transferred to TCS

    HCLT

    Jan ‘18 UK Cadent NA 5 Integrated public cloud hosting and SAP and Application Maintenance

    Services, including the migration of a significant applications portfolio to

    AWS public cloud

    Nov ‘17 UK Jardine Lloyd Thompson NA 5 Implement a fully orchestrated and automated cloud management

    platform with advanced automation capabilities, supported by DRYiCE

    Wipro

    Dec ‘17 NA Fortune 500Medical devices NA MYMM Global front-office transformation project

    Sep ‘19 India ICICI Bank 300 7 To provide a comprehensive suite of services through HOLMES. Wipro

    will absorb 3,800 employees of Vara Infotech – current service provider

    Dec ‘17 NA Global BFSI service provider NA MYMM Upgrade its user experience and simplify sales and service process

    Nov ‘17 US Luxury departmental store NA MYMM Reimagine its employee experience and modernize HR processes.

    Dec ‘17 NA International payment provider NA MYMM Leverage Designit’s expertise in technology, product and service design.

    Tech

    M

    Sep’ 19 US AT&T >1,000 MY Accelerate AT&T’s IT network application, shared systems

    modernization and movement to the cloud

    Jan’ 20 US Jackson Life Insurance

    (subsidiary of Prudential)

    800 MY To provide infrastructure management services, application

    development and maintenance to Jackson and Prudential assets in India

    Source: Companies, PhillipCapital India Research (*MYMM – Multi Year Multi Million)

    Strong management team with great experience As LTI became an independent listed entity in 2016, it started attracting global talent to grow its business. Right from the CEO, Mr. Sanjay Jalona, whom the company hired from Infosys, LTI has hired leading industry experienced executives from Infosys, CapGemini and Cognizant, over the last four years. MTCL, on the other hand, has always grown by hiring laterals from its competitors – the exercise just got a fillip, as the L&T group, post its hostile takeover of MTCL, tried to fill in the vacancies created by exodus of employees after the takeover. As a result, LTI + MTCL today have an exceptionally strong leadership team, across functions, which should help enable the merged entity continue traversing the growth path. In fact, we fear that the merged entity might end up having a ‘problem of plenty’ as it looks to eliminate duplicate roles.

  • Page | 17 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Both managements are strong, with great industry experience Date Name Designation Former employers Former designation

    LTI Apr-19 Deepak Khosla Chief Business Officer, Emerging Markets NIIT Tech President Asia Dec-18 Nachiket Deshpande Chief Operating Officer (COO) Cognizant Tech Senior VP & global delivery head (BFSI) Oct-18 Virender Soni Talent Acquisition Leader NCR Corp, Capgemini Talent Acquisition Leader Jul-18 Ajay Tripathi Chief Human Resources Officer Atos Senior vice president & HR - India Nov-17 Naheed Faiz Head - Global Leadership Hiring Atos Head of Recruitment Oct-17 Satya Samal SVP and Chief Business Officer, Europe NIIT Tech, Infosys Executive Vice President and Head of Europe Sep-16 Sudhir Chaturvedi President, Sales NIIT Tech, Infosys Chief Operating Officer Oct-15 Rohit Kedia Chief Business Officer, Manufacturing &

    ERP, Americas Infosys Vice President and Head - Manufacturing

    Americas Sep-15 Siddharth Bohra Chief Business Officer, Tech, Media,

    Consumer, Lifesciences; Head - Digital Infosys Vice President and Head of Hi-tech (Americas)

    Sep-15 Peeyush Dubey Chief Marketing Officer Mindtree, Infosys General Manager, Global Marketing Aug-15 Sanjay Jalona Chief Executive Officer (CEO) and

    Managing Director (MD) Infosys Executive Vice President & Global Head - Hi-

    Tech, Manufacturing and Engineering Services

    Mindtree Mar-20 Dayapatra Nevatia Chief Operating Officer Accenture, Wipro MD and Director of Delivery - Advanced

    Technology Centers India Oct-19 Manikandesh Venkatchalam SVP and Industry Head, Strategic Deals Genpact Vice President Oct-19 Vijay Ram Vice President and Global Head of

    Communications, Media & Technology Infosys Associate Vice President & Global Client Partner

    Sep-19 Paneesh Rao Chief People Officer LTTS Chief HR officer Aug-19 Debashis Chatterjee Chief Executive Officer (CEO) and

    Managing Director (MD) Cognizant Technologies President of global delivery

    Aug-17 Sreedhar Bhagavatheeswaran

    SVP and Head of Digital Business TCS Global Head of Sales & Solutions - TCS Digital Interactive

    Source: Company, PhillipCapital India Research

    Strong cash position – inorganic growth opportunities LTI+MTCL currently have cumulative cash reserve of Rs 41bn. This is a very strong cash position – representing 30% of its balance sheet, and would enable the merged entity to seek inorganic avenues of growth – not just for delivery capabilities, but also to boost growth. As ISG highlighted recently – lots of inefficiently run captives in South Asia (including India) are likely to be sold-off by their parents, and companies like TCS, Infosys, or CTSH would be willing buyers (as they have historically been). LTI+MTCL, too, would be a big contender for such acquisitions, in our opinion.

    Focussed acquisitions have been growth drivers for LTI and Mindtree Time Acquired entity Country Description Consideration ($mn)

    L&T Infotech Acquisitions

    Dec 2006 GDA Technologies US Electronic Design Services and Silicon Intellectual Provider NA

    Jan 2011 Citigroup Fund Services Canada Captive centre of Citigroup Canada 47

    Oct 2014 ISRC US IT unit of Otis Elevator 13

    Oct 2016 Augment IQ India Big Data Platform NA

    Nov 2017 Syncordis Europe To enhance core banking implementation capabilities 23

    Jan 2019 Ruletronics US Pega-systems Implementation partner 8

    Feb 2019 NIELSEN + PARTNER Germany Temenos WealthSuite Specialist 32

    Jul 2019 Lymbyc Solutions India AI, Machine Learning and Advanced Analytics co with proprietary product “Leni” 5.4

    Mindtree Acquisition

    Jan '16 Magnet 360 US Salesforce platform 50

    Jul '15 Relational Solutions Inc US IT solutions – CPG 10

    Jul '15 Bluefin Solutions UK IT solutions, SAP HANA solutions 63.5

    Jan '15 Discoverture Solutions US P&C Insurance 15

    Source: Company, PhillipCapital India Research

  • Page | 18 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Challenges to the merger Notwithstanding the immense benefits and synergies, we acknowledge that the merger of the two companies is easier on paper than in reality. We foresee multiple challenges to the merger and for the merged entity.

    Work culture: LTI and MTCL operate in different work environments. MTCL was ‘born digital’ and is known to be highly result-oriented – offering its employees flexible working hours and adequate infrastructure (for example, laptops for every developer). LTI, on the other hand, is probably more process-oriented and have a much more disciplined work environment – especially being part of the larger L&T group. Integrating the two work cultures could be a long drawn out and painful process and could lead to significant attrition.

    Employee pyramid: The employee pyramid in both companies is different. Getting it to even out would be a difficult task, and is sure to lead to the exits of a few key individuals. At the same time, as two people from each entity fight for the same role in the merged entity, few senior management people are also likely to leave the organization.

    Common assets: Both companies operate in the same geographies, with the US and the UK being the primary ones, Northern Europe having a higher share than other parts of Europe, and APAC and Middle East completing the RoW pie. Both of them would have common assets in those geographies (primarily S&M staff) many of whom would become redundant after integration. Relocating them to other regions/verticals would be difficult to manage and would lead to attrition in the pre-stabilisation period.

    Top management: And finally, one of the biggest issues would be – who will run the merged entity? We believe that the recent five-year extension of Mr. Sanjay Jalona, as CEO of LTI, is an indication of him being preferred for the top job. While this might be in the best interest of the merged entity, keeping the ‘other side’ happy and preventing attrition could prove a key challenge.

    Top client concentration and its contribution to growth One of the primary concerns about MTCL has been the lopsided growth from its top client – Microsoft (MS). The client contributes to 22% of MTCL’s current revenue (FY20) and constituted 49% of its incremental revenues in FY20. It has reported strong growth, quarter after quarter, and leads to concerns about the high revenue concentration. MTCL’s lopsided growth, driven by it top-client, has been a concern FY15 FY16 FY17 FY18 FY19 FY20

    Total revenue ($ mn) 584 714 780 847 1,001 1,089

    Top Client revenue ($ mn) 55 79 109 140 199 242

    % of Total revenue 9.4% 11.0% 14.0% 16.5% 19.9% 22.2%

    YoY growth 37.7% 43.6% 38.5% 28.2% 42.4% 21.5%

    % of Incremental revenue 18.2% 18.4% 46.0% 45.7% 38.3% 48.9%

    Source: Company, PhillipCapital India Research

    While we acknowledge the risk, we note that MTCL is not yet among MS’s top-3 vendors. MTCL works across multiple functions for MS, including its fastest growing Azure business. Its business with MS continues to expand in:

    Data analytics & support for new applications

    Infrastructure support for any new products

    Cloud ops – helping migrate to Azure platform, and post migration support

    Other enterprise IT offerings like testing, automation and engineering We believe that as MS benefits from higher cloud adoption in a post-Covid world, MTCL would continue to benefit from its growth. Also, post-merger, MS will form only 9% of the revenue of the merged entity – still being its largest client, but with lower revenue contribution. This ensures that even if in the worst-case scenario, the account decelerates/declines at some point – its impact on overall revenue and growth will be limited, and could be recuperated from growth in other accounts.

  • Page | 19 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    How to play this merger theme – LTI/MTCL/both? Having established the validity of the merger hypothesis, and significant probability of making handsome returns in the process, we now come to the execution part of the hypothesis. We believe investors can play the hypothesis through either of the two stocks – or both, if they don’t mind doubling down on the hypothesis. Both LTI and MTCL are trading at similar valuations (LTI 18x, MTCL 17x FY22 PE) – and hence offer very little differentiation in terms of road to the eventual return realization. However, we note the following pros/cons with the stocks: BUY L&T Infotech – CMP Rs 1,880, Target Rs 2,120: Pros:

    Stable revenue/margin profile. More certainty of financials reduces the downside in case of external shock

    Management of the merged LTI+MTCL entity is likely to comprise of more people from LTI’s senior management team than MTCL

    Cons:

    Few variables, so lower probability of unexpected positive surprise or better than expected performance

    Most expensive stock in the midcap space (and largecap too, excluding TCS). Also, LTI is slightly more expensive than MTCL, so potential for rerating is limited

    Higher exposure (15%) to the ‘segment of concern’ (Energy/Utilities) impacted by Covid-19 (due to low crude prices)

    BUY Mindtree – CMP Rs 909, Target Rs 1,050: Pros:

    Multiple margin levers; so, there is a high probability of better-than-expected margin expansion as seen in Q3/Q4Y20 results

    Slightly cheaper than LTI; trading at 17x FY22PE (vs. 18x for LTI) so there is slightly higher scope for rerating

    Cons:

    More volatile performance than LTI; hence, higher downside in case of external shock

    Higher exposure (17%) to the most impacted vertical (Travel/Transport) by Covid-19 – the company also has 2 TTL clients in its top-10 clients list

    High dependency on top client, which contributed to 49% of incremental growth in FY20

    BUY BOTH L&T Infotech & Mindtree Pros:

    Diversification across the two companies will help protect the downside, in case one of the two face some temporary challenges (internal/external)

    Cons:

    Akin to putting all your eggs in the same basket (the merger hypothesis)

    Duplicity of investment – as both stocks, trading at almost similar valuations, will offer the same upside

  • Page | 20 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Financials and Recommendations We maintain our estimates for all companies under coverage. However, we upgrade our multiples for a few, on better growth visibility and/or better market environment. We upgrade our target multiple for:

    All largecaps (excl TechM) – as they will continue to be preferred over midcaps, owing to their diversified business profile

    L&T Infotech and Mindtree – on the back of our thesis in this report, of the combined LTI+MTCL entity breaking into the top-5 club over next two years

    Recommendation summary CMP Mkt Cap Old Target New Target Price Upside Rating Rs Rs bn Multiple Multiple Target (Rs) %

    TCS 2,036 7,635 22.0 25.0 2,420 19% BUY Infosys 713 3,101 18.0 20.0 870 22% BUY Wipro 218 1,310 10.0 12.0 220 1% NEU HCL Tech 578 1,568 13.0 14.0 640 11% BUY Tech Mahindra 536 475 9.0 - 440 -18% SELL

    L&T Infotech 1,880 327 18.0 20.0 2,120 13% BUY L&T Tech 1,335 139 13.0 - 1,140 -15% NEU MindTree 909 149 18.0 19.0 1,050 16% BUY Cyient 217 24 6.0 - 165 -24% SELL NIIT Tech 1,372 85 15.0 - 1,315 -4% NEU Persistent 584 46 10.0 - 500 -14% NEU Mphasis 859 166 14.0 - 970 13% BUY Hexaware 323 96 14.0 - 330 2% NEU

    Valuation snapshot

    ________ROE (%)________ _________PE (x)__________ ________PB (x)__________ ______Div Yield (%)______

    Companies FY20 FY21E FY22E FY20 FY21E FY22E FY20 FY21E FY22E FY20 FY21E FY22E

    TCS 37.5 32.9 33.9 23.7 24.2 21.1 8.9 8.0 7.2 3.6% 2.8% 3.3%

    Infosys 25.5 21.9 22.3 17.9 18.6 16.3 4.5 4.1 3.6 2.5% 2.8% 3.1%

    Wipro 17.4 14.9 15.2 12.8 13.5 11.9 2.2 2.0 1.8 0.5% 2.8% 2.8%

    HCL Tech 21.5 18.2 17.4 14.1 14.1 12.7 3.0 2.6 2.2 1.4% 1.4% 1.4%

    Tech Mahindra 18.5 14.7 15.7 11.6 13.2 11.1 2.1 1.9 1.7 2.8% 2.8% 2.8%

    L&T Infotech 28.1 23.9 24.1 21.5 21.5 17.7 6.1 5.1 4.3 1.5% 1.7% 1.7%

    L&T Tech 29.6 23.1 22.8 16.7 18.0 15.2 5.0 4.2 3.5 1.6% 1.7% 1.7%

    MindTree 20.0 19.6 20.9 23.5 20.7 16.3 4.7 4.1 3.4 1.4% 1.4% 1.4%

    Cyient 13.4 8.1 10.4 6.8 10.6 7.7 0.9 0.9 0.8 7.1% 2.4% 4.7%

    NIIT Tech 18.8 16.9 18.4 18.5 18.7 15.3 3.5 3.2 2.8 2.3% 2.4% 2.6%

    Persistent 14.3 13.1 13.1 13.3 13.1 11.8 1.9 1.7 1.5 2.0% 2.0% 2.2%

    Mphasis 20.3 17.4 19.0 13.4 14.5 12.2 2.7 2.5 2.3 4.1% 4.1% 4.7%

    Hexaware 23.2 18.7 20.0 14.7 15.8 13.3 3.4 2.9 2.7 2.1% 2.1% 2.1%

    Financial snapshot USD Revenue growth (%) EBIT margins (%) EPS growth (%)

    FY20 FY21 FY22 FY20 FY21 FY22 FY20 FY21 FY22

    TCS 5.4 -4.0 8.0 24.6 24.0 25.2 2.7 -2.1 14.7 Infosys 8.3 -3.0 9.1 21.3 20.7 21.6 11.5 -4.2 14.4 Wipro 1.7 -4.8 7.6 17.3 16.6 17.5 14.0 -5.5 13.7 HCL Tech 15.1 0.1 9.0 19.6 18.7 19.4 9.3 -0.4 11.6 Tech M 4.3 -4.9 8.6 11.6 10.4 11.5 -4.6 -12.7 19.8

    L&T Infotech 13.0 0.0 12.0 16.1 15.4 16.5 0.3 0.3 21.1 L&T Tech 8.8 -5.0 10.2 16.5 15.8 16.8 6.5 -7.2 18.9 MindTree 8.7 -3.4 10.0 10.1 11.4 12.6 -16.3 13.8 26.6 Cyient -5.3 -18.2 7.1 9.2 5.2 7.6 -29.4 -35.9 37.8 NIIT Tech 12.3 0.0 10.6 13.1 12.2 13.5 9.4 -1.5 22.8 Persistent 4.3 -2.9 6.3 9.2 9.6 9.9 0.2 1.5 10.9 Mphasis 10.8 -3.2 8.1 16.0 15.3 16.2 13.6 -7.8 18.5 Hexaware 17.1 1.1 9.8 13.9 12.1 13.1 9.4 -7.0 18.6

    Source: PhillipCapital India Research

  • Page | 21 | PHILLIPCAPITAL INDIA RESEARCH

    L&T INFOTECH COMPANY UPDATE

    Financials (L&T Infotech)

    Income Statement Y/E Mar, Rs mn FY19 FY20 FY21E FY22E

    Net sales 94,458 108,786 114,344 129,804

    Growth, % 29 15 5 14

    Total income 94,458 108,786 114,344 129,804

    Employee expenses -61,643 -73,589 -77,824 -87,694

    Other Operating expenses -13,980 -14,905 -15,722 -17,375

    EBITDA (Core) 18,835 20,292 20,798 24,734

    Growth, % 50.8 7.7 2.5 18.9

    Margin, % 19.9 18.7 18.2 19.1

    Depreciation -1,471 -2,731 -3,161 -3,337

    EBIT 17,364 17,561 17,637 21,398

    Growth, % 58.8 1.1 0.4 21.3

    Margin, % 18.4 16.1 15.4 16.5

    Interest paid -106 -826 -884 -884

    Other Income 3,021 3,289 3,569 4,090

    Pre-tax profit 20,279 20,024 20,322 24,603

    Tax provided -5,122 -4,825 -5,080 -6,151

    Profit after tax 15,157 15,199 15,241 18,453

    Others (Minorities, Associates) 0 0 0 0

    Net Profit 15,157 15,199 15,241 18,453

    Growth, % 30.5 0.3 0.3 21.1

    Net Profit (adjusted) 15,157 15,199 15,241 18,453

    Wtd avg shares (m) 174 174 174 174

    US$ Revenues FY19 FY20 FY21E FY22E

    US$ Revenue ($ mn) 1,349 1,525 1,525 1,708

    Growth, % 19.1 13.0 (0.0) 12.0

    Re / US$ (rate) 70.0 71.4 75.0 76.0

    Balance Sheet Y/E Mar, Rs mn FY19 FY20 FY21E FY22E

    Cash & bank 4,150 5,252 5,410 9,743

    Debtors 23,845 27,541 27,130 31,446

    Loans & advances 3,854 2,422 2,795 3,300

    Other current assets 0 0 0 0

    Total current assets 31,849 35,215 35,335 44,489

    Investments 17,402 22,186 26,186 30,186

    Net fixed assets 9,414 19,788 20,688 22,088

    Non-current assets 5,641 8,020 7,022 8,139

    Total assets 66,692 88,248 92,270 107,941 abcd

    Current liabilities 13,981 19,415 15,664 17,885

    Provisions 3,335 14,600 12,700 13,265

    Total current liabilities 17,316 34,015 28,364 31,150

    Non-current liabilities 430 182 182 182

    Total liabilities 17,746 34,197 28,546 31,332

    Paid-up capital 174 174 174 174

    Reserves & surplus 48,772 53,877 63,550 76,435

    Shareholders’ equity 48,946 54,051 63,724 76,609

    Total equity & liabilities 66,692 88,248 92,270 107,941

    Source: Company, PhillipCapital India Research Estimates

    Cash Flow Y/E Mar, Rs mn FY19 FY20 FY21E FY22E

    Pre-tax profit 20,279 20,024 20,322 24,603

    Depreciation 1,471 2,731 3,161 3,337

    Chg in working capital -2,870 12,056 -4,616 -3,151

    Total tax paid -4,771 -5,726 -5,080 -6,151

    Cash flow from operating activities 14,109 29,085 13,787 18,638

    Capital expenditure -4,011 -13,105 -4,061 -4,737

    Chg in investments -4,759 -4,784 -4,000 -4,000

    Chg in marketable securities 0 0 0 0

    Other investing activities 0 0 0 0

    Cash flow from investing activities -8,770 -17,889 -8,061 -8,737

    Free cash flow 5,339 11,196 5,726 9,901

    Equity raised/(repaid) 2 0 0 0

    Debt raised/(repaid) 0 0 0 0

    Dividend (incl. tax) -5,686 -5,242 -5,568 -5,568

    Other financing activities 862 -4,852 0 0

    Cash flow from financing activities -4,822 -10,094 -5,568 -5,568

    Net chg in cash 20,279 20,024 20,322 24,603

    Valuation Ratios

    FY19 FY20 FY21E FY22E

    Per Share data

    EPS (INR) 87.1 87.4 87.6 106.0 Growth, % 28.0 0.3 0.3 21.1

    Book NAV/share (INR) 281.3 310.6 366.2 440.3

    CEPS (INR) 95.6 103.0 105.8 125.2

    CFPS (INR) 93.9 172.3 63.3 100.7

    DPS (INR) 27.9 28.0 32.0 32.0

    Return ratios Return on assets (%) 25.3 20.3 17.5 18.9

    Return on equity (%) 31.0 28.1 23.9 24.1

    Return on capital employed (%) 32.1 25.8 21.7 22.8

    Turnover ratios Asset turnover (x) 4.3 4.0 3.5 3.5

    Sales/Total assets (x) 1.6 1.4 1.3 1.3

    Sales/Net FA (x) 11.6 7.5 5.6 6.1

    Working capital/Sales (x) 0.1 0.1 0.1 0.1

    Receivable days 92.1 92.4 86.6 88.4

    Payable days 22.5 61.7 48.7 49.6

    Working capital days 53.0 35.4 45.5 47.4

    Liquidity ratios

    Current ratio (x) 2.3 1.8 2.3 2.5

    Quick ratio (x) 2.3 1.8 2.3 2.5

    Interest cover (x) 163.8 21.3 20.0 24.2

    Dividend cover (x) 3.1 3.1 2.7 3.3

    Total debt/Equity (%) - 0.6 0.5 0.4

    Net debt/Equity (%) (8.5) (9.1) (8.0) (12.3)

    Valuation

    PER (x) 21.6 21.5 20.0 16.5

    PEG (x) - y-o-y growth 0.8 77.8 72.3 0.8

    Price/Book (x) 6.7 6.1 4.8 4.0

    Yield (%) 1.5 1.5 1.7 1.7

    EV/Net sales (x) 3.4 3.0 2.6 2.3

    EV/EBITDA (x) 17.2 15.9 14.4 12.0

    EV/EBIT (x) 18.6 18.4 17.0 13.8

  • Page | 22 | PHILLIPCAPITAL INDIA RESEARCH

    MINDTREE COMPANY UPDATE

    Financials (Mindtree)

    Income Statement Y/E Mar, Rs mn FY19 FY20 FY21E FY22E

    Net sales 70,215 77,643 78,918 87,973

    Growth, % 28.5 10.6 1.6 11.5

    Total income 70,215 77,643 78,918 87,973

    Employee expenses -44,212 -50,647 -51,672 -56,667

    SG&A -15,358 -16,373 -15,389 -17,155

    EBITDA (Core) 10,645 10,623 11,857 14,152

    Growth, % 43.8 (0.2) 11.6 19.4

    Margin, % 15.2 13.7 15.0 16.1

    Depreciation -1,641 -2,754 -2,854 -3,035

    EBIT 9,004 7,869 9,003 11,116

    Growth, % 58.2 (12.6) 14.4 23.5

    Margin, % 12.8 10.1 11.4 12.6

    Other Operating expenses 893 948 1,208 1,517

    Pre-tax profit 9,868 8,288 9,700 12,121

    Tax provided -2,327 -1,979 -2,522 -3,030

    Profit after tax 7,541 6,309 7,178 9,091

    Net Profit 7,541 6,309 7,178 9,091

    Growth, % 32.3 (16.3) 13.8 26.6

    Net Profit (adjusted) 7,541 6,309 7,178 9,091

    Wtd avg shares (m) 164 164 164 164

    US$ Revenues FY19 FY20 FY21E FY22E

    US$ Revenue ($ mn) 1,001 1,089 1,052 1,158

    Growth, % 18.3 8.7 (3.4) 10.0

    Re / US$ (rate) 70.1 71.3 75.0 76.0

    Balance Sheet Y/E Mar, Rs mn FY19 FY20 FY21E FY22E

    Cash & bank 2,562 5,870 6,697 11,638

    Debtors 13,356 14,389 15,573 17,134

    Loans & advances 3,326 3,361 3,436 3,770

    Other current assets 2,267 2,442 2,225 2,448

    Total current assets 21,511 26,062 27,931 34,990

    Investments 8,036 7,748 9,748 9,748

    Gross fixed assets 9,669 14,092 14,892 15,692

    Add: Capital WIP 297 136 136 136

    Net fixed assets 9,966 14,228 15,028 15,828

    Non-current assets 1,889 1,693 1,780 1,958

    Total assets 41,790 51,566 56,322 64,359

    Current liabilities 7,151 11,512 11,259 12,168

    Provisions 1,399 1,724 1,686 1,853

    Total current liabilities 8,550 13,236 12,945 14,022

    Non-current liabilities 179 6,762 6,762 6,762

    Total liabilities 8,729 19,998 19,707 20,784

    Paid-up capital 1,642 1,646 1,646 1,646

    Reserves & surplus 31,419 29,922 34,969 41,929

    Shareholders’ equity 33,061 31,568 36,615 43,575

    Total equity & liabilities 41,790 51,566 56,322 64,359

    Source: Company, PhillipCapital India Research Estimates

    Cash Flow Y/E Mar, Rs mn FY19 FY20 FY21E FY22E

    Pre-tax profit 9,868 8,288 9,700 12,121

    Depreciation 1,641 2,754 2,854 3,035

    Chg in working capital -5,403 9,902 -1,382 -1,387

    Total tax paid -2,216 -3,101 -2,560 -2,863

    Cash flow from operating activities 3,890 17,843 8,612 10,907

    Capital expenditure -1,947 -7,016 -3,654 -3,835

    Chg in investments -772 288 -2,000 0

    Cash flow from investing activities -2,719 -6,728 -5,654 -3,835

    Free cash flow 1,171 11,115 2,958 7,071

    Equity raised/(repaid) 3 4 0 0

    Debt raised/(repaid) -4 -5 0 0

    Dividend (incl. tax) -6,328 -2,214 -2,131 -2,131

    Other financing activities 4,431 -5,592 0 0

    Cash flow from financing activities -1,898 -7,807 -2,131 -2,131

    Net chg in cash -727 3,308 827 4,941

    Valuation Ratios

    FY19 FY20 FY21E FY22E

    Per Share data

    EPS (INR) 46.0 38.5 43.8 55.5 Growth, % 32.3 (16.3) 13.8 26.6

    Book NAV/share (INR) 201.7 192.6 223.4 265.9

    FDEPS (INR) 46.0 38.5 43.8 55.5

    CEPS (INR) 56.0 55.3 61.2 74.0

    CFPS (INR) 38.7 101.9 45.7 58.4

    DPS (INR) 33.0 13.0 13.0 13.0

    Return ratios Return on assets (%) 19.1 14.2 13.9 15.6

    Return on equity (%) 22.8 20.0 19.6 20.9

    Return on capital employed (%) 24.9 18.5 18.3 20.0

    Turnover ratios Asset turnover (x) 3.4 4.1 4.6 4.6

    Sales/Total assets (x) 1.8 1.7 1.5 1.5

    Sales/Net FA (x) 7.2 6.4 5.4 5.7

    Working capital/Sales (x) 0.1 0.1 0.1 0.1

    Receivable days 69.4 67.6 72.0 71.1

    Payable days 13.1 14.1 14.3 14.3

    Working capital days 54.1 32.7 38.3 38.7

    Liquidity ratios

    Current ratio (x) 2.5 2.0 2.2 2.5

    Quick ratio (x) 2.5 2.0 2.2 2.5

    Dividend cover (x) 1.4 3.0 3.4 4.3

    Total debt/Equity (%) 0.0 - - -

    Net debt/Equity (%) (7.7) (18.6) (18.3) (26.7)

    Valuation

    PER (x) 19.7 23.5 20.1 15.9

    PEG (x) - y-o-y growth 0.6 (1.4) 1.5 0.6

    Price/Book (x) 4.5 4.7 3.9 3.3

    Yield (%) 3.6 1.4 1.4 1.4

    EV/Net sales (x) 2.1 1.8 1.7 1.5

    EV/EBITDA (x) 13.7 13.4 11.6 9.4

    EV/EBIT (x) 16.2 18.1 15.3 11.9

  • Page | 23 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Stock Price, Price Target and Rating History (L&T INFOTECH)

    Stock Price, Price Target and Rating History (MINDTREE)

    N (TP 1420)

    N (TP 1600) N (TP 1620)

    N (TP 1640) N (TP 1700)

    N (TP 1700)

    N (TP 1760) N (TP 1800)

    N (TP 1400) N (TP 1510)

    B (TP 1890)

    B (TP 1580)

    B (TP 1910)

    0

    500

    1000

    1500

    2000

    2500

    J-18 F-18 A-18 M-18 J-18 A-18 S-18 N-18 D-18 F-19 M-19 M-19 J-19 J-19 S-19 N-19 D-19 J-20 M-20 A-20

    S (TP 380) S (TP 380)

    N (TP 550)

    N (TP 800)

    N (TP 910) N (TP 1020) N (TP 1070)

    N (TP 1020)

    N (TP 900)

    N (TP 930)

    N (TP 700) B (TP 910)

    B (TP 990) B (TP 890) B (TP 900)

    200

    400

    600

    800

    1000

    1200

    1400

    J-17 J-17 A-17 O-17 N-17 J-18 F-18 A-18 M-18 J-18 A-18 O-18 N-18 J-19 F-19 M-19M-19 J-19 A-19 S-19 N-19 D-19 F-20 M-20M-20

  • Page | 24 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. We have different threshold for large market capitalisation stock and Mid/small market capitalisation stock. The categorisation of stock based on market capitalisation is as per the SEBI requirement.

    Large cap stocks Rating Criteria Definition

    BUY >= +10% Target price is equal to or more than 10% of current market price

    NEUTRAL -10% > to < +10% Target price is less than +10% but more than -10%

    SELL = +15% Target price is equal to or more than 15% of current market price

    NEUTRAL -15% > to < +15% Target price is less than +15% but more than -15%

    SELL

  • Page | 25 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    1 Whether compensation has been received from the company(ies) covered in the Research report in the past 12 months for investment banking transaction by PCIL

    No

    2 Whether Research Analyst, PCIL or its associates or relatives of the Research Analyst affiliates collectively hold more than 1% of the company(ies) covered in the Research report

    No

    3 Whether compensation has been received by PCIL or its associates from the company(ies) covered in the Research report No

    4 PCIL or its affiliates have managed or co-managed in the previous twelve months a private or public offering of securities for the company(ies) covered in the Research report

    No

    5 Research Analyst, his associate, PCIL or its associates have received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in the Research report, in the last twelve months

    No

    Independence: PhillipCapital (India) Pvt. Ltd. has not had an investment banking relationship with, and has not received any compensation for investment banking services from, the subject issuers in the past twelve (12) months, and PhillipCapital (India) Pvt. Ltd does not anticipate receiving or intend to seek compensation for investment banking services from the subject issuers in the next three (3) months. PhillipCapital (India) Pvt. Ltd is not a market maker in the securities mentioned in this research report, although it, or its affiliates/employees, may have positions in, purchase or sell, or be materially interested in any of the securities covered in the report.

    Suitability and Risks: This research report is for informational purposes only and is not tailored to the specific investment objectives, financial situation or particular requirements of any individual recipient hereof. Certain securities may give rise to substantial risks and may not be suitable for certain investors. Each investor must make its own determination as to the appropriateness of any securities referred to in this research report based upon the legal, tax and accounting considerations applicable to such investor and its own investment objectives or strategy, its financial situation and its investing experience. The value of any security may be positively or adversely affected by changes in foreign exchange or interest rates, as well as by other financial, economic, or political factors. Past performance is not necessarily indicative of future performance or results.

    Sources, Completeness and Accuracy: The material herein is based upon information obtained from sources that PCIPL and the research analyst believe to be reliable, but neither PCIPL nor the research analyst represents or guarantees that the information contained herein is accurate or complete and it should not be relied upon as such. Opinions expressed herein are current opinions as of the date appearing on this material, and are subject to change without notice. Furthermore, PCIPL is under no obligation to update or keep the information current. Without limiting any of the foregoing, in no event shall PCIL, any of its affiliates/employees or any third party involved in, or related to computing or compiling the information have any liability for any damages of any kind including but not limited to any direct or consequential loss or damage, however arising, from the use of this document.

    Copyright: The copyright in this research report belongs exclusively to PCIPL. All rights are reserved. Any unauthorised use or disclosure is prohibited. No reprinting or reproduction, in whole or in part, is permitted without the PCIPL’s prior consent, except that a recipient may reprint it for internal circulation only and only if it is reprinted in its entirety.

    Caution: Risk of loss in trading/investment can be substantial and even more than the amount / margin given by you. Investment in securities market are subject to market risks, you are requested to read all the related documents carefully before investing. You should carefully consider whether trading/investment is appropriate for you in light of your experience, objectives, financial resources and other relevant circumstances. PhillipCapital and any of its employees, directors, associates, group entities, or affiliates shall not be liable for losses, if any, incurred by you. You are further cautioned that trading/investments in financial markets are subject to market risks and are advised to seek independent third party trading/investment advice outside PhillipCapital/group/associates/affiliates/directors/employees before and during your trading/investment. There is no guarantee/assurance as to returns or profits or capital protection or appreciation. PhillipCapital and any of its employees, directors, associates, and/or employees, directors, associates of PhillipCapital’s group entities or affiliates is not inducing you for trading/investing in the financial market(s). Trading/Investment decision is your sole responsibility. You must also read the Risk Disclosure Document and Do’s and Don’ts before investing.

    Kindly note that past performance is not necessarily a guide to future performance.

    For Detailed Disclaimer: Please visit our website www.phillipcapital.in IMPORTANT DISCLOSURES FOR U.S. PERSONS This research report is a product of PhillipCapital (India) Pvt. Ltd. which is the employer of the research analyst(s) who has prepared the research report. PhillipCapital (India) Pvt Ltd. is authorized to engage in securities activities in India. PHILLIPCAP is not a registered broker-dealer in the United States and, therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence of research analysts. This research report is provided for distribution to “major U.S. institutional investors” in reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). If the recipient of this report is not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be copied, duplicated and/or transmitted onward to any U.S. person, which is not a Major Institutional Investor.

    Any U.S. recipient of this research report wishing to effect any transaction to buy or sell securities or related financial instruments based on the information provided in this research report should do so only through Rosenblatt Securities Inc, 40 Wall Street 59th Floor, New York NY 10005, a registered broker dealer in the United States. Under no circumstances should any recipient of this research report effect any transaction to buy or sell securities or related financial instruments through PHILLIPCAP. Rosenblatt Securities Inc. accepts responsibility for the contents of this research report, subject to the terms set out below, to the extent that it is delivered to a U.S. person other than a major U.S. institutional investor.

    The analyst whose name appears in this research report is not registered or qualified as a research analyst with the Financial Industry Regulatory Authority (“FINRA”) and may not be an associated person of Rosenblatt Securities Inc. and, therefore, may not be subject to applicable restrictions under FINRA Rules on communications with a subject company, public appearances and trading securities held by a research analyst account. Ownership and Material Conflicts of Interest Rosenblatt Securities Inc. or its affiliates does not ‘beneficially own,’ as determined in accordance with Section 13(d) of the Exchange Act, 1% or more of any of the equity securities mentioned in the report. Rosenblatt Securities Inc, its affiliates and/or their respective officers, directors or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein. Rosenblatt Securities Inc. is not aware of any material conflict of interest as of the date of this publication Compensation and Investment Banking Activities

    http://www.phillipcapital.in/

  • Page | 26 | PHILLIPCAPITAL INDIA RESEARCH

    IT SERVICES SECTOR UPDATE

    Rosenblatt Securities Inc. or any affiliate has not managed or co-managed a public offering of securities for the subject company in the past 12 months, nor received compensation for investment banking services from the subject company in the past 12 months, neither does it or any affiliate expect to receive, or intends to seek compensation for investment banking services from the subject company in the next 3 months. Additional Disclosures This research report is for distribution only under such circumstances as may be permitted by applicable law. This research report has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient, even if sent only to a single recipient. This research report is not guaranteed to be a complete statement or summary of any securities, markets, reports or developments referred to in this research report. Neither PHILLIPCAP nor any of its directors, officers, employees or agents shall have any liability, however arising, for any error, inaccuracy or incompleteness of fact or opinion in this research report or lack of care in this research report’s preparation or publication, or any losses or damages which may arise from the use of this research report.

    PHILLIPCAP may rely on information barriers, such as “Chinese Walls” to control the flow of information within the areas, units, divisions, groups, or affiliates of PHILLIPCAP.

    Investing in any non-U.S. securities or related financial instruments (including ADRs) discussed in this research report may present certain risks. The securities of non-U.S. issuers may not be registered with, or be subject to the regulations of, the U.S. Securities and Exchange Commission. Information on such non-U.S. securities or related financial instruments may be limited. Foreign companies may not be subject to audit and reporting standards and regulatory requirements comparable to those in effect within the United States.

    The value of any investment or income from any securities or related financial instruments discussed in this research report denominated in a currency other than U.S. dollars is subject to