3QFY2013 Result Review | IT

February 14, 2013

IT 3QFY2013 Result Review

Large-caps lead growth momentum
Modest revenue growth but volume growth subdued: For 3QFY2013, the overall results of large cap IT companies were better than their mid-cap peers. The tier-I IT pack under our coverage posted a better-than-expected revenue growth. Volumes were soft during the quarter, which is partly attributable to lower billing days. Moderate realization improvement coupled with subdued volume growth led to better-than-expected revenue growth, with tier-I firms USD revenue posting 3.9% qoq growth (3.4% excluding Lodestone). BFSI performance surprises positively but telecom continues to be a laggard: During 3QFY2013, tier-I IT companies witnessed better-than-expected revenue growth from the BFSI industry vertical despite the impact from furloughs and Hurricane Sandy, which could be an indication of consolidation in gains and improvement in discretionary spends. The telecom vertical continued to be a laggard. Verticals such as lifesciences & healthcare, manufacturing and retail maintained their revenue growth momentum. Initial signs of divergence in commentary fading away: The commentaries given by the Managements of the top four Indian IT players suggest pockets of optimism for the sector. Initial signs show that CY2013 IT budgets are expected to remain flat. Infosys Management indicated that the environment remains almost as same as where it was a few months back, however, Infosys signed eight large deals with TCV worth US$750mn during 3QFY2013. Infosys Management indicated at flat to declining IT budgets for CY2013 with more clarity coming in by February 2013. TCS Management sounded confident of FY2014 being a better year than FY2013 as clients seem to have a better handle on the kind of projects they want to execute, and are aware of the challenging macro environment. They have planned their IT spending considering these challenges. Cognizant has issued CY2013 guidance of at least 17% yoy growth in revenues. Outlook and Valuation: Nasscom has recently issued guidance of 12-14% yoy growth for the Indian IT exports and estimates the industry to reach ~US$8487bn in FY2014. We believe demand for IT offshore services would continue to be strong due to the need for operational efficiency & cost rationalization and regulatory compliance & risk management. Given the current economic situation, we see IT budgets to remain largely flat for CY2013 and expect volume growth of tier-I Indian IT companies to be 9% plus. We expect TCS and HCL Tech to lead growth in the tier-I IT pack by growing higher than the industry average in FY2014. TCS stock price has run up significantly and is currently trading at 18.3x FY2014E EPS, which leaves little room for upside in the stock price. The PE premium between TCS and Infosys has reduced now given Infosys outperformance during 3QFY2013 after six quarters of disappointment. We believe, a couple of quarters of outperformance is required from Infosys for its stock to get re-rated further. HCL Tech is trading at 13.4x FY2014E EPS; we maintain Accumulate rating on the stock with a target price of `765. Among mid-caps, we recommend Buy rating on Hexaware with a target price of `113. Tech Mahindra remains one of our preferred picks in the entire IT space as the company has recently acquired two companies which will give it inorganic boost. Also, post its merger with Mahindra Satyam, the risks which the company is facing right now such as client concentration and industry concentration will be curtailed.
Please refer to important disclosures at the end of this report

Ankita Somani
+91 22 3935 7800 Ext: 6819 ankita.somani@angelbroking.com

IT | 3QFY2013 Result Review

Modest revenue growth but volume growth subdued

During 3QFY2013, overall results of large cap companies were better than midcap firms as factors such as demand pressures, limited pricing power, high client concentration and limited bench sizes restricted profits of mid-tier IT companies. This is contrary to the trend seen in the past few quarters, when tier-2 firms comprehensively outperformed their tier-1 counterparts. The entire tier-I IT companies under our coverage posted better-than-expected revenue growth. Volumes were soft during the quarter for both tier-I and tier-II companies, which is partly attributable to lower billing days. Among tier-1 firms, Wipro reported a 1% qoq decline in overall volumes while HCL Tech reported the highest volume growth of 3% qoq. Overall realisation improved for almost all the tier-I IT companies but this was because of change in business mix (slightly more discretionary spending, which has higher bill rates) and a higher proportion of fixed-price projects which brought in productivity gains. Based on comments from company Managements, prices are likely to remain stable in the near term, indicating that the growth will be led by volumes. Discretionary spending showed initial signs of revival during 3QFY2013, which have led to expectations of a demand recovery in the IT sector.

Exhibit 1: Trend in volume growth (qoq)

6 4.9 4 3.2 3.1 1.8 3.3 2.0 0.8 0 (1.5) 3QFY12 4QFY12 Infosys TCS 1QFY13 HCL Tech 2QFY13 Wipro* 2.7 1.8 0.8 0.2 5.3 5.0 4.5 3.8 3.0 2.0 1.3

(%)

(1.0) 3QFY13

(2)

Source: Company, Angel Research; Note: *For IT services segment

Moderate realization improvement coupled with subdued volume growth led to better-than-expected revenue growth with tier-I firms USD revenue posting a 3.9% qoq growth (3.4% excluding Lodestone). For tier-II IT companies, USD revenue came in the range of (0.4)-10.1% with Tech Mahindra leading the pack aided by revenues from two acquisitions done recently. The incremental revenue addition is higher during 3QFY2013 in the last four quarters.

February 14, 201

IT | 3QFY2013 Result Review

Exhibit 2: Trend in USD revenue growth (qoq) Tier I

7 6 5 4
(%)

6.3 4.6 3.4 2.4 2.2 2.0 2.4 2.5 2.0 3.0 3.0 3.2 2.6 1.7 3.6 3.3 2.4

3 2 1 0 (1) (2)

3QFY12

4QFY12 (1.9) Infosys

1QFY13 (1.1) TCS (1.4) HCL Tech

2QFY13

3QFY13

Wipro*

Source: Company, Angel Research; Note: *For IT services segment

Exhibit 3: Trend in USD revenue growth (qoq) Tier II

12 10 8 6 10.1

(%)

4 2 0 (2) (4) Tech Mahindra Mahindra Satyam MindTree Persistent 4QFY12 1QFY13 2QFY13

2.5 0.6 1.2

0.5

(0.4) 3QFY13

Hexaware

Infotech

Source: Company, Angel Research

BFSI performance surprises positively but telecom continues to be a laggard

During 3QFY2013, tier-I IT companies witnessed better-than-expected revenue growth from the BFSI industry vertical despite the impact from furloughs and Hurricane Sandy, which could be an indication of consolidation gains and improvement in discretionary spends. Tier-II companies, however, reported weak performance in the BFSI industry vertical. TCS Management was optimistic about the growth prospects from BFSI vertical, while Infosys Management guided for a declining budget. Wipros Management indicated pressure in the capital markets segment. The telecom vertical continued to be a laggard during the quarter with TCS and HCL Tech reporting 4.7% and 1.9% qoq decline in revenues. Infosys, on the other hand, reported a 3.1% qoq growth in revenues from the telecom vertical but the same was largely driven by inorganic revenues.

February 14, 201

IT | 3QFY2013 Result Review

Verticals such and lifesciences & healthcare, manufacturing and retail maintained their revenue growth momentum. Managements of IT companies indicated that retail industry vertical is likely to lead growth with opportunities coming in from areas like digitization, cloud and data analytics. In addition, healthcare is believed to be an emerging vertical in terms of IT spend.

Exhibit 4: Trend in USD revenue growth from the BFSI industry

12 10 8 6 5.0 3.4 3.0 2.0 2.8 (0.2) (0.6) (2.7) (4.7) 3QFY12 4QFY12 Infosys TCS 1QFY13 Wipro 2QFY13 HCL Tech 3QFY13 (1.1) 2.2 0.8 6.3 4.14.04.5 3.8 2.0 10.9

(%)

4 2 0

(2) (4) (6)

(2.1)

Source: Company, Angel Research

Margins mixed
On an average basis, the EBIDTA margin of tier-I IT companies remained almost flat on a sequential basis with Infosys being the biggest laggard by posting 60bp qoq decline in EBIDTA margin because of offshore wage hike. TCS and HCL Tech posted 53bp and 40bp qoq increase in their respective EBITDA margins led by productivity improvements. During 3QFY2013, tier-II IT companies disappointed in terms of EBITDA margin due to muted volume growth with almost flat utilization level. Tech Mahindra surprised positively on the EBITDA margin front with margin growing by 30bp qoq to 21.0%.

Exhibit 5: Trend in EBITDA margin Tier I

35 31.0 30 29.1 31.0 29.5 29.1 24.0 23.2 20 17.1 15 2QFY12 3QFY12 Infosys 4QFY12 TCS 1QFY13 HCL Tech 2QFY13 Wipro* 3QFY13 18.5 23.9 23.8 18.4 22.0 33.7 32.6 30.6 29.1 28.4 23.7 22.2 29.0 28.5 23.5 22.6

Source: Company, Angel Research; Note: *For IT services segment

February 14, 201

(%)

25

IT | 3QFY2013 Result Review

Exhibit 6: Trend in EBITDA margin Tier II

29 25 21 26.8 21.7 21.4 20.9 22.9 27.2 21.5 22.1 20.7 24.8 21.6 21.0 20.4 16.9 15.7

21.6 16.7

(%)

17 13 9 5 1QFY13

15.1

2QFY13 MindTree Persistent

3QFY13 Hexaware KPIT Cummins

Tech Mahindra

Mahindra Satyam

Source: Company, Angel Research

Initial signs of divergence in commentary fading away

The Managements of tier-I IT companies have been giving divergent commentary on the growth outlook since last three quarters. However the commentaries given by the Managements of the top four Indian IT players, at the time of 3QFY2013 results, suggest pockets of optimism for the sector. Initial signs show that CY2013 IT budgets are expected to remain flat. Infosys Management indicated that the environment remains almost as same as where it was a few months back. The company continues to see a challenging macro environment and delays in decision making from clients ends. However, Infosys signed eight large deals (six large deals signed in 2QFY2013) with TCV worth US$750mn during 3QFY2013. Infosys Management indicates flat to declining IT budgets for CY2013 with more clarity coming in by February 2013. TCS Management sounded confident of FY2014 being a better year than FY2013 as clients seem to have a better handle on the kind of projects they want to execute and are aware of the challenging macro environment. They have planned their IT spending considering these challenges. Factors like a healthy pipeline, broadbased deal signings and upturn in discretionary spending have collectively lent confidence to TCS in estimating FY2014 to be a better year than FY2013. The company continues to receive deals in transformation projects. The company bagged seven large deals in 3QFY2013. Wipros Management indicated that CY2013 IT budgets are expected to remain stable and anticipates a positive demand environment ahead. Prospects of growth revival remain healthy on the back of 1) better deal closures in 3QFY2013 as against in 2QFY2013, 2) 1.7x increase in the deal pipeline yoy and 3) ~2x increase in the number of large deals in the pipeline, yoy. HCL Tech signed 12 multi-year, multi-million dollar deals during 2QFY2013 on top of 12 deals signed in 1QFY2013. The Management sounded confident of sustaining revenue growth within the top-tier league and has been focusing a lot of effort in the US and Europe geographies to chase the rebid opportunity with its recent win ratios of ~50%. Its Management cited that the re-bid renewal market
February 14, 201

IT | 3QFY2013 Result Review

continues to be strong, whether it's in the US or in Europe and in specific countries across Asia as well. Cognizant has issued CY2013 guidance of at least 17% yoy growth in revenues (includes anticipated acquisition revenue of US$90mn). The 1QCY2013 guidance (~2.6% qoq growth) implies ~4% CQGR over 2Q-4QFY2013 to meet the lower end of the CY2013 organic revenue guidance of ~16%. Its Management indicated that the deal pipeline is better as compared to what it was at the start of CY2012. Within industry verticals, the company is positive on BFSI as it sees pent up demand and strength in insurance driving growth, while it remained cautious on healthcare, considering contraction in IT budgets within pharma clients.

Outlook and Valuation

Nasscom has recently issued guidance of 12-14% yoy growth for the Indian IT exports industry and estimates it to reach ~US$84-87bn in FY2014. Nasscom estimates 10.2% yoy growth in IT service exports to US$75.8bn in FY2013, ie in the mid range of its lowered guidance of 9-12% (Nasscom lowered its guidance from 11-14% growth in February 2012 to 9-12% in November 2012). Given the lower base of FY2013, some rebound was bound to happen in FY2014. Nasscom is optimistic about growth in CY2013 for Indian IT vendors. Gartner has recently indicated an optimistic outlook and has increased IT spending growth forecast for CY2013 to 4.2%, up from the prior forecast of 3.8%, mentioning that uncertainty around the globe is coming to end and the same is likely to lead to an increase in IT spending. In addition, International Data Corporation (IDC) also predicts worldwide IT spending to exceed US$2.1tr, up 5.7% yoy in CY2013. After a gap of almost a year, commentary from Managements of various IT companies on growth is turning positive. The incremental revenue addition on a qoq basis in 3QFY2013 was also the highest in the last four quarters as economic conditions in developed economies have stabilized and clients are now spending prudently, keeping in mind the challenging business environment. IT stocks have reacted positively post 3QFY2013 results commentary on the back of factors such as: 1) pick up in discretionary spending, 2) FY2014 deal pipeline looking better than FY2013, 3) less cautious commentary from Managements, 4) upbeat revenue by tier-I IT companies in a lull quarter and 5) revenue growth seen from BFSI industry vertical suggesting that weakness in BFSI is abating, which is the highest revenue generator for IT companies. An uptick in discretionary spending is clearly visible as the incremental revenue additions from consulting and system integration services have picked up in the last two quarters and are higher on a yoy basis for the first time in the last five quarters. Further, Oracle and SAP license sales have been better-than-expected with positive commentary going ahead. 3QFY2013 witnessed slight revival in discretionary spending which has led to expectations of a demand recovery and convergence between erstwhile leaders and laggards. We believe demand for IT offshore services would continue to be strong due to the need for operational efficiency & cost rationalization and regulatory compliance & risk management. From a longer term perspective, IT companies are now investing in areas of cloud, mobility and analytics.

February 14, 201

IT | 3QFY2013 Result Review

Policy and economic recovery coupled with clarity on fiscal cliff and containment of Europe crisis, will likely result in higher IT spending and increase in demand for discretionary spend. Given the current economic situation, we see IT budgets to remain largely flat for CY2013 and expect volume growth of tier-I Indian IT companies to be 9% plus. However, we do not foresee any price erosion as of now. In terms of mid-cap IT companies, we expect challenges to persist due to factors such as high client concentration, demand pressures, restricted pricing power, limited margin levers, and limited bench sizes. Most of the tier-II companies started CY2012 with a strong outlook on growth. But as the year progressed, the Management commentary on growth has moderated. We expect TCS and HCL Tech to lead the growth in tier-I IT pack by growing higher than the industry average in FY2014. TCS stock price has run up significantly and is currently trading at 18.3x FY2014E EPS, which leaves little room for upside in the stock price. The PE premium between TCS and Infosys has reduced now, given Infosys outperformance during 3QFY2013 after six quarters of disappointment. Infosys is currently trading at 16.3x FY2014E EPS which is at a premium to the Sensex. We believe, a couple of quarters of outperformance is required from the company for it to get its stock re-rated further. HCL Tech is trading at 13.4x FY2014E EPS; we maintain Accumulate rating on the stock with a target price of `765. Among mid-caps, we recommend a Buy rating on Hexaware with a target price of `113, owing to steep correction in the stock price despite expectations of the company posting revenue growth at par with the industry average. In addition, we like KPIT and have a Buy rating on it with a target price `140 on the back of its niche position. Tech Mahindra remains one of our preferred picks in the entire IT space as the company has recently acquired two companies which will give it inorganic boost. Also, post its merger with Mahindra Satyam, the risks which the company is facing right now such as client concentration and industry concentration will be curtailed and the company will be able to reap benefits from Mahindra Satyams capability in enterprise services.

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IT | 3QFY2013 Result Review

Exhibit 7: Recommendation summary

Company HCL Tech Hexaware Infosys Infotech Enterprises KPIT Cummins Mahindra Satyam MindTree Mphasis NIIT^ Persistent TCS Tech Mahindra* Wipro Reco Accumulate Buy Neutral Accumulate Buy Accumulate Accumulate Accumulate Buy Neutral Neutral Accumulate Accumulate CMP (`) 705 81 2,813 163 108 116 795 344 25 535 1,447 1,002 396 Tgt Price (`) 765 113 184 140 126 868 396 36 1,105 429 Upside (%) 8.5 39.9 13.0 29.4 8.7 9.1 14.9 44.9 10.3 8.3 FY2014E EBITDA (%) 20.7 18.3 28.8 17.4 15.2 19.8 19.3 17.5 10.9 24.1 28.9 19.6 19.4 FY2014E P/E (x) 13.4 8.0 16.3 8.4 8.4 10.2 9.2 9.1 4.0 9.9 18.3 9.1 14.3 FY2011-14E EPS CAGR (%) 13.6 4.1 5.9 10.3 16.9 3.7 17.4 0.0 (2.7) 15.1 13.3 7.9 6.8 FY2014E RoCE (%) 1.6 0.8 2.9 0.5 0.7 1.2 0.9 0.6 0.1 1.1 3.7 1.7 1.6 FY2014E RoE (%) 22.9 21.2 21.3 13.6 20.5 23.7 21.7 13.5 14.1 18.0 29.7 22.3 17.9

Source: Company, Angel Research; Note: ^Valued on SOTP basis

February 14, 201

IT | 3QFY2013 Result Review

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Analyst ownership of the stock HCL Tech Hexaware Infosys No No No No No No No No No No No No No Angel and its Group companies ownership of the stock No No No No No No No No No No No No No Angel and its Group companies' Directors ownership of the stock No No No No No No No No No No No No No Broking relationship with company covered No No No No No No No No No No No No No

Infotech Enterprises
KPIT Cummins Mahindra Satyam MindTree MphasiS NIIT Persistent TCS Tech Mahindra Wipro

Note: We have not considered any Exposure below ` 1 lakh for Angel, its Group companies and Directors

Ratings (Returns):

Buy (> 15%) Reduce (-5% to 15%)

Accumulate (5% to 15%) Sell (< -15%)

Neutral (-5 to 5%)

February 14, 201

IT | 3QFY2013 Result Review

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10