Tech Mahindra Limited

Strong Revenue Visibility-Buy:

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Tech Mahindra

1.Tech Mahindra (TM) is a niche IT player largely focused on the Telecom space,which puts the Company in a better position, compared to its peers, to weather the current global recession. In addition, the Company has an order book of around USD 3 bn for the next 3–5 years, which provides strong revenue visibility for the medium term. However, TM's high revenue concentration (around 65%) from British Telecom (BT) remains a matter of concern.

2.We expect revenues to grow at around 12% and 6% for FY09 and FY10,respectively, in USD terms. This is primarily attributable to the strong revenue visibility due to the Company’s healthy order book. However, with the deteriorating macroeconomic environment, we expect volume growth to moderate in the next 2–3 years. Nevertheless, TM will gain from the rupee depreciation; consequently, we expect revenues to grow at around 21% and 11% for FY09 and FY10, respectively, in INR terms.

3.We expect the EBITDA margin to remain under pressure, largely on account of the increasing transition periods and slow ramp-ups in the large deals. Besides,expected increase the selling efforts to diversify the revenue base will also strain the margin in the short term.

4.At the current market price (CMP) of Rs. 266.55, the stock trades at an attractive forward P/E of 5x and 4.9x for FY09E and FY10E, respectively.Based on DCF valuation, we have arrived at a target price of Rs. 345,assuming a 17.6% cost of equity, a 5% terminal growth rate, and a 17.5% weighted average cost of capital (WACC). Since our target price indicates a significant upside of 29.5% over the CMP, we recommend a Buy rating.

Patni Computer Systems:

Attractive Valuation-Buy:

1.Given the recent stock correction, we believe that the current market price (CMP) of Patni Computer (Patni)'s stock factors in the negative near-term outlook for the IT sector. At the CMP of Rs. 128.95, the stock trades at an attractive forward P/E of 4x and 5.2x, which is at a heavy discount to the industry average multiple of 8.5x and 7.5x for CY08E and CY09E, respectively.Besides, based on DCF valuation, we have arrived at a target price of Rs. 166,assuming a 13.1% cost of equity, a 5% terminal growth rate, and a 13.1% WACC. With a significant 28.6% upside from the CMP, we recommend a Buy rating.

3. We expect Patni's top line to grow by around 6.5% in CY08 but shrink by a negative 6.5% approximately in CY09, in USD terms. This is because we believe that the sales volume will contract for the next 2–3 years due to the decreasing number of clients and the elongated client decision cycles. Besides,the Company is highly dependent on its top 10 clients (accounting for around 45% of the overall revenues), which will further pressurise the billing growth rate for CY08 and CY09.

4.We expect the EBITDA margin to remain under pressure in the short-tomedium term due to the increasing pricing pressure. Besides, the Company will need to increase its selling, general and administrative expenses in order to enhance its client acquisition efforts; this is likely to offset the benefit from the improvement in the various operational parameters, such as increased offshoring (estimated at around 45% in CY09), increased revenue from fixed-price projects, enhanced utilisation levels (currently at 75%), and a controlled attrition rate.