Sunday, 23 November 2008

MindTree: Buy

Holistic offering of IT and R&D

Improving operating metrics

Expanding Indian presence

The relatively strong business positioning and reasonable valuations make MindTree one of the best-placed players among the mid-tier IT companies.

Investments with a one-two year perspective can be considered in the shares of MindTree, considering its relatively strong business positioning among mid-tier IT companies and reasonable valuations.

Given the current difficult macro-environment where clients tighten IT spends and demand more value for money, MindTree may be one of the best-placed players in the mid-tier segment to weather the crisis. The company’s focus on applications delivery to the key areas of operations of the various verticals that it operates in, lends confidence in the current difficult macro-environment.

At Rs 234, the stock trades at seven times its likely 2008-09 earnings. This is at a slight premium to mid-tier players such as Hexaware Technologies and KPIT Cummins.

But MindTree’s blended offering of IT and R&D services, better revenue visibility on a wider vertical-mix, and an increasing domestic presence, may justify this premium. MindTree resembles any of the top-tier IT players in terms of service offering, but operates on a smaller scale. This apart, improvements in several key operating metrics and opportunities in areas such as testing, after the Aztecsoft acquisition, are positives for the company over the long run.


MindTree offers both IT and R&D services, catering to a wide range of clientele. Traditional services such as application development and maintenance (ADM), package implementation, testing and the like are delivered to clients across four-five verticals. MindTree also works on product-realisation services with clients who produce storage and server systems, consumer appliances, communication systems and automotive systems.

This mix of IT-R&D services is around 80:20 in terms of revenue contributions to the company. Over the long run, R&D services have the potential to lead to IP-led revenues that are not linked to the manpower added and, therefore, may provide scope for margin expansion.

In terms of vertical-mix, MindTree is also favourably placed, given the current problems in the financial sector. Manufacturing contributes 27 per cent of the revenues, BFSI (26.4 per cent) and travel and transportation (20.4 per cent); clients are other important contributors. For instance, in the manufacturing segment, MindTree works in areas such as distribution planning and sales routing, business intelligence, and trade promotion data management to give feedback to product managers. In the BFSI, the company is quite selective in the way it operates.

ADM services contribute nearly 75 per cent of its revenues. Though these command lower billing rates, they are non-discretionary in nature.

Gains from acquisition

This means that IT-budget tightening of clients poses less of a threat to project flows. Together, these factors lend better revenue visibility over the medium term for the company.

MindTree has also looked to grow inorganically and has acquired a 79.9 per cent stake in Aztecsoft at an enterprise value of Rs 360 crore. MindTree is funding over 50 per cent of this deal through internal accruals.

Aztecsoft works with clients in niche areas such as transaction portals, intranet and extranet portals of enterprises, independent software vendors and mobile and wireless companies. It counts Microsoft and AOL as its clients.

Aztecsoft has enterprise software capabilities in these segments and has capabilities in key technology areas such as SaaS, Web 2.0 and cloud computing. MindTree’s R&D division together with Aztecsoft’s capabilities would now be able to address the entire value chain of product development business.

Aztecsoft has a strong independent testing service practice, which is slated to be a key growth area of outsourcing, according to Nasscom reports.

India Presence

HUL, ICICI Bank, ING Vysya and Titan Industries are some of MindTree’s major clients in India. Over the past year, MindTree has been pursuing deals in the government and Defence segments.

It has also participated in the e-governance initiative, with a large project for the Rajasthan Government for citizen services.

Other assignments include work done for the Chief of Army Staff and the Deputy Chief of Army Staff and a consulting assignment to manage the logistics of a war.

India contributes around five per cent of Mindtree’s overall revenues and the company hopes to enhance this. The company is eyeing more such deals and gain from government spends on IT enablement.

Improving operating metrics

Over the last few quarters, the company has enhanced several operating metrics to optimise costs and manage margins.

Utilisation, which was at 65 per cent levels, is now 70.5 per cent and MindTree hopes to increase this over the next year or so. In terms of revenue-mix, the offshore component is over 70 per cent.

This makes MindTree a player with one of the best mix among mid-tier IT players.

A better offshore component ensures better margins (but lower revenues) compared to onsite where revenues come at lower margins. Million dollar client additions are healthy.

Repeat business at 99 per cent is comparable to top-tier IT players and indicates that there is no significant reduction in engagement with existing clients.

Attrition has also come down significantly to 15 per cent from 16.3 per cent.


There is a possibility of clients coming back for price reductions for deals, which may hurt realisations.

With several large companies in the BFSI space filing for bankruptcy, and with automotive companies also facing the heat, the overall pie of newer deals may be reduced for MindTree.

Source: TheHinduBusinessLine

1 comment:

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