4 April 2016

Update | Sector: Technology

Mphasis

BSE SENSEX S&P CNX CMP: INR454 TP: INR520(+14%) Neutral 25,400 7,759

Stock Info Bloomberg MPHL IN Equity Shares (m) 210.2 52-Week Range (INR) 534/363 1, 6, 12 Rel. Per (%) 3/15/26 M.Cap. (INR b) 95.4 M.Cap. (USD b) 1.5 12M Avg Val (INR M) 97 Free float (%) 39.5 Financials Snapshot (INR b) Y/E Mar 2016E 2017E 2018E Sales 61.1 63.5 73.1 EBITDA 8.9 9.7 11.4 PAT 7.2 7.7 8.6 EPS (INR) 34.2 36.5 40.7 EPS Gr. (%)* 5.9 7.0 11.5 BV/Sh. (INR) 276.6 288.0 301.1 RoE (%) 12.7 12.9 13.8 RoCE (%) 13.2 14.1 16.1 P/E (x) 13.3 12.4 11.1 P/BV (x) 1.6 1.6 1.5 Shareholding pattern (%)

As On Dec-15 Sep-15 Dec-14

Promoter 60.5 60.5 60.5

DII 9.0 8.3 4.5

FII 23.1 20.4 26.5

Others 7.2 10.8 8.6

FII Includes depository receipts Stock Performance (1-year)

Blackstone to acquire HP’s stake ~USD200m annual revenue visibility from HPE welcome Blackstone acquires HPE stake, triggering open offer for 26% minority

shares Blackstone India has entered into a definitive agreement with HPE (HP

Enterprise) to buy a majority stake in Mphasis. HPE currently owns 60.5% of Mphasis. Blackstone will pay a purchase price of INR430 per share to HPE.

This will trigger a mandatory open offer for a purchase of additional 26% shares of the company (open offer @INR457.54/share) and the acquiring entity has released a public announcement to the stock exchanges. Based on the open offer subscription, the purchase price consideration will vary between INR54.66b and INR70.71b (or, approximately USD825m - USD1.1b).

HPE and Blackstone have agreed a Master Services Agreement (MSA) which HPE proposes to sign with Mphasis, post approval by Mphasis’ Board of Directors and shareholders. The duration of the MSA is five years with three automatic renewals of two years each. Under this MSA, HPE has proposed to commit a minimum revenue amount escalating year over year and totaling USD990m over the next five years

Two clear positives – Visibility of HP revenues and new logos in Direct business The MSA with minimum revenues totaling USD990m over 5 years lends

visibility to revenues from the HP Channel for MPHL, which is positive, and also implies bottoming out of revenues from HP business near current levels. Mphasis will be included in HPE’s Preferred Provider Program opening up significant additional revenue opportunities.

Secondly, Blackstone cited the synergy of exposing its portfolio as potential clientele for MPHL, implying some leads for the Direct channel business as well. MPHL could leverage these specially to create more credible references in its focus areas of Digital and GRC. Blackstone India has entered into a definitive agreement with HPE (HP Enterprise) to buy a majority stake in Mphasis. HPE currently owns 60.5% of Mphasis. Blackstone will pay a purchase price of INR430 per share to HPE.

One multiple accretive possibility – could the dividend be upped given the

base on books? Net cash on MPHL’s books stands at INR112 at present, 24.5% of CMP. This is

one obvious avenue of efficiency for Blackstone, to improve the capital allocation, return ratios and consequently valuation multiple. We saw this with HEXW too, where healthy payout ratios have meant a premium multiple to even some of the better performing peers.

280

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MphasiSSensex - Rebased

Ashish Chopra (Ashish.Chopra@MotilalOswal.com); +91 22 3982 5424 Sagar Lele (Sagar.Lele@MotilalOswal.com); +91 22 3982 5585

Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

Mphasis

4 April 2016 2

MPHL trades at ~10x operational income – and the scope of expansion in which is healthy given three-pronged possibility of: [1] Improved HP Channel revenues, [2] New logos in Direct Channel and [3] Improved Payout ratios.

The overhangs: Pricing uncertainty and prevailing Digital ‘Risk’ Apart from the value of USD990m over 5 years, any other details concerning the

modalities of the deal remain unknown. Whether there is a risk to pricing and profitability as a result over the foreseeable future remains to be seen.

Also, key prevailing concern at MPHL has been the revenues from Digital Risk. Currently at a run rate of USD40m per quarter, this could decline to ~USD30-35m after completion of a couple of projects, and revival will be subject to deal wins. We are currently modeling USD160m in FY18 from Digital Risk, while it may taper to USD130-140m annualized run-rate in the near term.

Change in estimates: Factoring HPE business visibility With immediate effect, we have revised our estimates to factor ~USD200m

revenues from HPE in FY18 v/s USD175m earlier. We were already estimating USD196m from HPE in FY17, which sees no significant change.

Consequently, our earnings estimate is up 2% for FY18 to INR40.7, and unchanged at INR37 for FY17.

Exhibit 1: HP under pressure since the last many quarters

Source: MOSL, Company

Exhibit 2: Digital Risk revenue expected to decline over the next two quarters

Source: MOSL, Company

71 70 69 67 67 62 58 58 55 54 52

46 41 40 37 36 36 36 35 31 29 27 24

20 30 40 50 60 70 80

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HP Channel % of Total Revenues

34.2 42.5 46.3 45.5

29.6 38.0 34.0

22.4 30.8

38.0 40.8 39.9

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Digital Risk Rev. (USD m)

Mphasis

4 April 2016 3

Valuation and view Our FY17 revenue estimate stands at USD948m compares with FY13 (YE

October) annual revenues of USD1,025m. Revenues from the HP channel have posted a decline in 18 of the last 20 quarters and now constitutes to ~24% of total revenues. The contribution of the HP channel has significantly reduced in the portfolio, but finally there has been some reprieve in the form of an MSA with ~USD1b revenue visibility over 5 years.

With strong deal wins in the Direct channel, and the hive-off of the domestic BPO business, we estimate MPHL to stem the decline in revenues and post growth at a CAGR of 7.2% over FY16-18E. Revenue growth confidence would be the single most important factor for a re-rating. However, with uneven growth seen in Digital Risk since its acquisition, consistency yet seems to be lacking. While valuations at 12.4x/11.1x FY17E/18E are much discounted to peers (particularly after factoring the Cash Balance), the rate of decline within HP channel remains a risk.

Although it has guided for EBIT margin of 13-15% for now, the modalities of the MSA with HPE remain unknown, posing potential risk to the margins. While sustained momentum in the Direct channel business is a plus, any pricing implications of the MSA with HPE will wipe out the visibility in the channel for the company.

Impressive execution in Direct International business lends visibility of above-industry growth in 2/3rd of MPHL’s business. Our current target price of INR540 discounts forward operating PAT by 11x, added to expected net cash of INR120/share (compared to current cash of INR112/share). While Blackstone’s buyout of HPE stake looks positive on the balance, we will revisit our Neutral rating following clarity on the deal with HP and / or any visibility in the Digital Risk business.

Key Triggers Momentum gain in Direct International channel Pick up in quarterly deals TCV

Key risks Continued volatility in Direct Channel emerging markets Failure to grow Direct International channel faster than industry growth Volatility in Digital Risk

Exhibit 3: MPHL 1-year forward PE chart

Source: Company, MOSL

Exhibit 4: MPHL 1-year forward PB chart

Source: Company, MOSL

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PB (x) Peak(x) Avg(x) Min(x)

Mphasis

4 April 2016 4

Story in charts

Exhibit 5: HP Revenues have been declining rapidly…

5MFY14* comparison normalized to be comparable

Exhibit 6: … Now compounded with volatility in digital risk

Exhibit 7: India revenue reduced further after sale of BPO operations

Exhibit 8: … and portfolio issues have dragged EPS lower year after year

5MFY14* comparison normalized to be comparable

Exhibit 9: 13-15% target EBIT margin band

Exhibit 10: Digital Risk revenues have rebound sharply; outlook bleak again

Source: Company, MOSL

777 731 586 455 157

325

-5.9

-19.9 -22.4

-17.0 -13.8

FY10 FY11 FY12 FY13 5MFY14 FY15

HP Revenues % Change

34.1 43.5 55.6 63.2 65.5

65.9 56.5 44.4 36.8 34.5

FY11 FY12 FY13 5MFY14 FY15

Direct Channel (%) HP Channel (%)

1,728

1,229

989 925

1,097 876

1,359 1,218

1,479 1,462

1,455 1,480

1,120

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India Revenue % Change

43.2 48.6 39.4 37.5 35.3 14.7 32.3

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-19.0

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-8.6

FY09

FY10

FY11

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5MFY

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EPS % Change

21.7 20.6 16.4 16.4 15.3 15.2 13.3 13.3 13.9 14.2

4.2 4.4 4.6 5.4 5.2

6.1 6.2 6.3 6.2 6.0

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FY10

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5MFY

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FY16

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FY18

EBIT Margin (%) S&M (%)

34.2 42.5 46.3 45.5

29.6 38.0 34.0

22.4 30.8

38.0 40.8 39.9

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Mphasis

4 April 2016 5

Exhibit 11: Operating metrics Operating metrics Apr-13 Jul-13 Oct-13 Jan-14 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Vertical Contribution (%)

Banking and Capital Markets 35.9 39.7 41.8 41.4 41.5 40.7 41.9 39.6 41.8 44.3 46.9 49.7 Insurance 11.6 11.5 12.1 12.9 12.1 12.8 13.4 14.9 15.3 15.5 15.2 15.7 IT, Commn & Entmt 21.0 17.8 16.2 16.1 16.3 16.8 16.9 16.9 15.6 14.3 12.7 10.0 Emerging Industries 31.5 31.0 29.9 29.7 30.1 29.7 27.8 28.6 27.3 25.8 25.2 24.6 Total 100 100 100 100 100 100 100 100 100 100 100 100 Revenue by Delivery Location (%)

Onsite 42 45 47 47 46 45 46 43 47 49 49 51 Offshore 58 55 53 53 54 55 54 57 53 51 51 49 Secondary Market Segment (%)

HP Channel 46 41 40 37 36 36 36 35 31 29 27 24 Mature Market - Direct Channel 47 54 56 57 57 56 58 56 60 64 67 70 Emerging Market - Direct Channel 7 5 4 5 7 8 7 9 9 7 7 5 Service Type (%)

App Maintenance 31 31 31 29 26 28 29 29 29 29 30 33 App Development 21 22 22 20 23 22 24 25 25 25 24 23 Customer Service 5 5 5 5 5 5 6 6 6 5 4 2 Service/Technical Help Desk 3 3 3 3 3 3 3 2 2 2 2 2 Trasaction Processing Service 5 5 5 5 5 5 6 7 7 7 7 7 Infra Management Services 20 17 16 18 19 20 18 20 17 15 15 15 Knowledge Processes 14 17 18 18 18 16 15 11 14 17 18 18 License Income 1 0 1 1 0 0 0 1 1 1 0 1 CLIENT METRICS

Client wins

BCM 6 4 3 2 2 9 1 2 4 5 5 5 Insurance 3 1 4 3 0 1 0 0 1 2 0 2 ITCE 4 3 1 0 2 1 2 0 2 0 0 0 Emerging industries 8 8 9 6 4 5 7 1 5 3 3 1 Total 21 16 17 11 8 16 10 3 12 10 8 8 Client wins Channels

Direct Channel 10 10 8 10 4 11 5 3 8 10 7 5 HP Channel 11 6 9 1 4 5 5 0 4 0 1 3 Total Client additions 21 16 17 11 8 16 10 3 12 10 8 8 Clients Contributing More than

USD1m 128 122 117 110 112 110 104 100 102 98 100 102 USD5m 42 44 41 42 43 42 41 42 39 36 39 35 USD10m 22 22 21 20 19 17 17 17 19 20 19 18 USD20m 9 10 11 11 11 10 10 8 9 8 7 8 Clients - Direct Channel

USD1m 62 58 59 54 57 57 52 49 57 58 61 63 USD5m 19 20 20 21 25 25 25 25 25 24 27 25 USD10m 10 12 12 12 13 12 12 12 14 15 15 14 USD20m 6 7 8 7 8 7 7 6 7 6 5 6 Clients - HP Channel

USD1m 66 64 58 56 55 53 52 51 45 40 39 39 USD5m 23 24 21 21 18 17 16 17 14 12 12 10 USD10m 12 10 9 8 6 5 5 12 5 5 4 4 USD20m 3 3 3 4 3 3 3 2 2 2 2 2

Mphasis

4 April 2016 6

Source: MOSL, Company

Financials and Valuations

Key assumption 2011 2012 2013 2014 2015 2016E 2017E 2018E

INR/USD Rate 45.7 53.0 57.5 58.7 61.3 65.7 67.0 69.0

Revenues (USD m) 1,117 1,036 1,025 427 944 928 948 1,066

Total Delivery Headcount 40,408 36,640 37,052 35,663 34,059 22,062 23,362 26,087

Net Addition 446 -3,768 412 -1,389 -1,604 -11,997 1,300 2,725

Per Capita Productivity (USD) 27,646 28,284 27,655 28,717 27,716 42,049 40,594 40,876

HP Channel Revenue (%) 65.9 56.5 44.4 36.8 34.5 27.6 23.4 19.9

Direct Channel Revenue (%) 34.1 43.5 55.6 63.2 65.5 72.4 76.6 80.1 Income Statement (INR Million) Y/E Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Net Sales 50,980 53,574 57,963 25,939 57,949 61,140 63,515 73,148 Change (%) 1.2 5.1 8.2 7.4 -6.9 5.5 3.9 15.2 EBITDA 9,934 10,511 10,335 4,397 8,701 8,949 9,747 11,440 EBITDA Margin (%) 19.5 19.6 17.8 17.0 15.0 14.6 15.3 15.6 Depreciation 1,550 1,745 1,446 504 980 801 929 1,075 EBIT 8,384 8,766 8,889 3,893 7,721 8,148 8,819 10,365 Other Income 1,751 1,513 1,062 389 1,687 1,726 1,776 1,448 Extraordinary items 0 0 0 0 0 0 0 0 PBT 10,135 10,279 9,951 4,282 9,408 9,875 10,594 11,813 Tax 1,827 2,357 2,514 1,191 2,630 2,694 2,913 3,249 Tax Rate (%) 18.0 22.9 25.3 27.8 28.0 27.3 27.5 27.5 Min. Int. & Assoc. Share 0 0 0 0 0 0 0 0 Reported PAT 8,308 7,922 7,437 3,091 6,778 7,181 7,681 8,564 Adjusted PAT 8,308 7,922 7,437 3,091 6,778 7,181 7,681 8,564 Change (%) -19.1 -4.6 -6.1 -0.3 -8.6 5.9 7.0 11.5

Balance Sheet (INR Million) Y/E Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E

Share Capital 2,100 2,101 2,101 2,101 2,101 2,102 2,102 2,102

Reserves 36,898 41,946 47,243 49,049 52,697 56,049 58,434 61,197

Net Worth 38,998 44,047 49,344 51,150 54,798 58,151 60,536 63,299

Debt 2,946 3,299 5,600 5,555 6,253 3,913 2,913 1,913

Deferred Tax -975 -1,015 -1,015 -968 -826 -757 -757 -757

Total Capital Employed 40,969 46,331 53,929 55,737 60,225 61,307 62,692 64,455

Gross Fixed Assets 11,339 11,401 10,892 10,912 10,055 10,027 12,147 14,267

Less: Acc Depreciation 8,495 9,041 8,770 8,734 8,499 8,520 9,449 10,524

Net Fixed Assets 2,844 2,360 2,122 2,178 1,556 1,507 2,698 3,743

Capital WIP 102 150 266 62 318 849 849 849

Investments 17,765 25,192 18,995 18,154 14,431 18,006 18,006 18,006

Current Assets 25,610 22,970 26,060 26,522 35,014 33,672 29,959 32,962

Inventory 0 0 0 0 0 0 0 0

Debtors 13,072 12,102 12,582 12,967 11,371 12,377 13,106 15,190

Cash & Bank 2,897 4,216 5,943 4,700 13,311 10,823 6,381 7,301

Loans & Adv, Others 9,641 6,652 7,535 8,855 10,332 10,472 10,472 10,472

Curr Liabs & Provns 14,050 13,953 16,013 13,044 12,875 15,660 11,754 14,038

Curr. Liabilities 9,098 8,765 10,167 9,446 7,145 9,071 9,605 11,132

Provisions 4,952 5,188 5,846 3,598 5,730 6,589 2,149 2,906

Net Current Assets 11,560 9,017 10,047 13,478 22,139 18,012 18,205 18,924

Total Assets 40,969 46,331 53,929 55,737 60,225 61,307 62,692 64,455

Mphasis

4 April 2016 7

Financials and Valuations Ratios Y/E Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E

Basic (INR)

EPS 39.3 37.5 35.3 14.7 32.3 34.2 36.5 40.7

Cash EPS 46.9 46.0 42.3 17.1 36.9 38.0 41.0 45.9

Book Value 185.7 209.6 234.9 243.5 260.8 276.6 288.0 301.1

DPS 6.5 17.0 17.0 7.0 16.0 18.8 21.0 23.0

Payout (incl. Div. Tax.) 16.5 45.3 48.1 47.6 49.6 54.9 57.5 56.4

Valuation(x)

P/E 12.9 14.1 13.3 12.4 11.1

Cash P/E 11.1 12.3 12.0 11.1 9.9

Price / Book Value 1.9 1.7 1.6 1.6 1.5

EV/Sales 1.3 1.3 1.2 1.2 1.0

EV/EBITDA 7.4 8.5 7.9 7.6 6.3

Dividend Yield (%) 3.7 3.5 4.1 4.6 5.1

Profitability Ratios (%)

RoE 23.1 19.1 15.9 14.8 12.8 12.7 12.9 13.8

RoCE 22.2 19.6 17.4 16.7 13.1 13.2 14.1 16.1

Turnover Ratios (%)

Asset Turnover (x) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Debtors (No. of Days) 90 86 78 74 77 71 73 71

Inventory (No. of Days) 0 0 0 0 0 0 0 0

Creditors (No. of Days) 0 0 0 0 0 0 0 0

Leverage Ratios (%)

Net Debt/Equity (x) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Cash Flow Statement (INR Million) Y/E Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Adjusted EBITDA 9,934 10,511 10,335 4,397 8,701 8,949 9,747 11,440 Non cash opr. exp (inc) 1,751 1,513 1,062 389 1,687 1,726 1,776 1,448 (Inc)/Dec in Wkg. Cap. 1,247 3,862 697 -4,674 -50 1,639 -4,635 200 Tax Paid -1,827 -2,357 -2,514 -1,191 -2,630 -2,694 -2,913 -3,249 Other operating activities -221 -40 0 47 142 69 0 0 CF from Op. Activity 10,884 13,489 9,580 -1,032 7,850 9,690 3,975 9,840 (Inc)/Dec in FA & CWIP -1,985 -1,309 -1,324 -356 -614 -1,283 -2,120 -2,120 Free cash flows 8,899 12,180 8,256 -1,388 7,236 8,407 1,855 7,720 (Pur)/Sale of Invt -3,165 -7,427 6,197 841 3,723 -3,575 0 0 Others -4,812 -914 -12,887 634 84 -1,152 0 0 CF from Inv. Activity -9,961 -9,650 -8,014 1,119 3,193 -6,010 -2,120 -2,120 Inc/(Dec) in Net Worth -704 1,307 2,040 436 903 901 0 0 Inc / (Dec) in Debt 2,490 353 2,301 -45 698 -2,340 -1,000 -1,000 Interest Paid 0 0 0 0 0 0 0 0 Divd Paid (incl Tax) & Others -1,598 -4,180 -4,180 -1,721 -4,033 -4,730 -5,297 -5,801 CF from Fin. Activity 188 -2,520 161 -1,330 -2,432 -6,169 -6,297 -6,801 Inc/(Dec) in Cash 1,111 1,319 1,727 -1,243 8,611 -2,489 -4,442 918 Add: Opening Balance 1,786 2,897 4,216 5,943 4,700 13,310 10,822 6,379 Closing Balance 2,897 4,216 5,943 4,700 13,311 10,822 6,379 7,298

MPHASIS

OTHER COMPANIES

SECTOR UPDATES

MPHASIS GALLERY

Mphasis

4 April 2016 9

N O T E S

Mphasis

4 April 2016 10

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