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Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capitalmay have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

TechnologyMonthly

MONTHLY UPDATE SEPTEMBER 10, 2013

RecommendationsHCL Tech BUY

Target Price: 1,207 Upside : 19%

TCS BUY


Wipro SELL

Target Price: 430 Upside : -8%

Infosys SELL

Target Price: 2,581 Upside : -15%

eClerx BUY


Persistent BUY

Target Price: 677 Upside : 19%

Polaris SELL

Target Price: 109 Upside : -7%

Analyst Details

Ankur Rudra, CFA+91 22 3043 [email protected]

Nitin Jain+91 22 3043 [email protected]

The Hedging Conundrum

Given the sharp INR depreciation, Indian IT services firms have begunto rethink their hedging strategies. Our analysis and conversations withmanagement teams indicate a reluctance to enter into longer-termcontracts and preference towards forward contracts over options. Wealso highlight the differences in accounting policies of our IT coverageuniverse. Our post-mortem analysis of HCL Techs higher-than-industry-average revenue productivity indicates that the primary underlyingreasons are its non-linear revenues in RIM and its business mix. Finally,we analyse the reasons for HCL Techs structurally higher currentliability days (than its peers) and highlight the one-off items that led tothe significant QoQ and YoY increase.

Dissecting the hedging policies

Whilst Infosys accounts for all hedging gains/losses in its P&L, HCL Tech, TCSand Wipro distribute the gains/losses across the P&L and the balance sheet.Also, Wipro and HCL Tech recognise the gains/losses on maturity of theeffective cash flow hedges in revenues vs the industry practice of recognising itin other income. Forwards are the preferred hedging tools, with the exceptionof TCS which uses a mix of forwards and options.

Initial evidences of changing hedging strategies

With significant currency volatility, we find CFOs reluctant to enter into longer-duration contracts and prefer forwards over options. An analysis of thereported hedging data indicates that whilst eClerx has increased the tenure aswell as quantum of its hedge book, HCL Tech appears to be increasing the mix

of forwards in its hedge book. Finally, hedges are likely to mature at 59 in 2Q.

Delving deeper into employee productivity

Although HCL Techs EBIT margins are below its tier-1 peers average, itsprofitability per technical employee is the best in the industry. Our analysisindicates that the secret lies in HCL Techs best-in-class employee productivity,arising from: (1) ~40% non-linear revenues in its IMS service line, (2) lowerproportion of BPO and emerging market revenues, and (3) higher EASemployee productivity that is onsite heavy with lower maintenance revenues.

Explaining HCL Techs structurally higher current liabilities

HCL Techs higher-than-industry-average current liabilities primarily arise from:(1) unfunded gratuity plan vs funded gratuity plan for its peers, (2) bonus accrualsover 3Q/4Q, (3) higher outsourcing costs, (4) larger proportion of projects undertransition phase, and (5) lease equalisation (for operating leases). It alsobenefitted from one offs extended vendor credit and delayed invoice processing.

Valuation summary

Company Reco Mcap CMP TP FY14 EPS FY14 PE FY14 EV/EBITDA

TCS BUY 26,661 3,021 2,582 190.7 15.5 11.0

Infosys SELL 59,665 1,980 1,986 101.0 17.0 13.0

Wipro SELL 17,700 468 430 31.9 13.9 10.1

HCL Tech BUY 10,866 1,013 1,209 86.9 10.2 7.0

Polaris SELL 179 117 109 25.9 3.9 2.7

Persistent BUY 348 570 677 61.2 9.1 1.1

eClerx BUY 381 826 1,082 95.9 7.9 5.2

Source: Bloomberg, Ambit Capital research

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September 10, 2013 AMBIT CAPITAL Pvt Ltd Page 2

The Hedging ConundrumThe INR/USD rate depreciated by ~19% in a short period of five months, and thus,the volatile exchange rate has become a cause for concern for the CFOs of the IndianIT services industry. Our discussions with the company managements and analysis ofthe reported data broadly indicate that forward contracts are replacing options(where premiums have sky-rocketed) but managements prefer short-term contracts as

a matter of conservatism. eClerxs management is, however, following a contrarystrategy by increasing the hedge tenure as well as the hedge coverage. Infosys datatoo suggests a slight increase in longer duration contracts (>3 months); however, theaverage contract duration remains low (~5 months). HCL Tech has been increasingthe use of forward contracts. In the sections to follow, we compare the hedging andhedge accounting policies across our coverage universe.

Taking a closer look at hedging policies

Exhibit 1: Hedging policies across our coverage universe

Company Hedging policy

TCSMix of forwards and options (layered options). TCS hedges 1-2 quarters of revenues on a rolling basis.

Infosys Short-term hedging policy, covering net open exposure in thenext two quarters.

WiproHedges 50% inflows for the next 12 months; predominantlyforwards.

HCL TechThe cash flow hedge covers 40% of likely inflows in less thanone year and 25% of likely inflows after one year.

PersistentHedging 40-60% of net open foreign currency positions (i.e.net of natural hedge) on a 12-month rolling basis. This isdone through plain-vanilla forward contracts.

Source: Ambit Capital research

Traditional users of forward contracts TCS emerges as

an outlierAlthough the hedging strategies differ across firms, most of the Indian IT servicesfirms have traditionally used forward contracts to hedge their receivables. TCS is theonly exception among the tier-1 firms, with an equal proportion of options andforwards in its hedge book. Whilst forward contracts provide true hedging (effectivelylocking the rate), options (particularly put options) provide only downside protection.However, this comes at a cost. Our discussions with the company managementssuggest that companies tend to be reluctant to use options, given the associatedupfront costs associated with options.

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Exhibit 2: Forward contracts dominate the hedging book of IT firms (as on June 2013)

Source: Company, Ambit Capital research estimates; Note: Wipro also uses predominantly forward contracts forhedging (the exact proportion is not reported by the company)

With the high volatility in the INR/USD rate over the last few weeks, options havebecome less cost-effective for the companies to hedge. On the other hand, increasingforward premiums are providing opportunities to the companies to get attractiveforward rates. The increase in limits to cancel and re-book the forward contracts byexporters from 25% to 50%1will provide a further fillip to the use of forward contractsby the companies.

Exhibit 3: Increasing forward premium makes forwardsan attractive hedging tool


Exhibit 4: High volatility in INR/USD leading to expansionin option premiums


Hedge accounting Infosys appears to be the mostconservative

A look at the hedge accounting practices of Indian IT firms indicates that all the ITfirms (except Infosys) classify their hedges into cash flow (designated) and non-designated hedges. Whilst designated hedges are taken against the expected cashflows (i.e. revenues - with one-on-one mapping), non-designated hedges are takenagainst a pool of receivables without one-on-one mapping. The accounting treatmentalso differs the MTM gains and losses on the effective portion of the designatedhedges are booked in the balance sheet whereas those on the ineffective portion arerecognised in the P&L. All the MTM gains/losses on non-designated hedges arebooked in the P&L.

1 http://economictimes.indiatimes.com/news/economy/policy/exporters-can-re-book-50-of-cancelled-forwards-rbi/articleshow/22296602.cms

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Among the companies under our coverage, whilst eClerx and Persistent recogniseforward contracts as cash flow hedges and classify them as effective, HCL Tech, TCSand Wipro classify their hedges into designated and non-designated and alsobifurcate their designated hedges into effective and non-effective. TCS and Wiproclassify ~57% and ~47% of their receivable related hedges (i.e. excluding the hedgesrelating to the borrowings) as cash flow hedges.

Wipro and HCL Tech partly make P&L adjustment inthe top-line; Infosys and TCS show the entire amountbelow EBITDA

The accounting methods for the hedging-related gains/losses in the P&L account arenotably different across firms. Companies such as TCS, Infosys, Persistent Systems,eClerx and Polaris show the hedging gains/losses as a part of other income. On theother hand, HCL Tech and Wipro account for gain/loss on completion of the effectivecash flow contracts as a part of revenues.

Although both the methods are legitimate from an accounting point of view, itcreates inconsistency during margin comparison among peers. The EBIT/EBITDAmargins are overstated in case of hedging gain and understated in case of hedging

losses under the methods followed by HCL Tech and Wipro. The hypotheticalanalysis in Exhibit 5 illustrates this point.

Exhibit 5: Margin impact analysis under methods of accounting hedging losses in P&L(Rs mn)

Base case (cash flow hedginggains/losses booked as other

income)

Cash flow hedginggain of 100 adjusted

in revenues

Cash flow hedging lossof 100 adjusted

in revenues

Revenue 10,000 10,100 9,900

EBIT 2,000 2,100 1,900

EBIT margin 20% 21% 19%

Forex adjustment 100

Source: Bloomberg

Foreign currency borrowing additional source of forexrisk for Wipro

Wipro has external commercial borrowings of US$150mn, for which it has an interestrate swap agreement of US$150mn.

CFOs hedging dilemma

Significant volatility in the INR/USD rate over the last one month has increased theuncertainties associated with hedging. Our conversations with company CFOsindicate three broad trends:

Companies are reluctant to enter into longer-term contracts (though eClerx is anexception).

Companies are opting to remain at the lower end of the board-approved hedgingcover range (hedging implies the forward 12-month revenue covered byhedging).

High premiums are making options unattractive; companies are increasinglyusing forward contracts.

The change in hedging strategies is evident from eClerxs and HCL Techs reportedmetrics. eClerx has increased its hedging exposure both in duration as well asquantum (eClerx increased the amount of its hedge book from ~65% of TTMrevenues in FY13 to 81% in 1QFY14). Further, it increased the proportion of long-

term hedges (>1 year duration) from 23% in March 2013 to 33% in June 2013. Thestrategy adopted by eClerx is somewhat contrary to the views heard from othercompany managements. HCL Tech, on the other hand, has increased the proportion

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of forward contracts in its hedge book. Exhibits 6 to 11 below display the changingtrends in hedging strategies.

Exhibit 6: TCS Stable hedging trends; not much movementin use of forwards and hedging coverage

Source: Company, Ambit Capital research

Exhibit 7: Infosys slight uptick in use of longer-termhedging contracts


Exhibit 8: Wipro Slight decline in hedging coverage;management indicates no change in strategy


Exhibit 9: HCL Tech growing percentage of forward contractshedge book; slight increase in long-term hedges


Exhibit 10: Persistent Systems Some uptick in hedgingcoverage; management indicates no change in strategy


Exhibit 11: eClerx Increasing hedge coverage; hedgingcontinues to be driven by forward contracts


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Average hedging rates at ~Rs59 levels; may lead todeterioration in cash conversion

Among the companies that share the hedge booking rate data (HCL Tech, PersistentSystems and eClerx), we observe that the average booking rate has been ~Rs59.Given the significant depreciation in INR over the last one month, the averageexchange rate for the quarter could be ~Rs63 (assuming INR stays at the current

levels for the rest of the quarter). Given that the hedges expiring during theSeptember 2013 quarter would have been below the average Rs59 level, this wouldimply lower realisation. As revenues and expenses (and hence EBITDA) would beconverted at the average exchange rate of ~Rs63 whilst realisation would be lowerdue to lower hedge booking rates, the cash conversion (CFO/EBITDA) might comeunder pressure in 2QFY14. Furthermore, the 11.5% depreciation in INR since the endof the last quarter would imply MTM hedging losses.

The quantification of the hedging losses is not possible as the granular details oncash flow - effective and non-effective and non-designated hedges - are not sharedby the companies, which makes it difficult to determine the extent of the impact onthe P&L and balance sheet. Further, these hedging losses/gains would be offset tosome extent by revaluation in net monetary assets.

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Employee Productivity AnalysisAlthough HCL Techs EBIT margins, at 21%, are at the lower end of the industrysmargin range (23% average for tier-1 peers for the quarter-ending June 2013), HCLTechs profitability per technical employee is the best in the industry i.e. ~7% aboveTCS (the company with the best EBIT margins) and ~8% above Infosys (the next bestEBIT margins after TCS). This has been a subject of constant debate among investors

and has raised questions over the companys secret behind achieving this.

Our analysis indicates that the secret lies in HCL Techs best-in-class employeeproductivity (revenue per billed employee), which more than offsets its lower EBITmargins. HCL Techs employee productivity, adjusting for sub-contractors, is 34%above its tier-1 peers average. However, adjusting for utilisation, HCL Techsrevenue productivity is 21% above the average. Similarly, per employee productivityadjusted for utilisation is 5% above Infosys, which still charges a premium forservices.

Exhibit 12: Employee productivity adjusting for subcontractors

Source: Company, Ambit Capital research estimates

RIM is the largest source of high employee productivity: According to themanagements estimates, ~40% of HCL Techs revenues in this service line arenon-linear (i.e. de-linked from headcount), largely reflecting the higherproportion of managed service deals and industrialisation initiatives by themanagement. RIM accounts for ~31.5% of HCL Techs consolidated revenues.

Business mix also explains the divergence: Furthermore, the higherproportion of blue-printing and implementation business in EAS, lower proportionof BPO in the business mix and the least exposure to lower-realisation emerginggeographies are the additional factors contributing to better-than-peer employeeproductivity.

Gauging the impact of business mix variance onproductivity

Exhibits 13 to 16 below compare the revenue productivity of tier -1 firms adjusted forsubcontractors, onsite business, EAS and BPO, because a different mix of theseservices affects overall employee productivity. Our analysis indicates that even afterexcluding the revenues from BPO and EAS and billed employees from the equation,HCL Techs employee productivity is 9% higher than its tier-1 peers average.

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This largely reflects significantly higher employee productivity in the RIM business,arising from a higher non-linear component (which is also reflected in the higherproportion of fixed-price contracts) as indicated by the management and lowpresence in emerging geographies. Note that HCL Tech has the highest effort mix ofCore software services (excluding EAS) among the tier-1 firms (see Exhibit 20). Itssignificantly better-than-peer employee productivity in Core Software Services(excluding EAS) has a positive effect on overall business employee productivity.

Exhibit 13: Revenue productivity adjusted for onsiterevenues (adjusted for subcontractors and utilisation)


Exhibit 14: Revenue productivity adjusted for EAS(adjusted for subcontractors and utilisation)


Exhibit 15: Revenue productivity adjusted forBPO (adjusted for subcontractors and utilisation)


Exhibit 16: Revenue productivity adjusted forEAS and BPO (adjusted for subcontractors and utilisation)


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Exhibit 17: HCL Tech has the lowest presence in Emerginggeographies


Exhibit 18: HCL Tech has the highest proportion of fixed-price contracts in the revenue mix


Exhibit 19: HCL Techs EAS employee productivity is the bestthe industry thanks to higher proportion of Blue-printingand Implementation work


Exhibit 20: HCL Tech has the highest proportion of effortsin its Core Software Services business (excl EAS), where itenjoys higher productivity led by the RIM business


Exhibit 21: Despite lower EBIT margins, HCL Techs per employee productivity is the beindustry, thanks to best-in-class employee productivity

For the quarter-ending June TCS Infosys Wipro HCL Tech

EBIT margin 27.0% 23.6% 20.0% 21.0%

EBIT per billed employee 17,222 17,329 13,360 16,245

EBIT per technical employee 12,592 12,438 8,657 13,422


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Key assumptions used for the analysis

To calculate revenue productivity, we have adjusted the denominator forutilisation and also included the estimated sub-contracted employees. Hence, ouranalysis calculates revenue productivity per billed employee (including thesubcontractors). Note that we have used the reported utilisation metrics of thecompanies. Firms have different definitions of utilisation; e.g. Infosys excludes

employee leaves from utilisation whilst TCS, Wipro and HCL Tech includeemployee leaves. This may create certain inconsistencies in our analysis.

We have decomposed the employee productivity into IT outsourcing (onsite andoffshore), EAS (onsite and offshore) and BPO and calculated the weightedaverage based on the billed efforts in these businesses to arrive at theconsolidated employee productivity.

All the sub-contractor headcount is adjusted in the onsite non-EAS IT servicesheadcount, except for Wipro and HCL Tech. Wipro reports headcount as well asefforts including sub-contractors whilst HCL Tech reports effort mix in its coresoftware business including sub-contractors.

For all the companies except HCL Tech and Wipro, we assume Onsite revenuemix in the EAS business to be the same as the reported number for the overallbusiness. For HCL Tech, we have assumed onsite:offshore revenue mix of 75:25and for Wipro we assume 65:35.

EAS per employee productivity as a multiple of Core IT services for TCS is 2x vs2.1x for Infosys and Wipro and 2.6x for HCL Tech.

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Digging deeper into HCL Techs currentliabilitiesHCL Techs US GAAP current liability days (including unearned revenues) increasedby 12 days QoQ and 14 days YoY in 4QFY13 (quarter-ending June 2013), raisingconcerns over the sustainability of such an increase. Whilst the QoQ increase in

current liabilities was due to accruals for bonuses (which are paid over the Septemberand December quarters), our conversation with HCL Techs management indicatesthat two extraordinary items led to the sharp YoY increase in current liabilities andalso improved CFO:

1. Vendor credit of ~US$61.5mn for certain operating expenses; and

2. Postponement of vendor payments due to delay in installing new automatedvendor invoice processing system (not quantifiable in the absence of details).

Adjusting for the vendor credit (the only quantifiable item), the current liability daysincreased by 6 days QoQ and 9 days YoY, as elaborated in Exhibit 22 below.Similarly, the cash conversion ratio (CFO/EBITDA) was overstated due to theseadjustments. Removing the above-mentioned two one-off items, the 4QFY14 cash

conversion would have been 109% vs 117% reported (as elaborated in Exhibit 22below). Note that with further adjustment of the postponed vendor payments, theincrease in current liability days and the cash conversion days would have beenlower.

Nonetheless, the management expects the vendor credit arrangement to sustain,implying that the benefits may not reverse in FY14.

Exhibit 22: Current liability days (including unearned revenues and excluding short-term borrowings and financialderivative liabilities) HCL Tech

In US$ mn 1QFY11 1QFY11 2QFY11 3QFY11 4QFY11 1QFY12 2QFY12 3QFY12 4QFY12 1QFY13 2QFY13 3QFY13 4QFY13

EBITDA 137 131 141 158 178 171 189 193 237 247 261 267 288

CFO 133 10 80 118 173 26 132 103 248 70 251 177 336Current liabilities 675 691 730 765 755 720 742 770 888 830 861 957 1,102

Adjustments

Vendor credit from capex 0 0 0 0 0 0 0 0 0 13* 13* 13* 24#

Delayed payments due toinstallation of automatedvendor invoice processingsystem

NA NA NA NA NA NA NA NA NA NA NA NA NA

Derivative related losses(included in Currentliabilities)

NA NA NA NA NA NA NA NA 39 NA NA NA 39#

Adjusted Currentliabilities

NA NA NA NA NA NA NA NA 849 818 836 919 1,001

Adjusted Current liability

days NA NA NA NA NA NA NA NA 89 85 85 92 98Reported Current liabilitydays

109 103 101 98 90 82 82 82 93 86 88 96 107

Adjusted CFO NA NA NA NA NA NA NA NA NA 57 238 164 313

Adjusted CFO/EBITDA NA NA NA NA NA NA NA NA NA 23% 91% 62% 109%

CFO/EBITDA 97% 7% 57% 74% 97% 15% 70% 53% 105% 28% 96% 66% 117%

Source: Company, Ambit Capital research; Note: * Our estimates, # Company estimates

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Exhibit 23: Cash conversion trend (CFO/EBITDA) HCL Tech vs peers

Jun10 Sep10 Dec10 Mar11 Jun11 Sep11 Dec11 Mar12 Jun12 Sep12 Dec12 Mar13 Jun13 QoQ YoY

TCS 45% 61% 82% 56% 52% 41% 50% 61% 59% 63% 76% 73% 42% -3,151 -1,794

Cognizant 59% 92% 144% 16% 72% 102% 84% 29% 88% 97% 91% 17% 78% 6,087 -1,017

Infosys 79% 68% 69% 50% 78% 84% 73% 69% 72% 86% 89% 82% 80% -175 781

Wipro 57% 57% 37% 96% 23% 45% 58% 99% 60% 89% 101% 93% 60% -3,339 25

Average 60% 70% 83% 54% 56% 68% 66% 65% 70% 84% 89% 66% 65% -144 -501

HCL Tech 97% 7% 57% 74% 97% 15% 70% 53% 105% 28% 96% 66% 117% 5,050 1,221

HCL Tech (Adjusted) NA NA NA NA NA NA NA NA NA 23% 91% 62% 109% 4,690 NA


Exhibit 24: Current liability days comparison for quarter-ending June 2013

Source: Company, Ambit Capital research * Adjusted for derivative financial instruments

That said, HCL Tech's current liabilities have been significantly above the peeraverage in the last two years (see Exhibits 25 and 26 below). This has contributedsignificantly to the CFO (e.g. increase in current liabilities contributed US$206mn tothe CFO of US$834mn in FY13 and US$241mn contribution to the CFO ofUS$509mn in FY12).

Exhibit 25: Current liabilities (excluding borrowings andfinancial instruments) including short-term provisions(in days)

FY11 FY12 FY13

TCS 72 67 67

Infosys 74 73 78

Wipro 105 97 105

Average 84 79 83

HCL Tech* 86 96 NA

Source: Company, Ambit Capital research; Note: * Year-ending June for HCLTech

Exhibit 26: Current liabilities (excluding borrowings andfinancial instruments) (in days)

FY11 FY12 FY13

TCS 60 55 57

Infosys 49 46 50

Wipro 80 76 80

Average 63 59 62

HCL Tech* 68 77 NA

Source: Company, Ambit Capital research; Note: * Year-ending June for HCLTech

The below factors explain HCL Techs structurally high current liabilities relative to itspeers:

Bonus accruals in 4Q: HCL Tech creates accrued liability for Long TermIncentive Plans (LTIPs) and bonuses over 3Q-4Q (quarter-ending June) and paysit over 1Q and 2Q every year. According to the FY12 Annual Report, this is a

significant amount and was equivalent to 9.5/10.5 working capitaldays (2.6%/2.8% of revenues) in FY11/12. Among the tier-1 peers, whilst Infosysand Wipro have some element of bonus accruals in the quarterly balance sheet(not quantifiable due to absence of information), TCS does not have any balance

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sheet bonus accruals. A direct comparison is not possible due to informationasymmetry.

Unfunded gratuity plan: HCL Tech does not have a funded gratuity plan and itmanages the gratuity obligation on its own. This is booked as a part of short-termand long-term provisions. All of HCL Techs tier-1 peers have well-funded gratuityplans, implying a relatively lower amount in the current liabilities and provisions.

Higher outsourcing costs: HCL Tech does not own the data centres but leasesthem for the Infrastructure (RIM) business. Indeed, over 40% of the outsourcingcosts (which in turn constitute ~12% of revenues) are non-manpower related.This is also one of the reasons for higher accrued expenses (accrued expensesconstitute nearly one-third of HCL Tech's total operating current liabilities) ascompared to its peers.

Hunting-led growth - higher proportion of projects under transitionphase: HCL Tech has largely relied on hunting-led growth over the past severalquarters (also highlighted in our July issue of Technology Monthly Changingengines of growth). This also reflects in the comparatively lower revenues fromthe repeat business. The higher proportion of new client additions implies largerproportion of projects under the transition phase. According to the management,

many times, the transition phase involves certain advance payments from theclient.

Exhibit 27: Advances from customers (including unearned revenue days)

FY11 FY12 FY13

TCS 11 9 9

Infosys 11 9 11

Wipro 11 13 16

Average 11 10 12

HCL Tech 15 16 NA


Exhibit 28: Revenue growth decomposition (Mar08 Mar11)

Source: Company, Ambit Capital research; Note: * Comprising TCS,Cognizant, Infosys, Wipro and HCL Tech

Exhibit 29: Revenue growth decomposition (Mar11 Mar13)

Source: Company, Ambit Capital research Note: * Comprising TCS,Cognizant, Infosys, Wipro and HCL Tech
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Exhibit 30: HCL Techs revenue from repeat business is lower than the tier-1 peers


Operating leases: HCL Tech has some operating leases that inflated its FY13current liabilities by US$20mn due to lease equalisation. However, this shouldnot impact the CFO since it is a non-cash item and hence effectively is CFO-neutral. We do not know the absolute amount in FY12 and FY13 (not mentionedin the FY12 annual report).

Exhibit 31: HCL Techs current liabilities and provisions break-up (Rs mn)

FY11 FY12

Trade payable 2,770 4,694

% of operating current liabilities and provisions 8% 10%

Advance from customers and income received in advance 5,540 7,515


Employee benefit accruals 6,182 9,501


Accrued expenses 8,237 12,256


Taxes payable 1,829 2,315


Short-term provisions

- For employee benefits 2,347 2,882


- For taxes 4,282 7,269


Long-term provisions

- For employee benefits 1,442 2,879


Total operating current liabilities and provisions 32,628 49,311

% of revenues 21% 24%


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Sharp INR depreciationAssuming the exchange rates remain at the current levels for the rest of the year, theUSD vs INR and AUD is likely to appreciate by 12% and 9%, respectively, duringFY14, whilst other currencies are likely to remain relatively flat. During the past onemonth, the USD has appreciated by 7.3% against the INR and by 1.4% against EURwhilst it has depreciated by 1.5% against GBP.

Exhibit 32: INR/USD exchange rate movement


Exhibit 33: EUR/USD exchange rate movement


Exhibit 34: GBP/USD exchange rate movement


Exhibit 35: Estimated currency gains for FY14 over FY13*

Source: Bloomberg, Ambit Capital research; Note: * Assuming exchangerates remain at the current levels for the rest of the year.

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Market watchExhibit 36: Recent deal announcements

CompanyDeal announcement

dateClient Vertical Deal details

TCS 04/09/2013CTM, Macau TelecomIt is a multi-year, multi-million-dollar IT and business transformation project,wherein TCS will provide a new convergent rating and billing system.

HCL Tech 04/09/2013Direct Energy Energy andUtilities

It is an outcome-based deal, wherein HCL Tech will implement and manage Direct

Energy's residential billing and customer care operations in the Alberta market. Itwill provide Infrastructure hosting, Application Management and Business ProcessServices.

Wipro 03/09/2013Deutsche BankFinancialServices

According to media articles, this is a five-year ~US$125mn contract to provideApplication Maintenance services with elements of Application Development.

TCS 03/09/2013DNB GroupFinancialServices

It is a six-year Managed Services contract to provide Application Maintenance andDevelopment services.

Wipro 29/08/2013

US-basedhealthcareservicecompany

HealthcareIt is a ~US$100mn Infrastructure Management contract involving consolidation ofclients' multiple data centres.


News from the street

More exits and leadership rejigs at Infosys (September 06, 2013)

After the departures of three senior leaders (Basab Pradhan, Sudhir Chaturvedi andAshok Vemuri), Infosyss Latin America head of BPO business, Humberto Andrade,has quit to join Capgemini. He has been replaced by an Infosys veteran, AniketMaindarkar, who has re-joined after a short stint at Cognizant.

As part of the leadership rejig, V Balakrishnan (Head of BPO, Lodestone, Finacle andIndia business) has been given additional responsibilities as head of the newlycreated Utilities and Resources division in North America. Chandrashekhar Kakal,who currently heads the Business IT Services, has been given additionalresponsibilities to head the Consulting and Systems Integration business. Stephen RPratt, managing partner for Consulting and Systems Integration, will now manage theUtilities and Resources division and will report to V Balakrishnan.

The mid-to-senior management exit is a typical feature of organisational restructuring,as seen at Wipro as well during its restructuring phase. However, the leadership rejigby Infosys appears to be a reactive measure to the recent exits and will take some timeto settle down.

Cognizant enters into partnership with autonomics firm, IPSoft (August 27,2013)

According to media articles2, Cognizant has entered into a partnership with

autonomics firm, IPSoft, for its Infrastructure Management Services offerings. IPsoftand Cognizant will convert a data centre of Cognizant in the US into a centre ofexcellence for autonomics, and follow it up with two other such centres in Europe andIndia. Infosys also had entered into similar arrangements with IPSoft in April 2013.

Wipro plans to add 500 people in the Nordic region (September 03, 2013)

With a team of 500 people in the Nordic region already, Wipro is adding 500 more500 people to strengthen its operations in this market. It has also appointed Carl-Henrik Hallstrom as the Regional Head for the Nordic region. He will report to RajatMathur, Chief Sales and Operations Officer (Growth Markets) at Wipro. In hisprevious role, Hallstrom was associated with KPMG, Sweden.

2http://articles.timesofindia.indiatimes.com/2013-08-27/software-services/41495763_1_traditional-

automation-tools-ipsoft-worldwide-indian-american-chetan-dube

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Wipro partners with US firm Kana Software (September 07, 2013)

With this partnership, Wipro will provide customer service solutions to its globalinsurers through a joint development centre. Kana provides customer servicesolutions using a cloud computing (on-demand) network.

Polaris Company Secretary, B Muthusubramanian, resigns (September 02,

2013)

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Price performanceWith continued news flow on improving demand sentiments in the US and sharpdepreciation in INR against USD, IT services firms have materially outperformed theSensex. Indeed, many of these firms are trading close to their 52-week highs. NIITTech and Polaris were the highest gainers in the last two weeks. After a strong runpost the merger completion, Tech Mahindras share price declined by 1.4% in the last

two weeks.

Exhibit 37: Share price performance

Company5 Days

chg2 week

chg1 month

chg3 month

chg6 month

chg1 year

changeYTDchg

Sensex 3.49% 3.84% 2.87% -1.28% 0.09% 11.09% -0.81%

TCS -2.18% 7.97% 6.35% 35.22% 27.39% 44.58% 58.36%

Infosys -2.47% -0.05% 1.40% 24.67% 1.98% 25.06% 30.64%

Wipro -3.12% 2.05% 3.81% 41.97% 18.87% 39.17% 33.15%

HCL Tech -2.26% 7.67% 7.68% 36.02% 34.46% 78.87% 64.37%

Tech Mahindra -1.07% -1.40% 10.29% 47.06% 26.00% 62.29% 45.92%

Mphasis -0.78% 4.24% 4.94% -8.67% 5.15% 8.31% 8.61%Hexaware -2.42% -2.46% 5.26% 51.88% 43.27% -2.87% 46.89%

Mindtree -0.53% 2.47% 5.62% 24.80% 17.86% 47.57% 51.02%

eClerx -0.91% 4.82% 7.29% 19.23% 30.87% 4.80% 20.47%

KPIT 1.17% 0.68% 0.91% 14.59% 26.65% 3.05% 20.42%

Persistent -3.24% -0.60% 10.77% 7.83% 0.47% 44.44% 10.95%

Polaris -1.22% 11.53% -1.27% -2.17% -2.62% -3.58% 2.50%

NIIT Tech 3.81% 13.36% 18.28% 12.23% 7.27% 1.58% 20.80%

Source: Bloomberg

Exhibit 38: Share price performance over the last two weeks

Source: Bloomberg

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Relative valuationAt a consensus EPS CAGR of 13% over CY12-14E, HCL Tech looks attractive at thecurrent CY13 P/E multiple of 12.1x among the tier-1 firms (at a ~20% discount tolaggards, Wipro and Infosys), whilst TCS looks fairly valued. HCL Tech currentlytrades close to its five-year average forward P/E and EV/EBITDA multiple. Given theconsistent margin and revenue performance and improving RoEs over the past few

quarters, we expect potential upward re-pricing of shares.

After a strong set of results and an optimistic guidance (after a prolongedunderperformance), Wipro trades at a 16% premium to its five-year average forwardP/E multiple whilst Infosys trades at a slight premium to its five-year average forwardEV/NOPAT multiples.

Among tier-2 stocks, high-quality names such as Persistent Systems and eClerx aretrading close to their five-year average valuation multiples, whilst stocks such asPolaris (due to lack of traction in business and uncertainty over business structure)and Mphasis (due to lack of visibility in HP business) are trading at a significantdiscount to their historical average valuation multiples. Indeed, Persistent Systems iscurrently trading close to its lowest valuation multiples over the last five years.

We remain strong BUYers on HCL Tech (19% upside) among the tier-1 firms andeClerx (32% upside) and Persistent Systems (19% upside) among the tier-2 firms.

Exhibit 39: Premium to five-year forward P/E


Exhibit 40: Premium to five-year forward EV/NOPAT


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Exhibit 41: Forward P/E multiples relative to five-yearaverage, high and low


Exhibit 42: Forward EV/EBITDA multiples to five-yearaverage, high and low


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Exhibit 43: Indian IT Services - relative valuation as on 6 September 2013

Curr Price MCapDiv

YieldSales CAGR EV/SALES EBITDA CAGR EV/EBITDA

NOPATCAGR

EV

(Mn) CY13 (CY12-14) CY13 CY14 (CY12-14) CY13 CY14 (CY12-14) CY

Indian peers (Large-sized cos)

TCS INR 1,989 3,892,521 1.3% 20% 5.1 4.4 20% 17.6 15.2 21.1% 24Infosys INR 3,029 1,739,390 1.6% 15% 3.4 3.0 10% 12.4 11.2 10.2% 18

Wipro INR 469 1,154,757 1.6% 13% 2.6 2.3 14% 12.4 11.0 13.0% 17

HCL Tech INR 1,017 708,881 1.5% 16% 2.0 1.8 14% 9.2 8.1 13.3% 13

Median 1.5% 15% 3.0 2.7 14% 12.4 11.1 13% 18

Mean 1.5% 16% 3.3 2.9 15% 12.9 11.4 14% 18

Indian peers (Mid-sized services)

Tech Mahindra INR 1,360 316,016 0.6% 17% 1.7 1.6 14% 8.3 7.9 63.2% 15

Mphasis INR 418 87,728 4.0% 12% 1.2 1.1 8% 6.7 5.9 9.1% 10

Hexaware INR 125 37,409 4.3% 14% 1.4 1.3 14% 6.7 6.0 10.2% 9

Mindtree INR 1,031 42,868 1.2% 16% 1.4 1.3 16% 7.4 6.6 18.0% 10

eClerx INR 825 24,824 3.5% 15% 2.6 2.2 13% 6.6 5.8 15.1% 10

KPIT INR 134 25,824 0.7% 19% 1.0 0.9 21% 6.2 5.5 23.6% 9

Persistent INR 568 22,732 1.7% 19% 1.3 1.1 15% 5.2 4.6 13.5% 9

Polaris INR 117 11,648 4.3% 12% 0.4 0.3 14% 2.8 2.5 6.8% 5

Median 2.6% 15% 1.3 1.2 14% 6.6 5.9 14% 10Mean 2.6% 15% 1.4 1.2 14% 6.2 5.6 20% 10

Global Tier 1 IT services

IBM USD 184 201,723 1.9% 0% 2.2 2.2 8% 8.2 7.6 10.4% 12

Accenture USD 74 50,842 2.3% 2% 1.6 1.5 4% 9.4 9.2 8.0% 14

HP USD 22 42,660 2.6% -5% 0.5 0.5 -2% 3.9 3.9 -15.3% 7

Cognizant USD 76 22,904 0.0% 18% 2.3 2.0 17% 11.1 9.6 18.9% 16

BT USD 24 1,368 0.4% 0% 0.1 0.1 1% 4.2 4.2 0.7% 1

CapGemini EUR 44 6,931 2.4% 1% 0.7 0.6 8% 6.6 6.2 3.7% 11

CSC USD 51 7,482 1.6% 0% 0.6 0.6 1% 4.0 4.0 49.7% 10

Median 1.9% 0% 0.7 0.6 4% 6.6 6.2 8% 11

Mean 1.6% 2% 1.1 1.1 5% 6.8 6.4 11% 10

Global regional IT services

Atos EUR 57 4,901 1.2% 1% 0.5 0.5 5% 4.8 4.5 11.9% 10

Syntel USD 74 3,090 3.4% 12% 3.1 2.8 11% 9.8 9.1 7.3% 14

Median 2.3% 6% 1.8 1.7 8% 7.3 6.8 10% 12

Mean 2.3% 6% 1.8 1.7 8% 7.3 6.8 10% 12

Source: Bloomberg, Ambit Capital Research

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Exhibit 44: Ambit valuation summary

Infosys TCS Wipro HCL Polaris Persistent eClerx Redington InfoEdge

Price 3,021 1,980 468 1,013 117 570 826 57 295

Recommendation SELL BUY SELL BUY SELL BUY BUY BUY BUY

Price target 2,582 1,986 430 1,209 109 677 1,082 81 396

Upside/Downside -15% 0% -8% 19% -7% 19% 31% 42% 34%

Market Cap (US$ mn) 26,661 59,665 17,700 10,866 179 348 381 350 493

ADVT - 3 months (US$ mn) 49.0 39.5 14.6 17.6 1.9 0.3 0.3 0.3 0.7

EPS (Rs)

FY13 165 71 25 56 20 46 57 8 8

FY14E 191 101 32 87 26 61 96 8 11

FY15E 201 115 35 92 23 68 88 10 16

EPS CAGR 10% 27% 19% 28% 6% 21% 24% 11% 38%

PE (x)

FY14E 15.52 17.01 13.86 10.19 3.92 9.12 7.93 7.42 27.06

FY15E 14.75 14.93 12.54 9.65 4.50 8.23 8.67 5.71 19.28

EV/EBITDA (x)

FY14E 10.95 13.02 10.09 7.05 2.71 1.05 5.20 6.67 19.99

FY15E 10.75 11.77 9.30 6.80 3.06 0.97 5.54 5.54 14.20

EV/NOPAT (x)

FY14E 16.91 19.84 15.18 6.28 9.97 8.83 8.21 9.88 31.87

FY15E 16.72 18.15 14.15 6.11 11.83 8.17 8.97 8.29 21.80

ROE

FY14E 25% 47% 25% 37% 17% 22% 57% 16% 19%

FY15E 23% 43% 22% 29% 13% 20% 41% 17% 23%

Source: Ambit Capital research, Company

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Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Aadesh Mehta Banking / NBFCs (022) 30433239 [email protected]

Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]

Ankur Rudra, CFA Technology / Telecom / Media (022) 30433211 [email protected]

Ashvin Shetty Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power / Capital Goods (022) 30433252 [email protected]

Dayanand Mittal Oil & Gas (022) 30433202 [email protected]

Gaurav Mehta Strategy / Derivatives Research (022) 30433255 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Krishnan ASV Banking (022) 30433205 [email protected]

Nitin Bhasin E&C / Infrastructure / Cement (022) 30433241 [email protected]

Nitin Jain Technology (022) 30433291 [email protected]

Pankaj Agarwal, CFA NBFCs (022) 30433206 [email protected]

Pratik Singhania Real Estate / Retail (022) 30433264 [email protected]

Parita Ashar Metals & Mining (022) 30433223 [email protected]

Rakshit Ranjan, CFA Consumer / Real Estate (022) 30433201 [email protected]

Ravi Singh Banking / NBFCs (022) 30433181 [email protected]

Ritika Mankar Mukherjee Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Healthcare (022) 30433292 [email protected]

Shariq Merchant Consumer (022) 30433246 [email protected]

Tanuj Mukhija E&C / Infrastructure (022) 30433203 [email protected]

Utsav Mehta Telecom / Media (022) 30433209 [email protected]

Sales

Name Regions Desk-Phone E-mail

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Sarojini Ramachandran UK +44 (0) 20 7614 8374 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

E&C = Engineering & Construction

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Explanation of Investment Rating

Investment Rating Expected return (over 12-month period from date of initial rating)

Buy >5%

Sell

Documents

AMC_091013_6155