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Slump in HP business, higher tax rate to hit growth
December, 06th 2011

Sustained weakness relating to the company's biggest client Hewlett Packard, or HP, continues to drag down MphasiS. Business from the HP channel has declined by eight percentage points to 62% over the past five quarters. HP has been struggling to renew large multi-year contracts and the failure to renew the deals is likely to create pricing and volume pressure on MphasiS' profitability.

During the October 2011 quarter , despite revenue contribution from Wyde's acquisition, MphasiS' topline remained more or less flat at Rs 1,314 crore against the previous quarter. Even though, direct channel revenue grew 18.9% sequentially , the growth was offset by a 4% decline in the HP business. And despite a weak currency and improved utilisation, operating margin declined 160 basis points to 17.9%. Sluggish operating performance and higher tax rate led to a 6.1% decline in the company's bottomline to Rs 183 crore.

This is the fourth consecutive quarter of declining profits. MphasiS' headcount continued to decline for the second consecutive quarter. For FY12, total headcount is up by only 464 employees, reflecting a weaker growth outlook. MphasiS has a renewed focus on its direct business and expects direct channel and HP non-enterprise solution business to be the key growth drivers in the coming quarters.

In FY11, non-enterprise HP segment contributed nearly $35 million and the management expects the contribution to grow up to $100 million during the next fiscal. Also, with cash balance of nearly Rs 290 crore, the company is looking for acquisitions in the banking and capital markets segment as well as emerging technology areas. Moreover, with improved utilisation , consolidation of real estate and re-alignment of variable pay structure, operational improvements are also underway .

However, considering slow ramp-up in the direct channel, continued sluggishness in the HP business and uncertainty in the macro environment, MphasiS' growth is expected to remain muted. In addition, with the tax rate likely to hover around 23-24 %, the bottomline will remain under pressure. With no positive trigger for the stock in the near-term , several brokerages have given a sell rating on the mid-cap IT stock. At the current market price of Rs 324, the stock trades at 8.3 times its earnings for the trailing 12 months.

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