Will the overseas parent deliberately weaken MphasiS? The next two quarters will show the intention

Moneylife Digital Team

MphasiS, a unit of Hewlett-Packard (HP), is a mid-size company into application development and maintenance services, infrastructure technology outsourcing (ITO) services and business process outsourcing (BPO) services for global clients. The company has 29 offices in 14 countries with delivery centres in India, Sri Lanka, China, North America and Europe. MphasiS has grown through acquisitions and has been acquired as well. In March 2005, it acquired Eldorado Computing Inc, a US-based healthcare benefits management solutions company, to strengthen its US footprint and enter the healthcare insurance and payment market. In April 2006, MphasiS became part of Electronic Data Systems Corporation (EDS). In May 2008, after HP took over EDS, MphasiS became an HP company. HP owns close to 62% in MphasiS. To establish its presence in insurance solutions, in 2008-2009, MphasiS acquired AIG Systems Solutions Pvt Ltd, a subsidiary of the troubled American International Group Inc, US.

ITO or remote infrastructure management (RIM) is one of the fastest growing segments in the infrastructure services market. To give impetus to the direct ITO business with a focus on the SME (small and medium enterprises) segments, the company acquired California-based Fortify Infrastructure Services Inc.

MphasiS follows a fiscal year from November through October, in line with the practice at HP. During the financial year ended 31 October 2010, the company’s consolidated revenues were Rs5,036.52 crore compared to Rs4,263.88 crore for the financial year ended October 2009. Significant growth came through HP and its subsidiaries. The consolidated net profit was Rs1,090.75 crore in FY09-10, compared to Rs908.68 crore in FY08-09. Total revenue increased from Rs3,405.02 crore for the year ended 31 October 2009 to Rs3,770.09 crore. However, the results for the first quarter ended January 2011 were a shocker. The consolidated net profit was Rs226.67 crore for the November-January quarter, as against Rs268.27 crore in the year-ago period, even as total revenues increased to Rs1,233.50 crore from Rs1,191.60 crore. Among the causes for concern is that despite being a subsidiary of HP, MphasiS reported a 10% fall in revenues from HP to Rs840 crore, while its non-HP revenues declined 3% to Rs380 crore. The results were dismal on account of rate reduction by HP on a few engagements, sluggish growth from HP’s Enterprise Services segment and a non-repeating item from the previous quarter. The stock crashed from a high of Rs659 to a low of Rs421.15 over three days (24th, 25th and 28th February) on the Bombay Stock Exchange over such shockingly poor results.

Is HP slowly smothering MphasiS to buy out minority shareholders in the same way as it did in Digital Globalsoft in 2004? Leading brokerage house CLSA raised concerns over the collapse of corporate governance at the Mumbai-based outsourcing firm to serve HP’s interest. “MphasiS’ financial performance is now peripheral to the central issue of the shocking collapse in its governance standards,” CLSA analysts wrote in a note to investors.

Apparently, in 2003, Digital Globalsoft—then an HP-owned listed entity—went through a similar phase of massive price cuts from HP before HP bought out the minority shareholders in 2004. What is making CLSA analysts raise the alarm are the massive price cuts from HP—68% of total revenues—which has pushed down MphasiS’ dollar revenues 8.5% sequentially to $271 million in the quarter ended 31 January 2011.

The question some are asking is: Is this deliberate? Is HP planning to report poor results deliberately to bring the price down and then delist the company? If this is not so, then the stock has suddenly become undervalued. If HP is not planning any such move, the scrip remains a risky bet. MphasiS also earned the wrath of the investing community by stopping reporting on revenues/segment profits by earlier segment definitions (application, ITO and BPO); instead, it now presents segment-wise reports by verticals. The company has also stopped reporting details like revenues by geographies and billing rates. But, bowing to pressure from investors and analysts, MphasiS has disclosed figures under the various revenue segments as it used to do in the prior quarters.

Over the past five quarters, MphasiS reported an average growth in revenues and operating profit of 6% and 7%, respectively. Its average operating margin is 28% and return on net worth is 34%. Its market-cap to revenues is 2.90, while its market-cap to operating profit is 12.73 times. Its price to earning ratio is a low 9.55.  Buy the stock at the current market price.