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Q1. Global peers – e.g. EPAM, Globant, Endava – have called out weak demand for high-end product engineering work. Since HM derives ~40% of its revenues from the vulnerable product engineering services (PES), what is giving it the confidence to guide for 25% growth in FY24 amid the macro weakness?

Our answer: As per HM management, the areas on which HM is working for its clients are non- discretionary in nature. HM is working on core part of clients’ technology which the clients use to deliver their services or engage with their customers, or provide services to their employees. Therefore, they need to sustain these platforms and applications. For example, in PES, HM is working with a cyber-security company to build the latter’s cyber security platform for its end- consumers. It is helping a US-based technological research and consulting firm to measure and analyse user-engagement levels for its research reports. Plus, it does not have much exposure to big hi-tech and BFSI companies, which are currently going through an adverse macro cycle. HM is largely exposed to non-discretionary work for mid-sized clients.

Also, in the near term, because of a couple of large deal wins pushed forward to Q1FY24, we expect HM to grow faster than peers. (Table 1)

We also note that HM is much smaller in terms of revenue size compared to peers (EPAM, Globant, Endava) and it is therefore relatively easier to grow faster than peers in FY24.

Q2. Edutech industry revenues may be impacted because of shift in demand to generative AI-based educational tools. HM, having its largest exposure to the edutech market (~23% of revenues), may experience slowdown in the vertical going forward.

Our answer: HM does not do content creation work for edutech clients, which is likely to be impacted by generative AI. HM helps edutech clients in creating platforms, introducing new features and maintaining their core educational platforms, which is the sole means for the clients for engaging and serving their end-consumers. HM believes that personalisation of experience will be much better with generative AI, and is working with edutech customers to leverage ChatGPT.

Q3. Why is HM raising money (QIP) when it already has net cash balance of Rs2,243mn and is likely to generate ~Rs2,000mn operating cashflow every year?

Our answer: Large part of the money raised during IPO was OFS to provide exit to the VC investor, and HM had raised only Rs1,000 mn as fresh issue. HM is now raising money for organic and inorganic investments it needs to achieve ~25% CAGR in next 10 years. Company is on lookout for suitable inorganic opportunities with pureplay digital capabilities and revenue size of ~US$30mn-50mn.

Q4. HM has exposure to too many verticals (chart 1) contrary to vertical concentration seen in small-cap and mid-cap peers. Therefore, does HM possess the expertise to scale up in these verticals?

Our answer: Top management of HM has rich experience in scaling up IT services business across the erstwhile Mindtree (~year 2000-2011) and Wipro (~year 1985- 2000). We believe the top management can scale-up the company across all key verticals because of their ~30-40 years of industry experience and likely strong client relationships built across verticals over this period.

Q5. Valuations are expensive vs IT services and global peers

Our answer: HM is now trading at a 1-year forward P/E multiple of 41x vs last 2-year average of 64x and its higher valuation compared to peers can be attributed to high growth potential (guidance of 25% revenue growth in FY24) and superior margins compared to peers. We believe our DCF model captures the company’s long-term growth potential given the management vision to reach US$1bn in revenues in next 10 years and smaller revenue size compared to peers.

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