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Direct business to drive performance

DXC to remain a drag, but diminish over time

* MPHL’s 4QFY21 revenue growth was led by 3.5% CC QoQ growth in the Direct business, while DXC vertical (12% of revenue, -7.7% QoQ CC) remains a drag. EBIT margin dip of 30bp QoQ was due to higher sales investments. It won USD245m of new deals in 4QFY21, and announced its largest ever single deal of USD250m (BFSI, 10-year duration), which will count in 1QFY22 TCV.

* MPHL’s Direct business continues to deliver standout growth (FY19-21 USD CAGR of 19%) among stocks in our coverage universe. Given the acceleration in deal wins – TCV rose 51% YoY to USD1.1b in FY21 – and management commentary of industry-leading growth, we expect this to continue in FY22E (+18.7% YoY). We see the large deal momentum at MPHL as a key positive, as it should lead to better medium-term growth visibility in the business.

* This growth, despite the expected moderation in its mortgage business (DR), implies performance in line with midcap IT Services peers like LTI, COFORGE and MTCL, which are trading at a 20-30% premium valuation to MPHL.

* We expect DXC business to run significantly below the remaining commitment over the next few months in our base case, and view any fallback provision or near term pick up as an upside. Our analysis suggests that MPHL’s DXC business would decline by 30% CAGR over FY21-23E, and settle at mid-single digit contribution by FY23E.

* Reduced exposure to DXC should help lower growth concerns in the overall business and help its comparable Direct business (FY21-23E CAGR of 17%) to gain strength. This should lower the valuation discount v/s peers, despite comparable growth in the Direct business.

* We expect margin to improve in FY22 (+60bp YoY) and see MPHL performing near the upper end of its guidance of 15.5-17%, helped by operating leverage and lower exposure to DXC. This should help it deliver PAT growth of ~20% over FY21-23E.

* We have kept our estimates unchanged. Despite the DXC overhang, with strong Digital capabilities and client relationships, MPHL is well-positioned to be a key beneficiary in the current context. Our TP implies 22x FY23E EPS. Maintain Buy.

Topline above our estimates led by lower-than-expected DXC decline

* USD revenue grew 7% YoY to USD342m (est. USD 339m), EBIT grew 6% to INR4,054m (est. 5% growth), and PAT declined 10% to INR3,169m (in line) in 4QFY21. Revenue (USD)/EBIT/PAT grew 6%/10%/3% YoY in FY21.

* Revenue grew 2.5% QoQ to USD342m, above our estimate. In CC terms, revenue growth stood at 2% QoQ and 4.9% YoY.

* EBIT margin fell 30bp QoQ to 16.1%, in line with our estimate of 16.2%.

* PAT declined 2.6% QoQ to INR3,169m, in line with our estimate

* The stellar growth seen in Direct (+3.5% QoQ CC; +19.9% YoY CC) is encouraging. The strong momentum was partially offset by a 7.7% sequential decline (down 46.2% YoY) in the DXC business. DXC now contributes only 12% to overall revenue (v/s 23% a year ago).

* Vertical-wise, Banking declined (-3.6% QoQ); Insurance continued its growth momentum at 6.4% QoQ; IT, Communications and Entertainment grew 15.9% QoQ; Logistics and Transportation was up 8.7% QoQ; and other emerging technologies grew 5.8% QoQ.

* Among services, growth was driven by Application (9.3% QoQ), while BPO (- 8.3%) and Infrastructure services (-1.9% QoQ) declined.

* Among geographies, EMEA/India/RoW reported a sequential growth of 14.9%/9.5%/18.4%, while America came in largely flat.

* MPHL won USD245m worth of deal wins in the Direct channel, of which 69% was in new-gen services. This does not include renewals. This takes FY21 TCV to USD1.1b (+51% YoY).

* It announced a landmark deal win of USD250m in 1QFY22, the highest ever single deal for the company.

* OCF grew 10% YoY and OCF/EBITDA stood at 81% for FY21. FCF grew 11% and FCF/PAT stood at 109%.

Key highlights from the management commentary

* The management guided at industry-leading growth in FY22 in its Direct business. In the case of DXC, revenue will continue to decline and growth should settle in the mid-single digit range in the medium term.

* MPHL announced a landmark deal of USD250m won in 1QFY22. The initial agreement is for 10 years and ramp up would start in FY22. This deal sourced out of a UK based client is in the BFSI space. While the initial commitment is for 10 years, it can increase going forward. The deal involves transformation-related work in the middle and back office of the client.

* The management guided at margin to be in the 15.5-17% band. This is on the back of its intention to reinvest in the business. It is confident of managing investments despite rising cost pressures due to margin levers.

Valuation and view

* Impressive deal wins over the last three quarters and a healthy deal pipeline would likely drive growth in the near term. While the DXC business (~12% of revenue) related overhang persists, strong traction in Direct International should continue to drive overall performance. The management’s guidance on its ability to defend margin is a key positive.

* The ability to win multiple large Digital transformation deals proactively and under vendor consolidation scenarios indicates strength in its sales and delivery capabilities.

* Higher exposure to largely stable verticals (BFSI – ~60% of revenue) should help mitigate risks to some extent.

* The stock is currently trading ~19.5x FY23E EPS. We value the stock ~22x FY23E EPS. Maintain Buy.

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