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Sharp margin deterioration; deal-wins muted

Birlasoft saw a mixed performance in Q2FY25. Company saw sequential revenue growth returning, after the weak show in Q1; revenue was up 2.6% QoQ, broadly akin to our estimate. But EBITDA margin slumped by 260bps QoQ to 12.1%, well below our estimate of 14.7% on planned investments in tech and domain capabilities as well as in partnerships, and due to high upfront investments required for consolidation deals with onshore presence initially. Margin is expected to remain muted in Q3 too, with the company undertaking wage hikes (expected impact: ~150bps) given improvement from Q4. Deal-win TCV was weak, down 19.3% YoY on TTM basis, as client decision-making is still delayed. TCV is expected to improve in H2. While there are some green shoots, more clarity is likely to emerge only by end-CY24. Revenue momentum should sustain despite seasonal weakness in H2FY25. We cut FY25-27E EPS 5-16%, factoring in the lower margin; also, we trim our target multiple to 25x (from 26x), but retain ADD with reduced TP of Rs670, given undemanding valuations.

Results Summary

Revenue grew 2.6% QoQ (2.2% in cc) to USD163.3mn, broadly in line with our estimate of USD162.4mn. Growth was driven by ramp-ups in some projects that had been delayed earlier, better account mining, and incremental business from consolidation deals where the company has gained wallet share. Among verticals, Manufacturing, E&U, and BFSI grew 4.7%, 4.6%, and 1.3% QoQ, respectively, while Lifesciences declined 1.2%. Among services, Digital & Data and ERP saw growth of 6.5% and 4.4% QoQ, respectively, while Infra declined 18.9% QoQ. EBITDAM declined by 260bps QoQ to 12.1%, well below our estimate of 14.7%. Deal-win TCV stood at USD136m in Q2 (book-to-bill: 0.8x). Net new deal wins are worth USD89mn vs USD94mn in Q1. Total headcount declined 2.2% QoQ to 12,578. Attrition inched up marginally, to 11.8% from 11.6% in Q1. What we liked: Return to sequential revenue growth, relatively broad-based recovery in growth. What we did not like: Sharp miss on margin, weak deal-wins.

Earnings Call KTAs

1) Management does not foresee any material change in the demand environment, which continues to be challenging and is expected to continue till the US elections. 2) Company returned to sequential growth in Q2, and the management is hopeful of maintaining such growth momentum. Q3, however, will be facing seasonal furlough impact and is likely to remain muted, while the company heavily relies on a healthy Q4. 3) Growth was broadbased across verticals except in Lifesciences, which remains soft. Management expects the softness to persist for a few more quarters. 4) Margins were primarily impacted by increased onsite mix owing to ramp up of vendor consolidation deals, and by pricing pressure. Management has listed some levers that will aid margin improvement starting Q4 (as Q3 is likely to face a 150bps impact from wage hike) – offshoring, improving utilization (currently well below peak), price enhancement by existing customers, and quality of revenue improvement (like increasing digital mix), along with benefits from Project Optimus. 5) Mgmt is not satisfied with the lower deal wins in H1 and mainly attributes this to delay in decision making owing to the macro uncertainty. As a result, deals are pushed to Q3 and Q4 which should see an improved trend. The slowdown is not on account of losing any deal to a competitor. 6) ~50% of the deal-wins are new or net-new. It currently commands a win ratio of 30-32%, while aims for a higher 35-38% ratio. Mgmt has listed 2 key near-term focus areas – increasing deal flows, and improving margins (aspires achieving 15-16% in the next 4-6 quarters).

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