MphasiS BFL - Initiating Coverage - Outperformer

Worst over, Q2FY06 results signal an uptrend
Significant improvement in operating matrices in Q2FY06 results
§ The share of revenues from fixed price contracts has increased.
§ Higher utilisation levels.
§ Improvement in offshore billing rates
§ Improvement in client profile in IT Services and BPO – Reduced
dependence on top clients (IT and BPO), increase in million dollar clients
(IT services).
§ Improving geographic profile - The share of revenues in both IT
services and BPO from Europe has increased reducing the dependence on the US.
§ New clients (acquired in the last one year) have matured and ramped up.

IT services contribute 69% of revenues and a higher75% in profitability.
Visible traction in IT services. However, the fall in BPO revenues seems to
be bottoming out.
Turnaround in the profitability of both IT services (since Q3FY05) and BPO
(since Q2FY06)
Recent domestic BPO orders (Airtel, leading nationalised bank) leads to
stability in BPO business
Even though Airtel and a domestic business' profitability (14% PBIT) is on
par with international BPO, but due to domestic BPO being taxed, effective
margins are expected to fall to 10%.

Ownership issues
The uncertainties regarding Barings stake sale issue are over - Clients visits and orders were deferred due to the ownership uncertainties. However, Mr Jerry Rao stake sale has again raised other issues regarding ownership of the company. With Mr Rao's stake reducing, it is possible that Mphasis may be acquired. The acquisition will most possibly be at a higher price, with an open offer and will thus benefit the shareholders.

Buy back
The company has passed a resolution to buy back Mphasis stock (up to 10% amounting to Rs 2300 mn.) at the prevailing market price (effective from 1 April 2006). This buy back will be financed partly by debt. The buyback will help reduce floating stock and also put a floor on the downside in the stock price.
Valuations
The stock trades at P/E of 14.1x FY06E and 11.1x FY07E, lower than other mid-sized technology companies. The stock also has the potential to re-rate and we recommend an Outperformer with a price target of Rs. 185 in 12 months.