Decline in reliance on parent bodes well for MphasiS

The performance of MphasiS for the three months ended July shows the company continues to show traction in business from outside its parent HP. The company’s non-HP segment, or the direct channel, appears poised to grow fast after the recent acquisition of US-based Digital Risk.

In the next few quarters, the contribution from the US subsidiary and the income from the direct channel will be critical for growth as HP’s revenue share is likely to decline further.

Over the past three years, MphasiS has been reeling under pressure from the HP channel due to declining business volume and falling realisations. This makes it all the more critical for the company to strengthen its direct channel. As part of the strategy, it acquired Digital Risk in December 2012.

The strategy seems to be showing results as HP’s revenue share has fallen sharply to 41% at the end of July from 55% a year ago, helped by the integration of Digital Risk.




In addition, the direct channel now contributes more to client additions. Of the 16 new clients added during the July quarter, 10 were from the direct channel.

Also, the direct channel has contributed more clients than the HP channel in ticket size of above $10 million, which includes larger multi-year accounts. This augurs well for investors at a time revenue from the parent has ceased to grow.

For the July quarter, direct revenue rose by 5.2%, while HP-related revenue fell by 4%, both after excluding the benefit of a weak rupee. Total revenue grew by 3.4% to Rs 1,540 crore.

The effectiveness of the strategy will depend on the benefits from the integration of Digital Risk, which provides data analytics to banking and capital market sectors in the US.

The decision to acquire Digital Risk appears to be opportune considering the higher possibility of a gradual turnaround in the US economy. This, however, is expected to increase the outgo in terms of selling and general costs, which may impact operating profitability.

MphasiS did report a 110 basis points improvement in operating margin at 15.8% despite wage hikes during the July quarter as it was able to collect dues faster from clients.

The number of days for which sales were outstanding fell to 75 from 85 a quarter ago. The stock trades at around 11.5 times trailing four-quarters earnings, which looks reasonable considering its lower operating profitability relative to the 19%-27 % for some bigger peers.

A re-rating of the stock looks limited unless the company continues to show a strong business momentum in the coming quarters, coupled with improved profit margin.