Hexware buy side sample

Hexaware Technologies Limited Key Stats

COMPANY DESCRIPTION HEXW INDIA IT SERVICES NSE/BSE Rs 93/ Rs 45 41.5% 293.36 23,366 443

Relative Performance vs. Nifty

130

110

90

Hexware

03-Jan-12

03-Dec-11

03-Oct-11

03-Nov-11

03-Sep-11

03-Jul-11

03-Aug-11

03-Jun-11

03-Apr-11

03-May-11

03-Mar-11

03-Jan-11

70 03-Feb-11

Nifty

Shareholding Pattern (Dec 2011) Promoters 28%

 Client concentration: Robust traction with top 10 clients has led to strong growth over the last few quarters.

Hexaware’s revenue contribution from top 10 clients (53% of revenue in Q3CY11) is now at the higher-end of the peer group range, exposing the company to client concentration risk.  Slowdown in license signings by key partners: In its recent results (quarter ended Nov, 11) Oracle reported a slowdown in the new license signings. Continued weakness in license signings may impact Enterprise Application revenues.

FIIs 42%

DIIs 9%

INDUSTRY OVERVIEW

Financial Performance Revenue & Revenue Growth 23%

15,000 12,000

25% 15%

11%

9,000

5%

2%

-5%

-10%

3,000

-15%

0

-25%

2006

2007

2008

2009

Revenue (LHS - Rs mn) 2,500

2010

Revenue Growth

25%

EBITDA & EBITDA Margin

2,000

20%

19%

16%

15%

11%

11%

1,000

 Warrants a re-rating because of improved revenue visibility and turnaround in margins: Over the next two years, Hexaware’s topline and earnings growth is far ahead of the mid-cap peer group average and even compares favorably with Tier-1 vendors (see Peer Comparison exhibit below). We expect the stock to re-rate on the back of improved revenue visibility (from the recent large deal wins) and turnaround in margins (9m 2011 EBITDA margin at 16.2% vs 2010 EBITDA margin at 8.9%.; our 2012E and 2013E EBITDA margin estimates are at 18.6% and 18.9% respectively).  Our Rs 105 fair price for Hexaware is based on DCF valuation.  Superior growth outlook justifies premium over peers: Hexaware is currently trading at ~9x 2012 P/E. While the P/E implied by our fair price (11.8x) is at a premium to the average P/E for the mid-cap peer group (7.3x), we believe, the premium multiple (as compared to the mid-cap peer group) implied by our DCF valuation is justified because of its superior growth profile and higher margins.

10%

9%

500

5%

0

0% 2006

2007

2008

2009

EBITDA (LHS - Rs mn) 1,500

VALUATION

SA

6,000

 Growth in Offshore IT will continue to trump the growth in IT Outsourcing and Global IT Services spend: Global IT Services spend grew by 1.4% in 2010 to $574 bn. Within IT services, IT Outsourcing grew 2.4% to $231 bn. However, IT Offshoring grew much faster at 10.4% to $62-64 bn. Over 2006-2010, IT Offshoring has grown at a CAGR of 13% as against 5% for Global IT Services spend, a trend we expect will continue for some time. Offshoring still only constitutes 27% of the total IT Outsourcing and mere 11% of the Global IT Services spend. Given the low penetration, the secular trend towards offshoring is expected to continue over next several years. Indian offshore IT vendors are well positioned to capitalize on this, leveraging their execution prowess and financial arbitrage.

M

INDIA EQUITIES

 Revenue visibility from the large deal wins: Hexaware has signed six large “multiple” services deals over the past six quarters, cumulatively worth +$625 mn (~2x TTM revenue) and include some of the largest deals ever signed by the company. While bolstering the topline visibility, it simultaneously signals the transition into a fullservices vendor increasingly involved in multiple-service lines.  Superior client mining efforts: Aggressive client mining efforts are reflected in significant increase in revenue per client led by client’s transition to higher revenue buckets. Additionally, all the large deal wins have been from the existing clients and in most cases it has been able to garner incremental work from them. Company’s consistent efforts to expand its service offerings to include newer services such infrastructure management and BPO has enabled it to cross-sell these new services to existing clients, gaining greater wallet share.  Strong license signings by Oracle/SAP should support growth: Enterprise Application services are by far the company’s traditional forte (~31% of TTM revenue). Robust license signings by both Oracle and SAP, Hexaware’s global partners, over the last seven quarters is expected to drive demand for Enterprise Application services.  Long-term contracts should improve operating metrics: Ramp-up on large contracts will help Hexaware to improve operational efficiencies with a favorable impact on margins. In our view, the key margin levers include: 1) Utilization: As it delivers on deals, utilization levels should improve to +75% from ~70-71% currently, 2) Offshore revenue mix: While Hexaware has improved offshore revenue mix by 660bps YoY in the latest quarter, there is still some dry powder left to improve it further, 3) Employee pyramid: Improved revenue visibility would allow Hexaware the leeway to increase the proportion of fresher hiring to bring down the average employee costs.

RISKS AND CONCERNS

Others 21%

SUTHERLAND GLOBAL SERVICES

INVESTMENT CASE

PL

HEXAWARE TECHNOLOGIES LIMITED

150

A leading provider of IT and BPO services leveraging the onsite-offshore delivery model, Hexaware is ranked 18th on the NASSCOM’s IT Services Exporters list. The company has a total headcount of 8,164 and 194 active clients as of 30th September 2011, including 50+ Fortune 500/ Global 500 names. While the company delivers services across the entire IT/BPO spectrum, its key strengths lie in Enterprise Application Services, Business Analytics and Human Resource Outsourcing (HRO). In terms of verticals, Travel and Transportation is strong with Top 8 Global Carriers as clients. The company derives ~65% of the revenues from North America and ~28% from Europe.

E

Ticker Region/Country Sector Listed on 52-week high/ Low 1-year return Shares outstanding (mn) Market Cap (Rs mn) Market Cap (USD mn)

1,500

CMP: Rs 79 Fair Value: Rs 105 Potential: 32%

15%

2010

EBITDA Margin 15%

Net Profit & Net Margin 13%

1,200

12%

11%

900

9%

8%

600

6%

5%

300

3%

0

0% 2006

2007

2008

Net Profit (LHS - Rs mn)

2009

2010 Net Margin

Large deals won over last six quarters Deal Close Date

Deal Value ($mn)

Deal Tenure

Services offered

July 2010

$110 mn

5 years

July 2010 April 2011 May 2011 July 2011 November 2011

$60 mn $10-15 mn $25 mn $177 mn $250 mn

3 years 1 year 3 years 5 years 5 years

Application Development & Maintenance (ADM), Remote Infrastructure Management (RIM) and Enterprise Application Services (EAS) EAS, Business Intelligence & Analytics (BA & I), Testing ADM & RIM RIM EAS, BA & I, Testing, BPO & ADM EAS, BA & I, Testing, ADM & RIM

DCF Summary

Peer Comparison Margins Growth PAT EBITDA % PAT % Revenue EBITDA

MCap Revenue EBITDA

Mid Cap Peers Hexaware 22.6 Satyam 76.5 Tech Mahindra 72.8 MphasiS 65.1 Mindtree 16.3 KPIT Cummins 13.4 Persistent 12.6 Infotech Ent. 11.9 Polaris 11.6 Rolta 8.9 Average Average (ex-Hexaware)

135.3 109.6 59.4 69.6 31.8

97.6 76.2 41.6 52.0 19.9

29% 34% 20% 19% 17% 24%

21% 24% 14% 14% 11% 17%

16% 16% 21% 14% 16% 17%

14% 14% 21% 15% 14% 15%

15% 15% 19% 14% 15% 16%

36% 27% 22% 22% 24% 26%

29% 26% 21% 15% 14% 21%

18.9x 16.7x 18.3x 15.6x 10.5x 16.0x

5.8x 4.1x 3.8x 3.1x 2.3x 3.8x

4.1x 4.0x 2.6x 2.4x 1.2x 2.8x

1.2x 1.1x 1.0x 1.2x 0.7x 1.0x

14.6 63.1 53.3 52.6 18.3 13.0 9.5 14.9 20.4 19.4

2.5 9.7 8.5 9.4 2.4 1.8 1.8 2.4 3.0 7.2

2.6 9.5 9.6 7.3 2.2 1.5 1.3 1.2 2.2 2.5

17% 15% 16% 18% 13% 14% 19% 16% 15% 37% 18% 18%

18% 15% 18% 14% 12% 11% 14% 8% 11% 13% 13% 13%

19% 13% 10% 8% 16% 19% 18% 16% 15% 11% 14% 14%

24% 17% 7% 6% 18% 26% 18% 17% 16% 12% 16% 15%

12% 9% 10% 4% 14% 19% 15% 20% 16% -8% 11% 11%

24% 30% 22% 19% 19% 20% 16% 13% 18% 16% 20% 19%

16% 14% 14% 14% 14% 12% 12% 10% 11% 8% 13% 12%

9.0x 8.4x 8.6x 8.2x 8.7x 8.8x 8.4x 6.6x 4.8x 2.8x 7.4x 7.3x

2.2x 1.7x 1.5x 1.4x 1.5x 1.6x 1.3x 0.9x 0.8x 0.4x 1.3x 1.2x

1.5x 1.1x 1.2x 1.2x 0.8x 0.8x 1.1x 0.7x 0.5x 0.4x 0.9x 0.8x

0.8x 1.0x 0.8x 2.3x 0.6x 0.5x 0.6x 0.3x 0.3x n.a.

0.8x 0.8x

Margins EBITDA Margin EBIT Margin Net Margin

11.3% 11.5% 10.4% 8.1% 11.4% 1.05 2%

Sum of PV of Cash Flow (2011-18) (Rs mn) PV of Terminal Value (Rs mn) Enterprise Value (Rs mn) Add: Net Cash (Rs mn) Equity Value (Rs mn) Shares Outstanding (mm) Fair Value Per Share CMP Potential Upside

10,997 15,204 26,201 4,570 30,771 293 105 79.65 32%

Geographic Revenue Mix (Q3CY2011)

Service Revenue Mix (Q3CY2011)

PL

2007

2008

2009

2010

2011E

2012E

2013E

23% -14% -11%

11% 8% -46%

-10% 65% 128%

2% -54% -37%

34% 165% 191%

20% 27% 5%

18% 20% 19%

10.9% 8.7% 10.6%

10.6% 8.2% 5.1%

19.5% 16.9% 12.9%

8.9% 6.6% 8.1%

17.5% 15.8% 17.5%

18.6% 17.0% 15.3%

9% 14%

18% 23%

9% 8%

24% 21%

21% 23%

22% 24%

Valuation P/E P/B EV/EBITDA

21.5x 3.4x 16.6x

39.0x 3.5x 15.3x

17.7x 2.7x 9.3x

27.8x 2.4x 20.1x

9.6x 2.0x 7.6x

9.2x 1.8x 5.9x

7.7x 1.5x 5.0x

2.9%

1.9%

1.2%

5.3%

4.6%

BI & A 10%

Europe 28%

ADM 40%

Testing 9% Americas 65%

Enterprise Solutions 30%

Vertical Revenue Mix (Q3CY2011)

Trends in Billing Rates (USD/hour)

75

BFSI 35%

Emerging Segments 42%

18.9% 17.2% 15.5%

15% 12%

0.0%

Others 5%

BPO 6%

Asia Pacific 7%

72.9

72.0

71.2

71.2

69.0

72.5

72.0

60 45 30

22.4

21.6

21.5

21.9

22.5

22.2

23.0

15

Return Ratios ROE ROCE

Leverage Debt/Equity

WACC Cost of Equity Cost of Debt (Pre-Tax) Risk Free Rate (10-yr Govt. of India Bond) Market Return Adjusted Beta Terminal Growth Rate

Operating Metrics

M

902 2,849 2,849 4,356 5,476 6,254 7,025 2,160 2,065 1,526 1,919 2,329 2,787 3,295 1,158 1,035 1,257 1,632 2,125 2,543 3,007 4,221 5,950 5,632 7,907 9,930 11,585 13,327 2,255 3,234 3,151 2,919 3,363 3,784 4,142 3,383 1,347 2,597 1,739 1,743 1,743 1,743 9,859 10,531 11,379 12,564 15,036 17,111 19,213 2,330 3,008 1,998 1,475 1,760 2,079 2,449 463 704 710 1,309 1,263 1,448 1,103 2,793 3,711 2,709 2,785 3,023 3,527 3,552 0 195 163 112 600 600 600 7 0 10 13 13 13 13 7,059 6,625 8,497 9,655 11,400 12,971 15,047 9,859 10,531 11,379 12,564 15,036 17,111 19,213

SA

Balance Sheet (Rs mn) Cash & Cash Equivalents Sundry Debtors Other Current Assets Total Current Assets Fixed Assets (Including Capital WIP) Other Non-Current Assets Total Assets Current Liabilities Provisions Total Current Liabilities Borrowings Deferred Tax Liability Shareholders' Equity Total Liabilities & Shareholders' Equity

Growth Revenue EBITDA Adjusted PAT

PEG

465.3 324.0 293.2 363.8 186.1

Summary Financials 2007 2008 2009 2010 2011E 2012E 2013E Income Statement (Rs mn except EPS) Revenue 10,398 11,519 10,386 10,545 14,168 16,956 20,046 EBITDA 1,134 1,226 2,023 937 2,486 3,161 3,796 Depreciation & Amortization 232 285 271 242 255 280 341 EBIT 902 942 1,752 695 2,231 2,881 3,455 Profit Before Tax 1,233 745 1,445 944 2,920 3,319 3,956 Income Tax Expense 133 155 103 92 443 721 852 Profit After Tax (Before Exceptional Items) 1,101 590 1,342 852 2,477 2,598 3,104 Reported Profit After Tax 72 590 1,342 1,076 2,477 2,598 3,104 Adjusted EPS (Diluted) 3.70 2.04 4.50 2.87 8.27 8.68 10.37

Ratio Analysis

P/E

$/ hour

2,308.9 1,571.7 1,028.6 1,003.7 268.2

PAT

Valuations P/B MCap/Sales

E

Large Cap Peers TCS Infosys Cognizant Wipro HCL Tech Average

Return ROE ROA

4.0%

0 Q1CY10

Travel & Transportation 23%

Q2CY10

Q3CY10

Q4CY10

Onsite

Trends in Offshore Revenue Mix

Q1CY11

Q2CY11

Trends in Blended Utilization 72.7%

46.3%

71.4%

43.3%

39.7%

39.7%

39.7%

39.6%

Q1CY10

Q2CY10

Q3CY10

Q4CY10

Q3CY11

Offshore

69.1%

40.8%

Q1CY11

68.0%

Q2CY11

Q3CY11

Q1CY10

Q2CY10

68.5%

Q3CY10

70.6%

69.4%

Q4CY10

Q1CY11

Q2CY11

2|Page

Q3CY11