Tech Mahindra focus squarely on 5G, but await clarity on the timeline

We attended Tech Mahindra’s (TECHM) Analyst Day, wherein the management shared its refreshed strategy and opportunities in 5G and Cloud migration. Here are the key highlights from the meet:

• Potential opportunity in 5G across both Communications and Enterprise verticals was the key highlight. In addition to IT services and the impact on the business from a move to 5G (open network, micro-segmentation, etc.), it detailed the prospects in businesses like Network Services, product R&D, and on Enterprise network modernization through private networks.
• The management believes there is a large multi-billion dollar opportunity in 5G network services (christened Network Services 3.0), and expects the segment to grow at a faster pace than the overall Communications vertical.
• Despite the massive scale of opportunity, management is circumspect on the timeline, given the continued pressure on telcos’ revenues and limited visibility on a pickup. It continues to guide at single-digit growth in FY22.

Stock Info

Refreshed strategy focuses on Cloud and Platforms

• TECHM announced NXT.NOW as the next iteration of its well-established 3- 4-3 strategy. NXT.NOW focuses primarily on big bets within UX/CX, Platforms and Cloud businesses. It believes that this strategy is more appropriate in a post COVID world, and has already started to yield results in form of deal wins and record high deal pipeline.
• It plans to right-size its business through portfolio rationalization of non-core offerings, geography and customers, but does not anticipate an impact on near-term revenue. It is also streamlining its market penetration strategy.
• Financials Snapshot (INR b)

FII Includes depository receipts

Targeting USD100b Cloud opportunity

• In line with INFO’s recent commentary, TECHM highlighted the USD500b opportunity in services, part of the USD1t spend expected on Cloud. It is targeting the USD100b sub-set, which includes large deals, Data center monetization (excl. assets), scaling SaaS/IaaS, and automated deployment.

FY22 recovery to be modest

• The management expects FY22 revenue growth to be below 10% as the momentum in Enterprise should be muted by the modest recovery in Communications vertical despite the low base of FY21.
• While it is much more confident of a margin recovery, we remain skeptical due to the recent pickup being led by short-term measures.

Valuation and view

• We expect a recovery in the Communications vertical (40% of revenue) to precede any re-rating in the stock multiple and hence retain our Neutral rating. We see the need to invest back into the business as the key limitation to its aim of margin improvement.
• TECHM should deliver single-digit growth in FY22 (v/s double-digit growth by its peers), which would lead to a lower P/E multiple. We value the stock at 20x FY22E EPS, at a 25% discount to our target P/E for TCS. Remain Neutral.

 TECHM’s NXT.NOW strategy

• TECHM announced NXT.NOW as the next iteration of its well-established 3-4-3 strategy. NXT.NOW focuses primarily on big bets within UX/CX, Platforms, and Cloud businesses.
• This strategy has been yielding results with CME growth returning, momentum picking up in BFSI, Hi-Tech and Healthcare (expected to be over USD1b), and EBIT margin improving.
• It plans to right-size its business through portfolio rationalization of non-core offerings, geography and customers, but does not anticipate an impact on nearterm revenue. It is also streamlining its market penetration strategy.
• Post TECHM’s repair phase, which is expected to last for 1-2 quarters more, growth will become predictable and the company will be more agile and technology enabled internally and externally.
• The management has been undertaking M&As to fill gaps in its capabilities over the last two years. Integration and synergies from those is the key focus now.

Trends around Experiences, Data and Analytics and AI

• Currently, there are five key themes that are shaping experiences globally: 1) hyper personalization, 2) elastic enterprise, 3) longitudinal book of record, 4) the speed of the human mind, and 5) resilience.
• An increasing number of customers are migrating to the Cloud. By 2022, public Cloud services will be essential for 90% of innovation in Data and Analytics, and by 2023 Cloud-based AI will increase 5x from 2019.
• By the end of 2024, 75% of enterprises will shift from piloting to operationalizing AI, driving a 5x increase in streaming Data and Analytics infrastructure.
• The company’s growth strategy is to expand its Data and Analytics and AI footprint across over 1,000 accounts, focus on growth geographies and verticals and take up increased co-innovation with partners/customers startups.
• TECHM is leveraging IPs across the Data and AI value chain and delivered over 100+ AI use cases across enterprises.

 Exhibit 2: Market trends in enabling Data Driven and AI First enterprises

Cloudification of everything

• In line with INFO’s recent commentary, TECHM highlighted a USD500b services opportunity, part of the USD1t spend expected on Cloud. It is targeting the USD100b sub-set, which includes large deals, Data center monetization (excl. assets), scaling SaaS/IaaS, and automated deployment.
• Hybrid multi-Cloud is now the new normal with Amazon Web Services (AWS) leading the CSP pack and Azure closing in. Vertical SaaS has been gaining momentum, and focus has shifted to agility and speed of innovation.
• On the list of top priorities for clients is monetizing Data center exits. This is an excellent opportunity as it involves shifting of workload to the Cloud.
• TECHM’s deep focus on automation and proven ability to deliver large scale Cloud helps it capture market share in the rapidly increasing industry. It is also looking to reskill 70% of its IT workforce by 2024 under its Reskilling Academy for Cloud Execution (RACE).
• The company currently generates over USD900m revenue from Infrastructure Cloud Services. The same is growing at 22%. It booked TCV of 2x its TTM over the previous period.

Exhibit 3: A similar spend on services will drive total Cloud spend in excess of USD1t

5G technology – A paradigm shift

• Potential opportunity in 5G across both Communications and Enterprise verticals was the highlight of the meet. In addition to IT services and the impact on the business from a move to 5G (open network, micro-segmentation, etc.), it detailed the prospects in businesses like Network Services, product R&D, and on Enterprise network modernization through private
• With the introduction of 5G, intense activity is being seen in Europe, America and Asia, with a new set of companies being created to take advantage of this new
• Besides improved connectivity, 5G will drive greater customer experience, something which the telecom industry needed. It would revolve around themes like Open Platform, hyper-personalization, cost reduction, and service
• The management believes there is a large multi-billion dollar opportunity in 5G network services (christened Network Services 3.0), and expects the segment to grow at a faster pace that the overall Communications
• The company sees opportunities across five well defined areas:
  • Breaking up the supply chain into an open 5G network
  • Network on the Cloud
  • Intelligent operations by leveraging technology
  • Digital OSS
  • Enterprise network modernization
• TECHM has also identified scalable offerings in 5G for Enterprise: 1) private IT networks, 2) Multi-Access Edge Compute (MEC), and 3) industry applications pack including pre-integrated solutions.

Expect single-digit growth and expanding margins

• The management talked about the acceleration in digital transformation, which will speed up growth of IT services. Due to the fundamental shift in mindset, demand scenario will be elongated, rather than a one-time
• The Communications portfolio is expected to accelerate going into next year, even without 5G, though not at double-digits. On the Enterprise side, the strong momentum and funnel will place the company a little below the double-digit number on an overall
• In terms of margins, it is targeting an FY22 EBIT margin of 15%, on the back of a better onsite-offshore ratio and sub-contractor expenses. This target factors in return of travel and other discretionary costs and assumes a normalized state of salary

Valuation and view

• We expect a recovery in the Communications vertical (40% of revenue) to precede any re-rating in the stock multiple and hence retain our Neutral rating. We see the need to invest back into the business as the key limitation to its aim of margin
• TECHM should deliver single-digit growth in FY22 (v/s double-digit growth by its peers), which would lead to a lower P/E multiple. We value the stock at 20x FY22E EPS, at a 25% discount to our target P/E for TCS. Remain Neutral.