Our analysis of 15 subsidiaries of TECHM indicates that they were a significant drag on margins in FY16. TECHM’s consol. EBIT margins declined by 230bps in FY16 (YoY). However, excluding these subsidiaries, Ebit margins fell by only 60bps. This implies that aggregate Ebit at these subsidiaries fell 30% y-o-y.
Although lower margins at some subsidiaries will likely continue, we believe improvement in margins at subsidiaries such as SOFGEN, LCC, Comviva and FixStream provides margin tailwinds in the medium term. Among other things, worsening metrics at some subsidiaries also contributed to higher DSOs.
Eight of its 15 material subsidiaries registered deteriorating Ebit in FY16. In some cases the sharp fall was due to supernormal profits in FY15 (TECHM Business services). However, in many cases, the fall was due to investments (Comviva, FixStream, Growth Factories), significant macro headwinds (Complex IT) or client-specific issues (SOFGEN).
Further, larger contribution from low margin subsidiaries such as LCC (10.2% of revenue in FY16 vs. 2.7% in FY15; 0.9% EBIT margins in FY16) affected EBIT margins. Our interaction with management indicates that cost optimisation and/or monetisation of recent investments will lead to better margins at some subsidiaries (LCC, Comviva, SOFGEN and FixStream).