Synergy key to Tech Mahindra’s merger with Mahindra Engineering Services: Citi Research

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SummaryTech Mahindra’s merger of Mahindra Engineering Services (MESL) underscores its pursuit of inorganic growth to realise its vision

Tech Mahindra’s merger of Mahindra Engineering Services (MESL) underscores its pursuit of inorganic growth to realise its vision of $5 billion revenues by 2015. Valuations seem a tad higher (though unlikely to have a material impact on EPS). Key here will be synergy — important to note that buyers for engineering services and IT services could be likely different in the client organisations. We maintain ‘neutral’.

Valuations (approximately 2.3x EV/Sales; approximately 8.8x EV/Ebitda; approximately 15x P/E based on 1H14 run rate) appear a tad higher (Infotech Enterprises trades at approximately 11x P/E, approximately 6x EV/Ebitda based on FY14E Bloomberg consensus estimates) though unlikely to have a material impact on EPS. The deal is subject to regulatory approvals; management expects closure in 8-9 months.

With regards to top-line, 50% of MSEL revenues are from clients in the US while the balance is from clients in Europe and India. Management indicated that top 5 clients contribute approximately 70% of revenues.

Management expects the bulk of the synergies to be realised on the revenue side with limited opportunities for cost synergies. Given MESL is likely not dealing with the CIO office at these clients, the extent to which Tech Mahindra can cross sell IT services solutions remains to be seen.

Our target price of R1,700 is based on approximately 11.5x consol Mar'15E EPS (adjusted for treasury stock).

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