MphasiS reported weak Q1FY11 with revenue decline of 8.5%QoQ to USD271mn, due to one-time impact of 3%QoQ, shutdown at clients’ premises (3.5%QoQ), pricing decline (1%QoQ) and exchange rate impact (0.7%QoQ).

Revenue dips drastically;
pricing decline 1%QoQ Revenue declined 8.3%QoQ to Rs12,335mn. The gross margin declined 454bpsQoQ to 28.9%. G&A expenses as % of revenues dipped to all-time low of 2.9%. EBITDA margin declined 300bpsQoQ to 20.9%. PAT declined 20.2%QoQ to Rs2,267mn.

HP channel business declines
HP channel business contributed 68% compared to 70% in Q4Y10; revenue from this channel declined 9.8%QoQ. This has happened due to shutdown of HP and its clients’ premises during holidays. The situation wasn’t that grim last year as HP’s overall thrust on offshoring pulled up volumes. The outlook appears to be weak for HP channel business.

Business restructuring; no more APO, ITO and BPO but verticalisation strategy
MphasiS has discontinued segment reporting of Apps, BPO and ITO and restructured business units in terms of verticals viz. Banking and Capital Markets, Insurance, IT Communication & Entertainment and Emerging Industries.

Client addition robust; 1,700+ hiring positions open
Employee addition (net) of 1,097 to take the headcount to 41,059. Attrition still high at 29% for Applications. Utilisation dipped 300bps to 74% for APO and 500bpsQoQ to 69% for BPO.

Outlook and Valuation
The management has discontinued disclosure of key elements like pricing which was very critical for MphasiS business model, specifically when 68% of revenue comes from HP channel. The comfort on volume growth from the HP has gone down significantly. Also the pricing uncertainty persists; there will be another round of negotiation within six months. Although the fall in prices might not be drastic from the current levels. We revise our FY11 and FY12 EPS estimates downwards by 24.5% and 23%, respectively. Downgrade the recommendation to ‘HOLD’ with a target price of Rs500 (from earlier Rs780), based on 12x FY11E EPS of Rs41.4.