Acquisition by Blackstone to accelerate Mphasis' growth

Deal improves revenue visibility, given HP's commitment but execution will be key

Hewlett Packard Enterprise (HPE), the US-based information technology company, has sold its 60.5 per cent stake in Mphasis to private equity (PE) entity Blackstone at Rs 430 for each share.

Unlike in the earlier deal regarding peer Geometric, the minority shareholders of Mphasis might not have much to cheer. For, though the open offer price of Rs 457.5 is higher than the Rs 430 a share paid to the promoter, it is at a two2 per cent discount to Friday's closing price of Rs 467.4. While the share swap ratios of Geometric's sale to HCL Technologies and Dassault Systems gave a handsome premium to its minority shareholders, this is not true in Mphasis' case.

Thus, the two scrips moved in opposite directions on Monday. Geometric rose 19 per cent and Mphasis fell 2.8 per cent.

That said, what does the acquisition of Mphasis mean for investors? The answer is not straightforward. HPE has committed revenues to Mphasis for 11 years. In the first five years, Mphasis will get revenues worth $990 million from its previous owner i.e. HPE, and these will increase every year. This is a major positive for Mphasis, even as HPE’s share in the company’s revenues has been declining for many quarters, down from 52 per cent in January 2013 to 24 per cent in December 2015. The agreement will arrest this and improve revenue visibility for Mphasis.

The company will also be included in HP’s Preferred Provider Program and offer significant business opportunities to the former. Then, there are other benefits with Blackstone coming on board.

"We view the entry of a more focused PE player with committed revenues from HP as positive for the stock," says Rumit Dugar, analyst at Religare Capital Markets. He adds that the change in promoters will lead to greater deal participation for Mphasis.

While Mphasis’ direct or non-HPE revenues have grown at a rapid pace in recent quarters, it was offset to some extent by falling revenues from HPE. As a result, Mphasis' revenues were expected to grow by only five to six per cent annually in the next two years, prior to the deal. This rate could improve in the medium term, believe analysts, both led by HPE and non-HPE revenues.

Going ahead, till the deal is sealed (expected around October), the stock price will move in sync with the news flow around the open offer. While removal of a key business risk, falling revenues from a major client, is a big positive, the stock valuation of Mphasis (at 12 times the FY17 estimated earnings, versus its historical average one-year forward price to earnings ratio of about 16) also looks attractive.

However, even as most analysts see higher growth rates for Mphasis and are positive on the stock, they will want to see more progress in execution. They expect stock returns of only four per cent on an average from current levels. In this scenario, though the existing investors can continue holding the stock, others should wait for a sustained improvement in financial performance before entering.