Tech Mahindra Ltd Q3 FY2023 Concall Summary

Key Takeaways

• Enterprise revenue crossed \$1 bn for the first time, a milestone driven by connected enterprise and connected solutions investments, even as overall sequential growth was a modest 1.8% in reported currency.
• BPO delivered exceptional growth, contributing nearly two-thirds of the quarter's incremental revenue on a seasonally strong ramp-up, and remains one of the fastest-growing segments with ~21% YoY growth.
• Margins improved 60 bps QoQ to 12% EBIT, helped by currency tailwinds and operational rigor, but IT services margin has stagnated around 14.5–15% for three quarters as people cost and acquisition amortization weigh.
• Decision-making is slowing and bolt-on project revenue is shrinking, creating a near-term drag that management expects to persist for at least the next couple of quarters.
• What to watch next quarter: Whether top client softness bottoms out by Q4 as estimated, the pace of subcontracting cost reduction, and any evidence that large telco cost take-out deals are moving from discussion to closure.

Demand Environment

• Near-term challenges acknowledged: Some clients are pausing discretionary spending, decision-making is becoming slightly longer, and deal closures are taking more time as customers run scenario analyses before committing.
• Bolt-on revenue shrinking: Budgets have tightened with most customers, so opportunities for add-on or bolt-on projects on existing engagements are diminishing, diluting a contribution stream that had been material.
• Pipeline still robust: Large deal inflow remains quite strong and many deals are in a mature state of closure, but the conversion timeline has stretched.
• Americas and Europe weak: Core markets are under pressure from client-specific top account restructuring; almost all revenue added this quarter came from Rest of World, with the Middle East showing good momentum on digital deals.
• Average deal size unchanged: No significant shift from the last few quarters, with one large deal above average in the current quarter mix.

Rohit Anand: "While the deal wins look robust, there is a contribution dilution from these areas and as we move forward that pressure will continue kind of into at least the next couple of quarters as we see the demand environment peak the way it is right now."

BPO & Segment Performance

• BPO delivered remarkable growth: The business added almost \$20 million of the total \$30 million incremental revenue this quarter, driven by a seasonally stronger ramp-up than typical trends; headcount had been built in the prior quarter and was reduced as seasonality passed.
• Enterprise crossed \$1 bn: The milestone was driven by investments in connected enterprise and connected solutions; management expects good growth in retail, manufacturing, and BFSI, while hi-tech shows some tepidness as those clients reorganize spend.
• CME fueled by 5G: 5G continues to drive growth in the Communications, Media & Entertainment vertical, with 5G in enterprise a focus area; a tri-party rollout at Mahindra Group's Chakan auto factory involved Airtel and Tech Mahindra as value integrator.
• Top 5 client softness: Contribution from the top five clients declined YoY due to internal restructuring plans at a couple of customers and unfavorable FX on a reported basis; management estimates this will bottom out by Q4.
• Active client rationalization: Net new customer additions slowed because of a conscious project to rationalize and right-size tail accounts below a threshold that do not offer economies of scale.

Margins & Operational Levers

• EBIT margin improved 60 bps QoQ to 12%: The improvement was helped by currency tailwind and operational rigor, partially offset by certain SG&A increases.
• IT services margin stagnated at 14.5–15%: This has persisted for the last three quarters of FY23 despite utilization going up and subcontracting cost coming down; the biggest impact is people cost and supply chain pressure from the last four quarters causing a significant increase in the overall wage bill, plus amortization impact from acquisitions diluting margin by 80 bps to 1 percent.
• Subcontracting costs being driven down: Detailed, time-based actions started a couple of quarters back, with impact now visible in the P&L; management will continue to drive this down, though new deals may temporarily bump up the requirement.
• Portfolio pruning underway: The company has executed an annualized run rate of almost half the ~\$100 million target, giving a ~20 bps margin bump; limited impact in Q3, with discussions in progress that will continue into Q4 and next year.
• Offshoring headroom significant: Despite actions to move headcount from onshore to offshore, the offshoring percentage of total headcount has not yet shown change; a work stream has been created to move individuals project-by-project from onsite to offshore.
• FCF conversion low this quarter: Q3 FCF was at 20% of PAT because billings were impacted by furloughs and FX revaluation, and some movement from Q3 to Q2 normalized after Q2's very high cash flow; management maintains a strong view of FCF conversion to PAT for the full year.

Rohit Anand: "We will be very rigorous going forward, even our focus on cost is specifically the demand stretch environment, the focus on cost delivering measures, it is going to be even more scrutinized, so I think with that, the confidence level in driving this is pretty high."

Telecom & Cost Take-Out Outlook

• Large cost take-out opportunities expected: Management sees a tightening of operating budgets at telco clients that will drive a new wave of cost take-out deals, similar to what the industry saw a few years ago.
• Timing is midterm to long term: Some of the largest deals are already coming back into discussions, but they are expected to fructify in 2 to 3 quarters; consolidation is seen as a big growth trend for the sector.
• Short-term budget cuts: These will induce some decisions that could last as short as another quarter, creating near-term pressure before the larger opportunities materialize.

Manish Vyas: "I think what will happen and what is happening is, there will be a little tightening of the operating budget to basically find new ways of delivering services. So, we are going through that process of change, the other inflection point in many ways."

People & Attrition

• Attrition under control: The market is easing out a little bit, but niche skills remain a challenge; internal fulfillment this quarter was much better than any past quarter.
• Agile resource management: The company shifted from quarterly to monthly alignment with 1,290 customers to become more agile and responsive to changing client plans.

Harshvendra Soin: "The battle is not really won, I would say the journey is still ahead of us and we will concentrate on keeping this assets."

Guidance & Commitments

Key Metrics