Tech Mahindra Ltd Q1 FY2024 Concall Summary

Key Takeaways

• A quarter management calls a "blip": Revenue fell 4% QoQ and EBIT margin collapsed 440 bps to 6.8%, driven by a perfect storm in the Communications vertical plus a one-time bankruptcy provision.
• The CME vertical absorbed a "perfect storm": Telco budget freezes hit both discretionary digital spend and ongoing OPEX cost take-out simultaneously, with Europe worse than the US. Management believes the worst is behind.
• A customer bankruptcy added a one-time ~200 bps margin hit: The provision covers cumulative exposure built over 3-4 quarters; management says all billed and unbilled risks are fully covered and quarterly revenue going forward is unaffected.
• Recovery rests on a second-half rebound: Management expects gradual improvement starting this quarter and a definite pickup in H2, calling it a mirror opposite of last year, though the current dip is worse than expected.
• What to watch next quarter: Whether the CME bottom is real, the pace of subcon reduction toward the sub-10% target, and any fruition of the vendor consolidation and cost take-out deals currently in the funnel.

The CME Vertical: A Perfect Storm

• Budgetary double hit: Telcos are simultaneously freezing discretionary digital transformation spend and demanding cost take-out on existing OPEX, a combination management called a "perfect storm" that is geographically uniform across major Tier-1 operators globally.
• Europe bore the brunt: Europe declined more sharply than the US (which was broadly flat QoQ), driven by project closures at Leadcom and LCC Network Services plus more aggravated discretionary cuts among European telcos.
• Network Services and IT Digital both hit: Two areas saw significant pushback: IT Digital domain work and Network Services, where reprioritizations occurred across the board.
• Top 10 clients stabilizing: Pressure in a couple of top customers over recent quarters is getting closer to bottoming out, with positive momentum visible. The Network Services project closures were outside the top 10.
• Enterprise telco deals pushed out: The enterprise arms of major telcos delayed decisions because those businesses are undergoing organizational changes; this is specific to a couple of customers but significant in size.

Vyas: "I can't predict how soon things will ease out but where we have a good vantage point is from our funnel and our pipeline and the discussions both in terms of cost as well as opportunities. This is why I called it a perfect storm last quarter that maybe we've hit the worst, and we now need to start gradually inching forward."

Margin Collapse: The 440 bps Walk

• One-time bankruptcy provision took ~200 bps: A cumulative provision was taken for a customer declaring bankruptcy, representing exposure piled up over the last 3-4 quarters. Management confirmed all risks, both unbilled and billed, are fully covered and quarterly revenues already in the Q1 baseline were not impacted going forward.
• Revenue drop impact took ~200 bps: The 4% QoQ revenue decline, driven primarily by the 9.4% drop in CME, flowed through to margins.
• Comviva seasonality added ~50 bps: The seasonal downturn in Comviva contributed to the remainder of the margin compression.
• Wage hikes created a double hit: Despite a 10% headcount reduction over three quarters, employee costs rose because last year's increments happened in Q2 (missing from the baseline) while this year's majority were effective April. IT headcount reductions of ~1,000 were weighted toward the second half of the quarter, so the full benefit is yet to show.
• Sales headcount increase was a planned campus program: The ~200-person increase in sales and support headcount came from an annual leadership hiring program from campuses, not an expansion of the sales force. Management chose not to back away from it.

Margin Recovery Levers

• Subcon substitution is the primary independent lever: Subcon costs have already reduced dramatically over three quarters even while growth was stagnant or down. Management targets moving subcon from ~14% of costs to below 10% over the next few quarters, a lever that does not require growth to execute.
• Offshoring has 4-5% medium-term room: Driving further offshoring is a structural lever independent of the demand environment.
• Juniorization and productivity are partly growth-dependent: Juniorization of the pyramid may need a growth supplement to work, but pure productivity measures can be pursued regardless.
• Portfolio rationalization is on the table: Management flagged divesting non-strategic portfolio as a lever.
• Cost actions did happen but were back-end loaded: IT headcount fell by 1,000 QoQ, driven more toward the latter half of the quarter. The revenue decline was partly planned (Comviva seasonality, project closures) and partly gradual, so cost interventions were calibrated accordingly.

Gurnani: "I like the word 'boring organization'."

Deal Strategy: Singles Over Sixers

• Recalibrating for the environment: When large transformation deals are scarce, management is going back to basics with all accounts, being more realistic about closing dates, and hunting for smaller, transformative Gen-AI deals.
• Cost take-out deals still in play: Discussions are at various stages, with some pushed out as customers evaluate options. Vendor consolidation and tech workforce reformatting discussions are at varying maturity levels in the funnel and some should fructify over the next two quarters.
• Digital transformation clarity emerging: Management expects clarity to lead to decisions starting in the second part of the year.
• BFSI identified as a gap: The US will be a significant part of the BFSI strategy, with management acknowledging significant gaps geographically and within the vertical where the company does not play today.

Gurnani: "So, obviously what I'm trying to say is when you can't score runs by sixers or the bigger deals, then go for singles."

Vertical Performance

Leadership Transition & Organizational Tone

• Mohit Joshi joined as MD (Designate): He has been in the role for five weeks and has a 5-6 month extended transition period to develop a plan with the team to turn the trajectory around.
• 8,000 people trained in AI last quarter: The company upskilled employees in new AI platforms and generative AI, and is developing a large set of solutions and use cases through a Generative AI Studio.
• New investments announced: Management committed to more investments in quantum computing, cybersecurity, and AI.
• Execution is the singular mantra: Management repeatedly emphasized execution discipline, a return to basics, and becoming a predictable, "boring" organization focused on delivering consistently.

Gurnani: "I think it is important to recognize that our results could have been better... the best way is to reinforce my confidence that this quarter is a blip in our growth trajectory."

Guidance & Commitments

Key Metrics