Mastek Ltd

Market Capitalization: 1,617 Cr	Current Price:  700 (13 Aug 2020)
Stock P/E: 12	Debt to equity: 0.42
Sales Growth (3Yrs): 25.2%	Profit Growth (3Yrs): 95.6%
ROCE: 20.7%	ROE: 19.2%
Promoter holding: 38.2%	Cash Cycle: 56 days
Asset Turnover: 0.71	Net Profit Margin: 11.6%

ABOUT THE COMPANY

Mastek Limited (Mastek) is an information technology (IT) solutions provider. The Company and its subsidiaries are providers of vertically focused enterprise technology solutions. The Company’s segments include UK, North America and Others. The Company’s portfolio includes business and technology services, which consists of IT consulting, ERP Cloud Migration, application development, systems integration, application management outsourcing, testing, data warehousing and business intelligence, application security, customer relationship management (CRM) services and legacy modernization. The Company specializes in developing, maintaining and managing digital solutions for clients in government, health, retail and financial services. The Company carries out its operations in the United Kingdom and India, and has its offshore software development centers in India at Mumbai, Pune, Chennai and Mahape. Mastek recently acquired Evosys, which is an Oracle Oracle Platinum Partner and significant player in delivering ERP cloud application solutions for total sale consideration of USD 65 million.

BUSINESS PROSPECTS

New CEO has turned things around

John Owen took charge of Mastek as Group CEO towards the end of 2016. Since becoming CEO, John has transformed the company through his Vision 2020 strategy, building the capabilities needed to ensure that Mastek and its clients prosper in today’s digital world where disruption and change are the new normal. He previously held senior leadership roles in global blue-chips including HP, Nortel and Serco, as well as leading successful start-ups such as Sycamore Networks. As shown in the below graph, this has been the transformation in Mastek since John Owen took charge where all metrics like revenue growth, EBITDA margin and PAT Margins have consistently trended upward. EBITDA Margins and PAT Margins have improved from 9.3% and 5.8% respectively in Q4 FY2017 to 17.6% and 11.6% respectively in Q1 FY2021.

Evosys Acquisition could propel growth

In Feb 2020, Mastek acquired the Middle East business of Evolutionary Systems or Evosys for USD 65 million. Evosys is an Oracle Platinum Partner and significant player in delivering ERP cloud application solutions. Evosys, operates in a high growth segment within which it is a recognised leader, with 13 years of experience and 1000+ Oracle Cloud customers across 30+ countries. Evosys had revenues of USD61.6 million with EBITDA margins of 22.8%. This transaction allows Mastek to access new geographies and mine the strong customer base of Evosys in the Middle East. The successful partnering model that Evosys operates in can scale the combined businesses faster as the market for cloud services continues to expand in every geography. Evosys acquisition is margin accretive as Evosys operates on a much larger EBITDA margin base of 20-22%. Exacerbated by COVID scenario, there is significant shift towards enterprise cloud migration and Evosys expertise in Oracle cloud migration could win more clients in future. Enterprise Cloud ERP industry is growing at 30% CAGR as more companies adapt to fast changing digital world. This coupled with Mastek’s ability to cross-sell data analytics, application support with digital commerce will help the company win more integrated and larger deals. The average size of Evosys deal is small at around $200,000 to $300,000. However, this offers a good platform for Mastek to cross-sell using its range of capabilities as the clients essentially are multi-million dollar enterprises. One such cross sale happened in Q1 for USD 4 million and there are 4-5 deals in the range of $1 million. More such multi-million dollar deals and annuity type of deals will help the company drive healthy revenue growth. Evosys added 44 new clients in Q1 FY21 out of which 5 were billion dollar plus organisations and this could prove a major plus for Mastek if they can cross-sell their capabilities to Evosys customers.

Health Cash Levels in Books – Fuel for More Acquisitions?

Mastek has cash balance of INR 458 crore at end of Q1 FY2021. It has debt of INR 285 crore and hence Net of debt cash balance is ≈ INR 173 crore. In Q1 FY2021, Majesco US decided to sell its company to a private equity company for INR 3154 crore. Mastek holding a 6.5% stake in Majesco is due to receive net of tax cash proceeds of INR 198 crore on account of this sale. Hence, Mastek’s net of debt cash proceeds will subsequently improve to around INR 371 crore following this deal. This would mean Mastek has net of debt cash equal to around one-fourth of its current market capitalization. The cash proceeds received from Majesco deal help the company pare debt and look for other profitable acquisitions. Further, Mastek has non-core real estate worth INR110 crore in Mumbai and Pune which it’s looking to sell and plough the cash proceeds to further expand the company. Last but least, Mastek is generating healthy free cash flows with FCF/PAT at 212% in Q1 FY2021 and this is adding ≈ INR 40 crore cash every quarter. Hence, there is strong possibility Mastek will be more or less debt free with ≈INR 250 crore cash by end of FY 2021.

Organic Revenue Growth might be muted

Organic revenues are expected to be impacted by a ramp down by customers in UK private retail & financial services and pricing pressure in US retail partly offset by higher growth from UK government and health business. Mastek has a long-standing & sticky relationship with the UK government as it was working as a subcontractor to the large IT companies for execution of UK government’s projects. Mastek derives 37% of its revenue from UK Health sector and 31% from UK Government. COVID-19 has led to delay in orders in Q1 FY21 and this has resulted in order backlog decreasing from INR785 crore in Q4 FY20 to INR765 crore in Q1 FY21. With the onset of Covid, Mastek has realised few cost savings due to work from home and this has resulted in higher EBITDA margins. The company is looking to maintain this by reducing travel costs, no pay hikes, and reducing overhead costs. In addition, full year consolidation of Evosys which has higher margins will improve overall margins. As shown in the graph below, higher margin Oracle Suite and Cloud migration forms 35% of Mastek’s revenues and could increase further in future.

KEY RISKS

• Company holding high amount of cash in its books when they have debt.
• High cash reserves also has the effect of diluting the return ratios.
• Covid could impact the organic business of application development, analytics, application support and maintenance.
• Days Sales outstanding is 71 days and in Covid hit scenario need close monitoring as there is a potential some of its clients could go bankrupt.
• The UK private sector is facing the dual impact of Brexit and Covid-19 and will remain under stress.
• US revenue is impacted by Retail slowdown and recovery will be protracted.
• Promoter stake is low at 38.2% and has declined from 44.8% post acquisition of Evosys due to induction of Evosys shareholders.
• Company is looking to monetize its real estate holding and this poses a risk as to how the cash dealing will take place and whether it will benefit minority shareholders.

KEY POSITIVES

• As part of Mastek’s “Joint Go-To Market strategy”, it can now leverage Evosys customers to significantly increase the deal size by cross-selling data analytics, application support and digital commerce which will help the company win integrated and larger deals.
• The margin profile of the company could increase further due to Evosys acquisition and cost savings due to Covid scenario.
• Management compensation as percentage of sales is low at 0.5% and management seem very ethical in their dealings.
• Gartner Named Oracle (Oracle ERP Cloud) a Magic Quadrant Leader and Evosys is one of the leaders for Oracle Cloud Application Services.

GROWTH OUTLOOK AND VALUATION

Mastek is available at TTM PE of 11.4 and has witnessed robust top line and bottom line growth since the new CEO took over at the end of 2016. Considering the healthy amount of cash in its books which provides the manoeuvrability for the company to drive future growth and health order book, there is decent margin of safety available at these prices. Most importantly, the Evosys acquisition provides Mastek a decent opportunity to cross sell, acquire new clients, and enter new geographies. It could lead to higher order wins and greater margins in the future. In charts, Mastek recently broke out of 19 year old high and trading about that with decent volumes.

Disclaimer: Have personal investments in Mastek Ltd at the time of writing this note. Information in this blog is for educational purposes only. The articles  may contain external links , references and compilation of various publicly available articles. All copyrights and trademarks of images belong to their respective owners and are used for Fair Educational Purpose only.