Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent note to clients on Wipro (WIT):
WIT: Remain Constructive Despite EPS Reductions; Wipro Now Second Largest Indian IT Services Co.
- Investment Conclusion. Based on a modest deceleration in near-term Global IT Services revenue momentum and an extended acquisition-related margin drag, we are reducing our estimates: fiscal 2008 EPADS to $0.54 on revenue of $4.961 billion (48% YoY growth including acquisitions) from $0.55 on revenue of $4.917 billion; and fiscal 2009 EPADS to $0.63 on revenue of $6.524 billion (31% YoY growth) from $0.68 on revenue of $6.558 billion. At this time, we are also introducing a fiscal 2010 EPADS estimate of $0.77 on revenue of $8.409 billion (29% YoY growth). Our estimates imply 32%/16% compound revenue/EPADS growth in calendar 2007-09 – after factoring a one-time jump in the tax-rate due to expiration of prior tax benefits.
Given continued investor apprehension over the U.S. IT spending environment (62.2% of revenue), we are trimming our target price from $19 to $16.50. In 12-months, this would correspond to 20-25x forward EPADS of $0.73 – a premium to the current valuation (20x). Wipro remains differentiated by its leading presence across fast growing practices such as Infrastructure Management and BPO; penetration of the Technology vertical; significant margin levers; an acquisition program emphasizing domain/geographic expansion; focus on process excellence; and exposure to Indian consumer/infrastructure spending.
- 3Q08 Results. EPADS of $0.14 vs. $0.12 a year ago on revenue of $1.329 billion (30-35% YoY organic growth) met our $0.14 estimate on revenue of $1.291 billion. Revenue exceeded our estimates in all segments but profitability was adversely impacted by the recent Infocrossing acquisition. Highlights included 7.4% QoQ organic revenue growth in the Global IT Services segment (based on realized and not quarter-end exchange rates) despite fewer billable days; improved onsite (up 5.0% YoY) and offshore (up 2.2% YoY) price realizations; and validation of IT/business transformation capabilities with five $50+ million wins, including Aircel ($450-600 million), Reliance Capital and a global SAP implementation project for a forest products client.
- Wipro recorded reassuring organic growth in the U.S. region (7.2% QoQ and 30% YoY) and Financial Services segment (9.8% QoQ and 55% YoY). Management noted positive demand/momentum across all businesses, the addition of 25 U.S. clients, a healthy pipeline of large deals and its belief that the offshoring value proposition will endure. Challenges in the U.S. and Financial Services segments have not impacted its business to date. A majority of clients are expected to maintain their IT budgets at or slightly above 2007 levels – and while a few clients or "long-gestation" projects could face cutbacks, a clearer budget/allocation picture should emerge by quarter-end. Meanwhile, revenue at Wipro Infotech (Asia-Pacific business) advanced 53% YoY.
Including this segment (18% of total revenue) and recent acquisitions, Wipro now ranks as the second largest Indian IT services company. Recently acquired Infocrossing contributed revenue of $60 million; the operating margin was pressured by amortization/integration expenses but is expected to rebound from breakeven to 20% within six quarters driven by incremental revenue from a delayed contract, rising capacity utilization and cross-selling initiatives. In the Telecom OEM sector, post-M&A product restructuring and project ramp-downs appear to have stabilized. Chairman Premji outlined key strategic priorities that emphasize the following: account penetration; non-linear growth; large deals; talent access and employee-mix; game-changing partnerships with major players, e.g., Cisco, Microsoft, SAP and EMC; consulting expertise; investment in high-growth regions; and acquisitions to bridge gaps. Wipro recently announced a strategic alliance with Cisco to jointly deliver network-based IT solutions; the latter anticipates cumulative revenue of $1 billion over three years from this arrangement. Separately, responding to French regulatory authorities, Wipro confirmed last week that it is not in takeover discussions with Cap Gemini.
- WIT shares are suitable for aggressive investors. In our opinion, principal risks include the following: rising offshore salaries; appreciation of the Indian currency, which would translate into higher expenses incurred in rupees; correction in the Bombay Stock Exchange and/or U.S. markets; political opposition in the U.S.; and geopolitical uncertainty in the Indian subcontinent.