Mastek Ltd. reported its first quarterly results post de-merging its insurance business ("Majesco Ltd.") on 16th July. Majesco Ltd. subsidiary is already listed on NASDAQ as "Majesco US" and currently has mcap of 1100cr. Company has reiterated that Majesco Ltd. will be listed in India by August. Mastek's investors are interested in knowing what is the fair value of Mastek and whether it is worth to commit their money in the company now.
I would try to answer this with the following points:
1. Mastek business model
2. Its revenue driver and expected future growth
3. Fair value of Mastek
4. Where most of the analyst covering Mastek got their valuations wrong
5. Can there be more value unlocking
6. What could retail investor do now
1. Mastek business model : Erstwhile Mastek ltd had two business segment, Insurance software products catering primarily to US markets and software services business catering to UK government. Post demerger, Mastek will have services business while insurance will be transferred to Majesco ltd, which is expected to list in India by Aug'15. I am not writing anything in detail about business segment and geographies of Mastek here as that is available on company's website and other analyst report links which I have mentioned below. Important information is "Mastek currently holds 13.8% of Majesco US".
2. Revenue driver and future growth: Mastek ltd gets 70% of its revenue from government contract in UK, remaining 30% comes from BFSI and retail/telecom segment. This is a very stable business where the revenue has grown at 24% in the FY15 with 11% EBITDA margin. Earlier, Mastek use to partner with BT and Captiva to earn government contract. But in 2012, UK government let small and mid-sized companies participate directly in bidding contract. Government wants 50% of their contract to come directly from smaller firms. This effort is yielding positive results on Mastek as corroborated here:
http://www.channelweb.co.uk/crn-uk/news/2415332/meet-the-new-public-sector-supplier-stars
Management is guiding the revenue will continue to grow at above industry average of 12-14%, but the street is anticipating it to clock mere 10% growth and EBITDA margin will remain stable at 12%. Which brings us to 67cr EBITDA in FY16. However, there were lots of noise in the announced results:
2.A Company has earlier said there shouldn't be any further de-merger related exceptional items. But in the concluded quarter, they had further restructuring expense of 1.8cr.
2.B They acquired IndigoBlue in May'15 and its two month financials were included in the current quarter. Full impact on the financial will be reflected in the coming quarters, when the operations are stabilized and management will be in better position to give guidance regarding benefits of cross selling of products through IndigoBlue and vice versa.
2.C Management has done soft launch of its Law Practice Technologies' platform. Full launch is expected by the end of Sept, and management said they will be able to give better picture of the platform by the next quarter results.
3. Valuation: Now this is the most juicy part and one should spend more time in understanding how this company should be valued. I am covering one critical point here:
Mastek has about 156cr of cash and equivalent, including 18.8cr as investment (book value) in Majesco. (Market value of 13.8% stake in Majesco US is c.150cr). This cash is after company has paid over c.22cr to IndigoBlue. Now since the Majesco US is in expansionary mode and still not making money, all analyst are valuing it at EV/Sales multiple. Analyst are assigning it the multiple of 2x EV/Sales, which is also confirmed by the market as its valuation on NASDAQ is also coming around 1100cr. Importance of this information will be clear once you go through entire article. So, Mastek's 13.8% stake in Majesco should be valued separately as Majesco true value cannot get reflected through its current EBITDA or Net Income.
EV/EBITDA: Market is anticipating EBITDA of 60-70cr of Mastek business, excluding Majesco. Even if we assign a EV/EBITDA multiple of 6x (which is very low for IT sector, 6x multiple is mostly used in manufacturing and capital intensive sector), we come to EV of 360-420cr. We add 137cr cash to it and then add valuation of Majesco (after 30% holding discount) as 105cr. Total valuations come to (360-390 + 137 + 105) 602 - 662cr. Now, post this conservative target we have decent upside risk to our target price for the reason mentioned in 2B and 2C, to be precise 2B upside will start trickling in from 1H16, while 2C upside will take shape from 1H17.
PE multiple: In the concluded quarter, company reported net profit of 4.4cr while the adjusted net profit was 10cr. Bridge to this adjustment comes under exceptional expense for restructuring (1.8cr) and 3.4cr loss related to Law Practice Technologies ("LPT") , the platform which was into development phase. Management has mentioned in the concall that platform has already crossed its peak capex and will be fully launched by Sep. If we remove loss due to LPT and restructuring exp, profit before tax would come to 16cr. It was very close to EBITDA as depreciation was offset by other income (Company holds about 137cr in cash and there should be considerable interest income from it). So we can assume company is going to have yearly adjusted net profit of 45-50cr. We can take a multiple of 10x for the current year to arrive at the valuation of 450-500cr. Now, here also we have left Majesco and that value should be brought in separately, another 100cr to come at final value of 550 - 600cr. This is bit lower as we have factored in higher tax rate, our effective tax rate is assumed near 25%-30%. Needless to say upside remains same as mentioned in EV/EBITDA multiple.
Average of both method gives us valuation of 576 - 631cr, which is 33-45% upside from yesterday closing price.
4. Where most of the analyst covering Mastek got their valuations wrong : Here I would simply highlight some of the point missed by the analyst covering the stock.
http://www.moneycontrol.com/mccode/news/article/article_pdf.php?autono=1402491&num=0
At page 21 of the valuation section, target price of 174 using PE method clearly missed that about 100cr valuation should be added from Majesco above it. In the same page, though they mention company has acquired IndigoBlue but they have not incorporated revenue and profit from Indigoblue. The 13.6% growth mentioned there is mere organic one, hence if we add IndigoBlue our net profit should increase to 50cr in FY17.
http://www.indianivesh.in/Downloads/635696086909375000_Mastek__Co_Update_09062015.pdf
Here, we don't even acknowledge that company owns 13.8% in Majesco.
http://content.icicidirect.com/mailimages/IDirect_Mastek_CoUpdate_Sept14.pdf
Services business is valued at EV/EBITDA level but they have missed both, cash and investment in Majesco. Valuation is done on 1st page, 2nd paragraph
http://www.rathi.com/ResearchCoverage/635572635632228750_Mastek%20_IC_%2030%20December%202014.pdf
In page 16, they have directly computed target price from EV, though here we have taken 13.8% stake in Majesco, but forget to add cash balance, which company just reported as 137cr, post payment of 22cr to IndigoBlue, hence valuation should be 661cr + 137cr
5. Can there be more value unlocking : It is forgone conclusion that de-merging Mastek was brilliant move to unlock value, which is clearly visible in share price performance. At times, when most of the CEO's wanted to build empire and merge business, de-merger was definitely a investor friendly move. Once the Majesco Ltd shared get listed on the Indian market, Mastek management can think of 2nd level of value creation. Transfer the 13.8% Majesco US stake from Mastek Ltd to Majesco Ltd. With that, Majesco Ltd stake in Majesco US will increase from c.70% to 84%. Issue fresh shares of Majesco Ltd to Mastek current shareholders. This way we will have complete de-merger of insurance and services business. Investor can make their free choice, which business they want to invest in, true value unlocking.
Mastek is a cash rich company. Idle cash always encourage management to go for shopping as a result they often destroy value through acquistion. Mastek CEO already mentioned that company will be generating 40-50cr of free cash flow:
http://www.moneycontrol.com/news/business/acquisitions-diversification-to-lead-fy16-growth-mastek_1624201.html
Share buy back is another option to create value, distributing dividend brings dividend distribution tax of 15% and hence not ideal way for value creation. Management also has history of buy back earlier as shown in the link below:
http://money.rediff.com/companies/Mastek-Ltd/13020010/capital-structures?src=comp_research
6. What could retail investor do now : There is very little option left for retail investor here. We always depend on expert advice and market will also follow what analyst/research house are saying about the stock and its future prospect. Until analyst pick up the points mentioned here, re-rating of the stock is bit difficult.
I would try to answer this with the following points:
1. Mastek business model
2. Its revenue driver and expected future growth
3. Fair value of Mastek
4. Where most of the analyst covering Mastek got their valuations wrong
5. Can there be more value unlocking
6. What could retail investor do now
1. Mastek business model : Erstwhile Mastek ltd had two business segment, Insurance software products catering primarily to US markets and software services business catering to UK government. Post demerger, Mastek will have services business while insurance will be transferred to Majesco ltd, which is expected to list in India by Aug'15. I am not writing anything in detail about business segment and geographies of Mastek here as that is available on company's website and other analyst report links which I have mentioned below. Important information is "Mastek currently holds 13.8% of Majesco US".
2. Revenue driver and future growth: Mastek ltd gets 70% of its revenue from government contract in UK, remaining 30% comes from BFSI and retail/telecom segment. This is a very stable business where the revenue has grown at 24% in the FY15 with 11% EBITDA margin. Earlier, Mastek use to partner with BT and Captiva to earn government contract. But in 2012, UK government let small and mid-sized companies participate directly in bidding contract. Government wants 50% of their contract to come directly from smaller firms. This effort is yielding positive results on Mastek as corroborated here:
http://www.channelweb.co.uk/crn-uk/news/2415332/meet-the-new-public-sector-supplier-stars
Management is guiding the revenue will continue to grow at above industry average of 12-14%, but the street is anticipating it to clock mere 10% growth and EBITDA margin will remain stable at 12%. Which brings us to 67cr EBITDA in FY16. However, there were lots of noise in the announced results:
2.A Company has earlier said there shouldn't be any further de-merger related exceptional items. But in the concluded quarter, they had further restructuring expense of 1.8cr.
2.B They acquired IndigoBlue in May'15 and its two month financials were included in the current quarter. Full impact on the financial will be reflected in the coming quarters, when the operations are stabilized and management will be in better position to give guidance regarding benefits of cross selling of products through IndigoBlue and vice versa.
2.C Management has done soft launch of its Law Practice Technologies' platform. Full launch is expected by the end of Sept, and management said they will be able to give better picture of the platform by the next quarter results.
3. Valuation: Now this is the most juicy part and one should spend more time in understanding how this company should be valued. I am covering one critical point here:
Mastek has about 156cr of cash and equivalent, including 18.8cr as investment (book value) in Majesco. (Market value of 13.8% stake in Majesco US is c.150cr). This cash is after company has paid over c.22cr to IndigoBlue. Now since the Majesco US is in expansionary mode and still not making money, all analyst are valuing it at EV/Sales multiple. Analyst are assigning it the multiple of 2x EV/Sales, which is also confirmed by the market as its valuation on NASDAQ is also coming around 1100cr. Importance of this information will be clear once you go through entire article. So, Mastek's 13.8% stake in Majesco should be valued separately as Majesco true value cannot get reflected through its current EBITDA or Net Income.
EV/EBITDA: Market is anticipating EBITDA of 60-70cr of Mastek business, excluding Majesco. Even if we assign a EV/EBITDA multiple of 6x (which is very low for IT sector, 6x multiple is mostly used in manufacturing and capital intensive sector), we come to EV of 360-420cr. We add 137cr cash to it and then add valuation of Majesco (after 30% holding discount) as 105cr. Total valuations come to (360-390 + 137 + 105) 602 - 662cr. Now, post this conservative target we have decent upside risk to our target price for the reason mentioned in 2B and 2C, to be precise 2B upside will start trickling in from 1H16, while 2C upside will take shape from 1H17.
PE multiple: In the concluded quarter, company reported net profit of 4.4cr while the adjusted net profit was 10cr. Bridge to this adjustment comes under exceptional expense for restructuring (1.8cr) and 3.4cr loss related to Law Practice Technologies ("LPT") , the platform which was into development phase. Management has mentioned in the concall that platform has already crossed its peak capex and will be fully launched by Sep. If we remove loss due to LPT and restructuring exp, profit before tax would come to 16cr. It was very close to EBITDA as depreciation was offset by other income (Company holds about 137cr in cash and there should be considerable interest income from it). So we can assume company is going to have yearly adjusted net profit of 45-50cr. We can take a multiple of 10x for the current year to arrive at the valuation of 450-500cr. Now, here also we have left Majesco and that value should be brought in separately, another 100cr to come at final value of 550 - 600cr. This is bit lower as we have factored in higher tax rate, our effective tax rate is assumed near 25%-30%. Needless to say upside remains same as mentioned in EV/EBITDA multiple.
Average of both method gives us valuation of 576 - 631cr, which is 33-45% upside from yesterday closing price.
4. Where most of the analyst covering Mastek got their valuations wrong : Here I would simply highlight some of the point missed by the analyst covering the stock.
http://www.moneycontrol.com/mccode/news/article/article_pdf.php?autono=1402491&num=0
At page 21 of the valuation section, target price of 174 using PE method clearly missed that about 100cr valuation should be added from Majesco above it. In the same page, though they mention company has acquired IndigoBlue but they have not incorporated revenue and profit from Indigoblue. The 13.6% growth mentioned there is mere organic one, hence if we add IndigoBlue our net profit should increase to 50cr in FY17.
http://www.indianivesh.in/Downloads/635696086909375000_Mastek__Co_Update_09062015.pdf
Here, we don't even acknowledge that company owns 13.8% in Majesco.
http://content.icicidirect.com/mailimages/IDirect_Mastek_CoUpdate_Sept14.pdf
Services business is valued at EV/EBITDA level but they have missed both, cash and investment in Majesco. Valuation is done on 1st page, 2nd paragraph
http://www.rathi.com/ResearchCoverage/635572635632228750_Mastek%20_IC_%2030%20December%202014.pdf
In page 16, they have directly computed target price from EV, though here we have taken 13.8% stake in Majesco, but forget to add cash balance, which company just reported as 137cr, post payment of 22cr to IndigoBlue, hence valuation should be 661cr + 137cr
5. Can there be more value unlocking : It is forgone conclusion that de-merging Mastek was brilliant move to unlock value, which is clearly visible in share price performance. At times, when most of the CEO's wanted to build empire and merge business, de-merger was definitely a investor friendly move. Once the Majesco Ltd shared get listed on the Indian market, Mastek management can think of 2nd level of value creation. Transfer the 13.8% Majesco US stake from Mastek Ltd to Majesco Ltd. With that, Majesco Ltd stake in Majesco US will increase from c.70% to 84%. Issue fresh shares of Majesco Ltd to Mastek current shareholders. This way we will have complete de-merger of insurance and services business. Investor can make their free choice, which business they want to invest in, true value unlocking.
Mastek is a cash rich company. Idle cash always encourage management to go for shopping as a result they often destroy value through acquistion. Mastek CEO already mentioned that company will be generating 40-50cr of free cash flow:
http://www.moneycontrol.com/news/business/acquisitions-diversification-to-lead-fy16-growth-mastek_1624201.html
Share buy back is another option to create value, distributing dividend brings dividend distribution tax of 15% and hence not ideal way for value creation. Management also has history of buy back earlier as shown in the link below:
http://money.rediff.com/companies/Mastek-Ltd/13020010/capital-structures?src=comp_research
6. What could retail investor do now : There is very little option left for retail investor here. We always depend on expert advice and market will also follow what analyst/research house are saying about the stock and its future prospect. Until analyst pick up the points mentioned here, re-rating of the stock is bit difficult.
