{LONGTERMINVESTORS} Mphasis-A Special Dividend In August 2016?

We believe Mphasis revenues have bottomed out with a) likely stability in HP  business  from  Q2FY17  and  b)  steady  outlook  in  Direct  International  (non‐HP  business). EBIT margins too have bottomed out and management has raised the  margin guidance by 1% to 14‐16% for H1FY17. Mphasis' margins are amongst the  lowest in peer group (refer exhibit 6), and we see gradual margin up‐tick driven by  improvement in revenue growth trajectory. Company's quality of earnings, despite  a  lacklustre  fundamental  performance,  has  remained  better  than  peers  with  almost 100% conversion of Net Profit to FCF.   We raise FY17/18E EPS by 2%/4% driven by margin upgrade and increase TP to  Rs570, based on 14x FY18 EPS (was Rs515, 13x Dec‐17 EPS). We upgrade stock to  BUY from accumulate, as we forecast US$ EBIT CAGR of ~9.5% over FY16‐18E. We  expect Mphasis' YoY US$ revenue growth to hit double digit by 4QFY17. Special  dividend  or  share  buy‐back  may  act  as  a  trigger.  Company  has  cash  of  Rs~140/share and special pay‐out could be in the range of Rs50‐100/share.   HP business has bottomed out on quarterly basis: HP revenues which have  been on a sustained decline for past 5 years will bottom out from Q2FY17.  Company has signed a revised Master Services Agreement (MSA) with HP which  guarantees US$990mn revenue over a 5 year period. This implies ~US$50mn  quarterly run rate against Q4FY16 revenues of US$55mn. We have factored in  ~US$195mn HP revenues in FY17E, still a 19% YoY decline.    Direct business (non‐HP) to have steady growth: Direct International (~71% of  revenues) business reported FY16 US$ revenue growth of 14% YoY. We believe  with deal wins of US$303mn in FY16, this business is on a steady path and will  drive growth for the company and more than offset the HP decline. Continued  deal win momentum in Direct International business can drive double digit US$  revenue growth in FY18E (PLe: 8%).    Special dividend/Share buy‐back to act as a trigger: Blackstone (which acquired  HP's stake in Mphasis) has stated that they will consider share buy‐back and  special dividend post completion of the open offer process (July 4, 2016).

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