What is the fuss?
‘Digital transformation’, ‘Migration to Cloud’, ‘Extracting actionable insights from data’, using A.I. to fuel growth -> These are the common phrases you may hear in the booming IT (Information Technology) service sector. TCS, Infosys are the behemoths in this space. Given that IT is a multi decade growth story, are there potential smallcap picks who can grow to the size of TCS / Infosys in the next decade, generating disproportionate wealth for their investors?
This post uncovers the story of Mastek. This promising smallcap IT company is standing at a critical turn of events. Whether it will embark on a fast-track path to become an IT giant, or will it remain a second choice IT provider, is yet to be seen. Lets get started with Mastek’s background, Q4 FY 23 result highlights, and then discuss its future growth levers and associated risks.
Mastek — The Company
Mastek was established in 1982 by a bunch of IIM graduates. Their vision was to deliver business design and software to companies. Fast forward, in 2023, even though none of the founders run the company now, the vision has stuck and matured with time. Mastek is a leader in providing Cloud services, Data Management and Insights, and Digital Commerce management. Mastek is one of the first movers in AI space, by tying up with domain expert AI startups to deliver AI enabled services to its retail and commerce clients.
Mastek’s main client is the UK government. Over decades, Mastek has worked with the UK government, in their healthcare projects, security, and infrastructure projects. While client concentration is never a good sign, Mastek has been able to utilise its experience in working with a government to win similar government and city council owned IT projects across US and Australia.
Mastek’s clients are spread across UK, US, Europe, Middle East, and Australia. The company operates out of India, with 10–15% of its employees working from onsite locations.
If Mastek is a standard IT company, what makes it stand out and worthy of investment? Lets get into the growth levers in the next section.
Mastek’s Growth Levers
Lever 1: Focus on Government, Healthcare, and Retail clients
As a smallcap company, it is good to have focus. Focus leads to differentiation, brand recall, and quality delivery of projects. Mastek is focusing on three key types of clients — Government, Healthcare, and Retail/commerce.
Even though they are present in almost all sectors, from finance to HighTech, their focus key industry sectors and client types has bode well for them so far. This has led to healthy growth in order book (18% YoY), and stable operating margins (17–19%).
Lever 2: Inorganic Growth
Being a smallcap company in a mature and competitive industry such as IT, pace of growth and client additions is key. Inorganic growth via acquisitions is a good strategy in these situations. Mastek has a good record of successfully acquiring other IT / Tech companies, and integrating them with the Mastek culture.
Mastek acquired Evosys in 2020. This gave Mastek entry into a specialised Oracle Cloud service projects.
Mastek acquired MST Solutions in 2022. The acquisition is now complete, with MST contributing to Mastek’s balance sheet Q3 FY 23 onwards. MST overdelivered in FY 2023, providing 118% of revenues projected during its acquisition.
MST gives Mastek inroads into Salesforce related IT projects. Additionally, MST brings with itself a host of US clients it used to work with. More clients means more revenue generation opportunities via client mining.
Lever 3: Entering into emerging Technology Sectors
Mastek is among the first movers in new and emerging technology sectors, such as AI, High Tech manufacturing (example: semiconductor production).
As a recent example, Mastek entered into a partnership with Netail, a US based AI startup, to drive AI first IT projects for retail and consumer companies. Is Netail a big shot you ask? It kind of is, with Professor Andrew NG as its Chairman, and an experienced co-founding team.
It is good to see Mastek aiming to upgrade its technology service offerings to its clients, and keeping up with the times.
Lever 4: People, People, People
Journey of a good company to become great depends on the company’s people. Hiring talent, retaining them, and engaging them to drive innovation is not only required, but essential. Mastek has been able to source senior talent from other IT giants such as Wipro, Persistent Systems, and Cognizant. Some key leadership at Mastek are below.
In 2022, when most of the IT companies stopped hiring freshers, and made void already rolled out offers, Mastek took the hard call to honour rolled out offers, and take a short term expense spike for a couple of quarters. This led to decrease in employee utilisation for Q3 and Q4 FY 23. However this will lead to faster pickup of projects as they start landing, which is seen in Q4 FY 23 (29 new clients added in one quarter).
Key Risks to watch out for
Despite visible growth levers at Mastek, there are some key risks which one should watch out for in Mastek over the course of next few years.
Risk 1: Dependency on UK
UK is still the largest revenue source for Mastek. Mastek is actively trying to diversify in the US, Middle East. It recently hired a President of the US operations, and a Chief Growth Officer focused on the US market. It will be key to watch geographical diversification progress at Mastek in coming years.
Risk 2: Diversify away from Oracle
How many times have you read news of big companies transforming to cloud using Oracle? Not so much, right? And that is true. Oracle cloud has just 6% market share in the cloud industry. AWS and Azure rule the cloud market. New entrants such as Snowflake have grown fast and well into the cloud industry as well.
It is important for Mastek to diversify into preferred cloud services in order to increase chances of their deal wins in the future. Oracle might be a choice for government bodies, and city councils, but not so much for private companies.
Risk 3: New Leadership Team
The entire Mastek leadership was hired in the past 3 years, between 2020 and 2022. This includes its current CEO, CMO, COO, CGO (Chief Growth Officer), and its US country head. Even though these hires are industry veterans, it remains to be seen if they will become Mastek veterans as well. Retaining top talent for long, and promoting internal talent to leadership positions will be a success indicator to watch out for.
Risk 4: Larger Deal Wins (> USD 10 mm)
Mastek has been able to do small deal wins well. These are in the range of USD 2–5 million. However, in order to become the big boy in the industry, Mastek needs to win deals north of USD 10 million deals, maybe even a couple of deals in the USD 100 million range.
Mastek has not been able to crack the larger size deals so far. This might be because of its small size, and less than adequate lead generation team. This remains a key challenge to solve for.
Risk 5: Timely Debt Repayments
Mastek has a debt to equity of 0.25. This is not concerning, but higher than other IT giants such as TCS, LTIM who have near zero debt. Timely debt repayments is an important indicator to watch out for. Some of the debt taken is used for acquisitions, which will continue in FY 24 as Mastek completes the final tranches of payments for earlier acquisitions.
Parting Thoughts
Overall, what makes me positive on Mastek is walking the talk. Their management has been transparent in the concalls. They have been able to deliver on their future guidance.
Even though risks to growth remain, Mastek’s management have acknowledged these risks, and shared a mitigation plan in coming years for the same. Will the people of Mastek — Mastekeers as they call themselves, become the next TCS / Infosys? I, for one, will be watching closely as the story of this small IT company, with a large vision unfolds in a competitive technology service industry.
Happy investing!
Disclaimer: I am not a SEBI registered advisor. Do your own research before investing. Do consider subscribing to my newsletter here to receive subscriber only info on the Indian stock market.
