The Hindu Business Line : Software services rides out rough patch to turn winner — Action-packed year in mid-cap software arena

2005 proved to be a mixed year for the software services sector. On one hand, the $400-million application support contract bagged by TCS and Infosys from ABN Amro marked a defining moment for the offshoring trend. Frontline companies also widened their basket of service offerings and client portfolio, even as medium and small-sized companies got active on the mergers and acquisitions (M&A) front.

In contrast, the first half of the calendar year was affected by a turbulent phase. The lower-than-expected earnings guidance from Infosys in April, downward revision in guidance by select medium-sized companies, and an appreciating rupee took a toll on market sentiment.

But as the tide turned decisively in the second half, especially for frontline companies, the mood turned from despondency to cheer.

A combination of these factors had a bearing on the returns delivered by software stocks in 2005. Among frontline stocks, Satyam Computers was the star performer, outperforming the Sensex by a long chalk.

The stock also narrowed the valuation gap relative to its peers, Infosys, TCS, and Wipro. While Infosys performed in line with the Sensex, TCS and Wipro under-performed.

However, if investors had used the jittery first half to enter Infosys or TCS at their 52-week lows, they would have logged returns higher than the Sensex.

The returns delivered by the mid-cap service stable also present a contrasting picture.

Some of the relatively high-profile stocks such as MphasiS BFL, Hexaware Technologies, KPIT Cummins, NIIT Technologies, iGate Global, and Zensar Technologies under-performed and remained volatile in 2005.

In contrast, stocks that were languishing in earlier years or the ones that underwent extensive restructuring of their business models - organic or inorganic - crackled to life.

Stocks such as Aztec Software, VisualSoft Technologies, Subex Systems, Mastek, Sonata Software, Infotech Enterprises, and Megasoft posted handsome returns.

In this backdrop, there were a few trends that marked the progress of the IT sector in 2005.

Confidence leap for frontline companies

For the frontline companies, the highlight of the year was the $2.2-billion unbundled deal from ABN Amro that TCS and Infosys bagged.

This was significant as it established that clients with large outsourcing budgets were moving away from a single vendor approach to multiple vendors.

This, along with renegotiation of existing large deals and shrinking size of average deals, is expected to play to the advantage of Indian frontline vendors, as they compete head-on with the multinational vendors.

Even as the application development and maintenance markets continued to swell, frontline companies decided to aggressively widen their portfolio of offerings.

Apart from packaged implementation (such as Oracle and SAP), these companies targeted remote infrastructure management, engineering services, consulting, testing, and non-voice based BPO as the next engines of growth.

Since September, TCS has stepped on the acquisition pedal, notching up Australia-based FNS for the banking segment and a 12-year contract from UK-based Pearl Insurance and acquired Chile-based Comicron on the BPO front.

Infosys went aggressive on its consulting foray and outlined big plans for China.

For Wipro, the exit of Vice-Chairman, Mr Vivek Paul, marked the low point of the year, leading to some senior level management changes.

However, by the fag-end of the year, a couple of acquisitions of Austria-based NewLogic and US-headquartered mPower put some zing back into the company.

For Satyam, the highlights were its billion-dollar revenue target, launch of Futurus Business Solutions Lab, robust enterprise solutions practice, and aquisitions of UK-based Citisoft and Knowledge Dynamics.

Churn in the mid-sized space

It was an action-packed year in the mid-cap software arena. There was action on every front: acquisitions (both high and low profile), revision in earnings guidance, equity sale and delisting of companies, and extensive changes in business models.

Clearly, the significant highlight of the year was Oracle's acquisition of 43 per cent equity stake in i-flex Solutions.

Citigroup Venture Capital, promoter of i-flex, sold its equity stake for Rs 2,600 crore ($593 million) against an overall investment of under Rs 5 crore made in the 90s.

In the second half of the year, scaling down of earnings guidance by Hexaware, KPIT Cummins, and Geometric Software rocked the mid-cap space.

The revision was attributable mainly to unexpected delays and sluggish revenue growth by some European clients.

Hexaware also had to contend with an unexpected development. Following the acquisition of PeopleSoft by Oracle at the global level, Oracle decided to take over the India Solutions Centre, set up under the BOT model by Hexaware earlier this year.

In early May, Barings India Private Equity, which held 35.6 per cent equity stake in MphasiS BFL, put it on the selling block. After eliciting and evaluating bids from several quarters for well over three months, Barings decided to retain the stake, reportedly disappointed by the low bids.

In the same month, Flextronics Software (formerly Hughes Software), post acquisition by Singapore-headquartered Flextronics, announced a buyout of 30 per cent non-promoter equity stake and delist the stock.

Compared to a floor price of Rs 575, it finally fixed the price of Rs 725 to buy out the remaining equity stake.

These events were interspersed with a flurry of small-sized acquisitions by the likes of KPIT Cummins, MphasiS, Four Soft, and Helios and Matheson, among others.

And the year was finally capped in the mid-cap arena with the restructuring of VisualSoft, after the private equity arm of Softbank took 14 per cent equity stake in the company.

It recently decided to merge two companies, AppLabs and e-Solutions, with itself and emerge as a player in the outsourced product development and testing space.