The Hindu Business Line : Breathing easier

The pressure's easing, ever so slightly, on pricing and profitability margins for Indian software players. A steady Rupee and a global uptick in tech spending are pitching in to help clear the fog.

THE fog may be lifting for Indian software services vendors as they drive through the global doldrums seeking new boosters to rev up growth.

While front-runners such as Infosys Technologies, Wipro Ltd, Satyam Computers and HCL Technologies have reported robust volume growth and exuded confidence on the order pipeline front, the cramped pricing is also showing signs of creeping northwards, going forward.

At a recent technology conference in New York, hosted by Citigroup's investment banking arm, Salomon Smith Barney, companies such as Infosys and Cognizant mentioned an unexpected spurt in business. These companies have been selectively walking away from deals where pricing is the key determinant. High manpower utilisation (the June quarter utilisation for top firms was the highest in 12 quarters) and the ability to walk away from low-price deals are good leading indicators to stable/improving pricing.

According to analysts and industry players, rates for new deals are higher but this will take sometime to reflect on the average billing rate as these projects ramp up, since repeat business still accounts for over 85 per cent of revenue for all top companies. On the other hand, rate renegotiations and new business signed up at lower rates over the last two quarters should pull down pricing in the short term. Notwithstanding recent price cuts by long-term clients such as Northwestern Mutual and Aetna last September, Infosys has indicated a healthier pricing environment. The rupee, after its 5 per cent gain against the dollar, appears overvalued now based on the Real Effective Exchange Rate (REER) index. The ceiling of 100 basis points (bps) over LIBOR for NRE deposits should help restrict dollar inflows and could potentially be a stabilising factor, feel analysts. This, in turn, could help the local software vendors report healthier rates in dollar terms.

"The global economy signals a rebound. Several surveys indicate an uptick in technology spending. Moreover, offshore gaining mainstream in the outsourcing game helps both the clients and the vendors to strike deals at higher price points than the existing average price plain", a Singapore-based technology analyst says. "We must remember that price barriers crashed over the last two years tracking the tightening tech-spend... so the marginal recovery could lead us back to the pre-2000 levels in a staggered positive correction", he says.

The margins picture

For the last two-and-a-half years, sinking rates and a hardening Rupee have plagued Indian software vendors, driving operating margins down. With salary hikes effected in the top-tier companies, the fear of a further shrinking in the margins could be allayed through a favourable pricing environment, say analysts. A steady Rupee and stable pricing could help software vendors "significantly" revise their earnings guidance upwards in the near term.

For instance, Infosys, which had earlier factored in a one per cent sequential drop in rates in its annual guidance, prior to the June quarter, has said it expects prices to stay stabilised for now and upped its guidance.

Currently, Infosys has not been taking business rates below the current average. While re-negotiations have played out and bubble pricing has been removed from the system, the company has cited price discipline among industry players.

The favourable pricing scenario could well have been reflected in the company's second quarter earnings, where it beat guidance and street expectations by a wide margin for the second quarter in a row. Second quarter revenue for the current financial year was at $248 million (up five per cent sequentially, up 29 per cent from a year ago), ahead of guidance of $237 million but marginally below street expectations as most of the volume growth was realised offshore.

Net profit at $65.5 million (up eight per cent sequentially and 33 per cent year-on-year) came in above the consensus of $63.1 million. In a significant divergence from recent trends, the company reported an increase in billing rates for the first time in four quarters. Margins also improved.

While billing rates were up 1.5 per cent quarter-on-quarter, margins increased by 110 bps. The higher margins were on account of a continued trend to offshore (offshore volumes grew 10.5 per cent quarter-on-quarter while onsite volumes increased only 2.4 per cent). Besides the increase in the offshore ratio, Infosys also cut the cost of onsite subcontractors from 2.5 per cent of sales to 0.7 per cent of sales. This, coupled with better margins, helped the company report better margins despite the 2.1 per cent fall in the exchange rate realisation during the quarter.

Meanwhile, Wipro also said it was witnessing pricing stability. For the first time in two years, the company got price hikes from a select band of customers during the second quarter of the current financial year. Though the company does not see this as a trend, it points at the fast improving price environment. Wipro also saw better pricing from new clients and benefits of a better service mix working in favour of billing rates, going forward.

The company expects margins to remain stable in the third quarter despite a 12 per cent hike in offshore salaries effective October. "We believe a drop in low margin sub-contractor revenues and potential improvement in the offshore ratio should help offset the impact of higher salaries", a technology analyst with a European brokerage says.

Wipro too saw an increase in onsite billing rates and perhaps an improved operating margin. But, a sharp increase in subcontracted consulting revenues (from $5 million to $10 million) withheld a possible improvement in margins for the IT Services business during the quarter. Analysts estimate BPO margins to have remained stable as better price neutralises lower utilisations.

"We believe one-time costs and losses from two acquisitions (AMS and NerveWire) are backed into numbers and can only show upside. With retention bonuses paid out and initial integration costs borne, we expect these acquisitions to give back 80-100 bps of margins over the next three quarters. Wipro has also corrected the significant over-runs seen in large fixed-price projects in the previous quarters — one of the primary factors driving down pricing", notes Smith Barney.

However, the company reported a net profit of $50 million (four per cent jump sequentially, 12 per cent year-on-year) over revenues of $300 million, beating street expectations for the June quarter. During the quarter, sequential volume growth at 11 per cent was the highest seen in four quarters while onsite billing rates were up 2.2 per cent. The company saw volume growth across all its verticals with Telecom (14 per cent sequentially), Infrastructure services (36 per cent) and Packages Implementation (19 per cent) being the highlights.

The sharp decline in Wipro's margins over the last two quarters has been primarily driven by lower prices (down 4 per cent), cost overruns in fixed- price projects and acquisitions. While the margin impact from the acquisition will only be positive going forward, Wipro is seeing price stability. This could be reflected in the reported hike in onsite rates by 2.2 per cent in the June quarter.

Another front-liner Satyam Computers reported the highest sequential growth in revenue over 10 quarters for its June quarter. Although onsite biased, Satyam's volume growth (up 10 per cent sequentially) finally caught up with its frontline peers. However, the company reported a marginal 0.6 per cent drop in pricing.

Despite aggressive hiring and a salary hike and factored drop in margins, the company sounded positive on marginal pricing but does not expect better pricing on new projects to reflect on better average rates immediately.

Smelling a recovery in the US economy and buoyed by business visibility, the local tech sector is on a hiring spree, and the stock market has also boosted the new confidence through significant appreciation of frontline technology stocks.

abhrajit@thehindu.co.in

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