In 2004, with optimism

With many variables working against the sector, it was hardly surprising that the frontline software stocks participated in the broad-based market rally only in fits and starts till September. But once the bearish signals began to dissipate one-by-one, the upward revision in the valuation of these companies happened quite swiftly.

Both Infosys and Wipro have recovered from their 52-week lows of Rs 2420 and Rs 790 to trade now at Rs 5617 and Rs 1763 respectively. Both the companies have price earnings multiples in excess of 30 times 2003-04 earnings. A similar trend in the stock price is also evident in Satyam Computers, and to a lesser extent in HCL Technologies. The focus would be on whether the sharp re-rating in valuation is of a sustainable nature The following factors would play a key role:

The MNC challenge: The fence-sitting period for the multinational vendors such as IBM Global, Accenture or Cap Gemini is over. In 2004, these vendors may finally put their act together and pose a challenge to the Indian software majors.

The strong order book position and the domain expertise of the global vendors will be pitted against the strength of the Global Delivery Model of the Indian majors.

IT spending/billing rates: IT spending which has been sluggish in calendar year 2003 is expected to recover significantly in 2004. However, Indian software majors admit that this recovery is happening only in small pockets and is not broad based, as yet. So far, there are no indications that any new technologies or applications providing a sustained engine of growth. Unless that emerges, the attempts by the Indian software majors to move up the value chain may prove to be a slow affair.

There are also signs that the billing rates have started to stabilise. But sustained recovery can be factored in only when the billing rates start moving up in line with the recovery of the US economy. Otherwise, even with an increase in off shoring volumes, the Indian software companies may not be able to arrest the slide in operating profit margins.

Outsourcing backlash: As the US economy enters the election year, the prospect of an outsourcing backlash remains a live threat to the growth of the software industry. Though arguments in favour of offshoring have become quite compelling, these fears cannot be dismissed altogether.

It is likely that near-shoring initiatives to places such as Canada or Mexico may catch on. Indian companies may be able to capture this opportunity by increasing their onsite presence, but their operating margins may decline as a result of these initiatives.

Listing of TCS and Patni: The much-awaited IPO from Tata Consultancy Services may finally happen in 2004. And this may completely alter the portfolio strategy of investment managers and high networth individuals. In addition, the IPO from the Rs 900-crore Patni Computer Systems is also on the anvil and this may also broadbase investor choice.

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