The Hindu Business Line : Earnings preview of IT majors

The ABN Amro deal is expected to increase pressure among European vendors to outsource, and large unbundled deals may be closed more quickly. Once this trend picks up, it will enhance the scope for Indian vendors to cross-sell newer services.

FRONTLINE companies in the software services sector are slowly getting decked up for a bounce-back in the latest earnings season compared to the past two jittery quarters. The turbulence, especially among select frontline companies, was attributable to slower-than-expected growth among top clients owing to organisational restructuring, sluggish IT-spends on account of regulatory factors, limited scope for pricing upsides and rupee appreciation.

This combination of factors served to dampen market sentiment for most software stocks and contributed to their underperforming the bellwether indices.

What has changed?

Over the past month, however, there has been a relatively sharp pick-up in trading interest among frontline stocks and the factors that may bring the zing back are:

Mega deal from ABN Amro: The $400-million five-year application support contract bagged by Tata Consultancy Services and Infosys Technolgies in the $2.2-billion outsourcing deal from the Dutch major, ABN Amro, has changed the dynamics of the sector.

The strategic push towards the unbundling of multi-million dollar outsourcing contracts, which IT vendors have been talking about for a while, has finally happened.

With at least one more mega deal from GM, one of Wipro's key clients, likely to be concluded over the next few months, Indian vendors stand competitively placed vis-à-vis their multinational peers in such contracts.

According to the global sourcing advisory firm, TPI, the number of active `unbundled' deals in the pipeline is growing, and the participation of Indian offshore vendors will remain fairly high.

As a trend, the ABN Amro deal is expected to increase the competitive pressure among European vendors to outsource and large unbundled deals may be closed more quickly than in the past.

Once this trend picks up, it may enhance the scope for Indian vendors to cross-sell newer service lines such as infrastructure management, testing or BPO in the medium term.

Revving up of top clients: The subdued sequential growth in revenues from the top client and top two to five clients of some frontline companies is likely to change over the next couple of quarters.

The first indications of this may emerge in the July-September quarter, after two quarters in which growth between the top five to ten clients have powered the performance of frontline companies such as Infosys and TCS.

The predictability and stability that top five clients bring to the table are likely to build up in the coming quarters.

Rupee depreciation: The recent depreciation of the rupee against the dollar (and, to a limited extent, the euro and the pound sterling) is driving the fancy for software stocks. This is the reversal of the appreciating trend in the rupee over the previous quarters.

As a rule of thumb, we assume that a 1 per cent depreciation of the rupee will have a 1.5-1.75 per cent impact on per share earnings. No wonder, the CFO of Infosys recently indicated that the earnings guidance may be revised upwards in the light of this development.

What will be watched

Competitive reaction from MNC peers: The multinational companies such as IBM and Accenture are attempting to get their act together in the offshore arena. The feverish recruitment drive from these companies shows that they are willing to undergo short-term pain to establish their offshore presence.

EDS, which has been slow in establishing its offshore presence, hopes to jumpstart it through a strategic alliance with Cognizant for application-related work.

This can slowly put pressure on the Indian players to further broadbase their services portfolio, establish presence across geographies, enhance the number of $40-million and $50-million clients and engage in more violent turf battles with the MNC players.

Upside in billing rates: Though the revenues of Indian players will continue to be driven by volume-led growth, as the top clients' revenues rev up, it will be interesting to see whether there will be an upside in billing rates.

The Indian players have indicated that newer clients are coming in at higher billing rates for the past few quarters.

However, unless the pricing picks up for existing top clients and compensates for lower margins in the ABN Amro kind of deal, say in the first year, the margins may slowly start on a downcurve.

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