The Hindu Business Line : Wipro: Hold

SHAREHOLDERS can retain their exposures in the Wipro stock. At the current price levels, it is richly valued and fresh exposures can be considered on weakness linked to the broad markets. The stock has run-up by about 12 per cent since the start of 2006. The stock is appropriate for investors with annual return expectations of 15-20 per cent over a one/two-year period.

The latest $300-million five-year order estimated from General Motors, robust third quarter earnings from its IT services and products arm, and a couple of recent strategic acquisitions — NewLogic and mPower — are expected to improve its fundamentals.

The stock may witness some near-term turbulence as there are conflicting reports about the size of the deal. But the Wipro management has maintained that the potential revenue expected from GM is $300 million on a conservative basis. This includes the current revenues, expected revenues in partnership with EDS and the value of the direct contract won. GM is an existing client of Wipro.

It is also likely that Wipro may go ahead with its sponsored secondary ADR (American Depository Receipt), which has been in the works for some time now. No timeline has been indicated as yet. The promoters stake is now 82 per cent and may be brought down to comply with the continuous listing norms of 75 per cent. Following a strong third quarter earnings performance, the variables that will dictate Wipro's stock performance are:

Economics of large deals

For frontline companies, large deals are becoming a crucial element of growth, if business volumes and scale have to be maintained over the long term. With the $400-million five-year ABN Amro deal bagged by Tata Consultancy Services and Infosys and the latest total outsourcing deal of $330-million by DSG International awarded to HCL Technologies, Wipro was a key player left out of the `large deal' loop.

The latest GM contract, valued at $300 million, eases the pressure on incremental volume growth in the coming quarters. The partnership with EDS is significant as the latter has managed to retain 65-70 per cent of GM's IT spending on the overall contract, worth $6 billion, awarded so far. EDS was the sole service provider for GM in a 10-year contract, which is to expire in June 2006.

As the deal is primarily for application development and maintenance work, it will also help perk up Wipro's year-on-year growth from this segment. More so, as the growth from the this segment has been slowing down, relative to the newer service offerings such as technology infrastructure services, testing or non-voice BPO.

The Wipro management has claimed that this deal will not have any impact on its operating margins. But, in our view, most large deals may have a dampening effect in the first year or two; margins could pick subsequently. The only way in which the margin erosion can be offset will be by lowering selling, general and administrative expense and enhancing offshore utilisation in the initial years.

Strong metrics

For the third quarter ended December 31, 2005, the enterprise business contributed 63 per cent of revenues, with technology business contributing the rest. Though the proportion of revenues has shifted towards enterprise business, technology will start playing a bigger role in the next couple of years. As demand for automotive, consumer electronics, semiconductor and storage solutions are all looking up, the product engineering solutions division is expected to turn in a strong performance. The acquisition of Austria-based NewLogic for $56 million will open up opportunities for design services in the embedded space and cross-selling other services to its existing customers over the next year.

The other operating metrics of Wipro's Global IT Services arm are also in relatively good shape vis-à-vis its frontline peers. As one of the early players to widen its basket of service offerings, new services contribute nearly 40 per cent of revenues of this arm. While this contribution has stagnated in the 35-40 per cent range in the past couple of years, it is likely to rev up in the coming quarters.

The contribution of the top, top five and top ten clients has improved sharply in the latest quarter, reiterating the overall volume growth story. For the fourth quarter, the company projected a revenue growth of 8 per cent to $ 510 million. The client accounts in different revenue brackets such as $3-5 million and $5-10 million have grown at an encouraging pace. The number of clients in the $20-million and above bracket has also improved steadily over the six to eight quarters.

At the same time, the offshore utilisation, which was 68 per cent in the latest quarter, has considerable headroom for improvement. Once the utilisation is stepped up to the average of 73-75 per cent, the operating margins are likely to improve. Similarly, as the company transitions its BPO business from predominantly voice to non-voice transactions, its margins are likely to improve steadily.

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