Info-tech

Big-ticket deals may not come easily for IT firms

Our Bureau Bengaluru | Updated on December 25, 2020

The recent big wins may be one-time in nature as industries return to pre-Covid activities, say analysts

The recent euphoria over some of the domestic IT services’ companies winning multi-billion dollar deals is well justified, but some of these incremental spends from clients may be one-time in nature, analysts tracking the IT sector have said.

Domestic IT companies need to be cognisant of the fact that physical activity across most economies and industries is already reverting to pre-Covid baseline levels. Progress on inoculation over 2021 should further accelerate the reversion of traffic from digital to physical channels. As businesses focus on re-establishing human connect after a long gap, analysts expect re-calibration in IT spends, which appear partly pulled forward into CY20. Contrary to expectations, rather than a pent-up, IT spends could turn out to be lower than usual in 2021, analysts said.

 

More importantly, the analysts at ICICI Securities say that while there has been an increase in IT spends of top-five US/top eight global banks, what is significant to note is that some of these incremental spends may be one-time in nature (WFM enablement). “Even adjusted for this, we understand many firms incurred higher-than-normal spends in strengthening their systems to cater to peak-time digital traffic under lockdowns. We reckon this could have translated into partial pull forward of IT spends from future years,” ICICI Securities’ analysts Sudheer Guntupalli and Hardik Sangani said in a note to its investors.

Digital acceleration

Analysts also said the accelerated shift to digital — with IT services companies bagging multi-billion dollar deals — may not be a good enough comfort for the industry as nearly 50 per cent of the revenues still come from legacy spends. Therefore, the repurposing theory (redeploying resources to help clients accelerate their digital journey) may not be enough, as a significant deceleration in legacy spend is already underway.

“For most Indian Tier-I players, where 50 per cent of the revenue still comes from legacy spends, this is going to be a challenge to overall growth in the medium-term,” said Girish Pai, head of research for Nirmal Bang.

He added the multi-year strong growth narrative will likely gain a lot of credibility if there is conclusive proof of a sustained higher IT spend to sales ratio and/or a significant shift in spend to outsourcing (which was at 25-30 per cent of enterprise IT services spend in the recent past).

Analysts agree that indisputably, adoption of digital/cloud has been an evolving theme for a few years now, benefitting IT firms. Going forward into the medium term, too, this is expected to be an evolution rather than a revolution. “We are skeptical of the street’s hyper optimism around Covid-led acceleration in digital/cloud adoption. Weakness in incremental sales, recent moderation in the IT companies’ assessment and stagnancy in As-A-Service deals underpin our assessment,” ICICI Securities said.

Future outlook

What needs to be watched is how much stronger can this growth be in the near term, and how long can this double-digit growth last. “While eagerness to execute the shift to the cloud and likely normalisation of economic activity in the developed markets will lead to a sharp pick-up in growth in FY22 and FY23, there is a mixed picture about longevity of this phase,” Girish Pai said.

Another issue which needs to be monitored is whether the recent large deals surrounding the transfer of internal IT arms of customers goes from a trickle to a flood. Should the latter happen (as customers settle down in their businesses post vaccination), the market will get a hint that this is indeed a growth cycle that would stretch beyond FY23, Pai pointed out.

In some of the recent deals, especially in the case of Wipro and Infosys, most of these contracts are mostly people-takeover deals, with Infosys alone integrating more than 16,000 employees through other partnerships in recent years. Wipro, in turn for its contract with the German-based Metro AG, will absorb close to 1,300 employees spread across Germany (300), Romania (400) and India.

Published on December 25, 2020

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