IT's going steady

Even as the US and Europe grapple with debt problems and slowing economies, fears of a repeat of 2008 are being visualised by the market, with the result that a bearish picture is being painted for the Indian IT industry.

Be that as it may, key trends in factors such as deal flows, discretionary spends, vendor rationalisation and performance of key verticals, appear quite favourable to Indian software majors and select mid-size players. Management commentary across software services players of varying sizes as well as research and advisory bodies reinforces this.

Added to these is the heavy depreciation of the rupee against the dollar to the Rs 49 levels, which would further boost realisations for software companies.

A closer look at the sector in its entirety suggests that while there is some caution in the air, there is no pullback of projects, early closures or pricing discounts from the clients' end and concerns may be a tad overdone.

Projects on track

Companies such as Infosys, Wipro, and TCS, among others, have all indicated that compared to 2008, there have been no knee-jerk reactions this time around.

There have been no failures along the lines of Bear Stearns, Lehmann Brothers, and Nortel Networks or the US government having to bail out GM and Chrysler. All these were large clients for Indian IT players, and hence these companies faced severe IT budget cutbacks.

This time around, there have been no pre-mature project closures or quick client reactions in the form of slashing budgets or reducing the scope of contracts. Deals, especially from the BFSI segment, as well as other verticals such as manufacturing and retail, continue to flow in at a healthy pace for almost all top-tier IT players.

Second, no pricing cuts have been demanded by clients so far. After the initial round of pricing discounts given by Indian vendors in late 2008 and early 2009, for nearly two-and-a-half years, pricing was stable-to-marginally lower.

Given that they are not out of that cycle, any further reduction on this front appears unlikely. Third, there have also been no rollbacks in discretionary spends, at least for the clients of large Indian IT players, as indicated by the likes of Infosys and Wipro. Together, all these suggest that the going is steady as far as outsourcing budgets and IT spends of clients are concerned.

Large deals, vendor rationalisation

The flow of fairly large deals ($100-million-plus) continues to be in the pipeline.

Wipro, for instance, recently announced two deals totalling $500 million, Tech Mahindra won an estimated $250 million contract with Vodafone Hutchison Australia and HCL and TCS have bagged large projects from Deutsche Bank. Infosys has had a $100-million deal from a European client. Companies such as Hexaware and MindTree too have managed to grab multi-year, multi-million projects of substantial size. Clients thus appear to be on course to invest in transformational projects or on large multi-country rollouts.

According to industry research advisory bodies such as TPI, the other concern regarding vendor rationalisation too has not impacted Indian IT majors in any significant way. All the top five Indian IT majors, including the US-listed Cognizant, have managed to compete effectively with global players such as IBM and Accenture to grab deals in the $100-million category.

Also, the fact that clients have started to break up very large deals into much smaller parcels has meant that the value-at-risk is much lower. Indian majors still tend to win the lower-end applications portion of most deals, which may not help them climb the value-chain any time soon, but helps them offshore these portions, optimise costs as well as give themselves revenue visibility.

Applications services, being generally business efficiency related, are less susceptible to cut backs.

The vertical churn

Indian IT majors are also seeing an interesting shift in verticals that is driving growth over the last couple of years, which clearly indicates that these companies are not vying for the same pie.

Wipro, which has had manufacturing and telecom as its largest verticals, is increasing focus on BFSI, with the result that it is now the largest segment contributing over 26 percent of revenues. The other late entrant to BFSI, HCL Technologies too has seen this vertical become among its top contributors, growing at or faster than the overall company growth rate.

Manufacturing is another segment that is witnessing steady growth for HCL Tech. Infosys, on the other hand, is seeing growth (double-digits over the past four-five quarters) led by retail & CPG (consumer packaged goods). The company is winning large deals in this segment, in new areas such as digital market place. Manufacturing is another area that is growing steadily for Infosys. Together, manufacturing and retail and life sciences account for 43 per cent of the company's revenues.

TCS is probably the only large player that is seeing steady growth across verticals, even from telecom which is in doldrums for most other majors. The company has over 44 per cent revenues from BFSI segment, but all other verticals are smaller, accounting for less than 15 per cent of revenues.

Mid-sized players such as MindTree, on the other hand, are going after smaller banks and financial institutions in the US that are looking to outsource for the first time.

Favourable currency

The other key factor to prop realisations over the short-to-medium term would be the favourable exchange rate of the dollar vis-à-vis the rupee. Generally, if the rupee appreciates by one per cent, most IT companies witness 30-40 basis points erosion in margins. Given that the dollar is at Rs 49 levels, way above the Rs 44-45 comfort zone of software majors, would clearly cushion margins.

The cross currency exchange rate of the Euro vis-à-vis dollar too is favourable for these companies. Although the rupee appreciation has been prevalent only during this month, it would still aid realisations.

NOT SO BLEAK

Much of the projects to be executed over the course of this calendar year and even FY12 have been signed.

Budgets for the next fiscal would be finalised by clients by January 2012. But given that there have been no early ‘feelers' of any cut back, Indian IT services players can breath somewhat easy.

Industry body, Nasscom, has projected a 16-18 per cent growth in software services export for this fiscal and is sticking to this forecast, suggesting reasonable business confidence. In this light, companies such as Infosys, TCS and HCL Tech, by virtue of their showing in the June quarter and an expectedly strong September quarter, should be able to scale those levels in terms of revenues. It remains to be seen how Wipro, with an anaemic first quarter numbers, manages to grow.

With all these companies moving proactively to special economic zones and making adequate tax provisions for existing facilities, a major margin-diluting factor too appears out of the way. Indeed, with tax-incidence in the range of 20-27 per cent, there could be very limited increase on this front.

While it may not be a completely rosy for these companies, especially if there are sovereign debt defaults, it certainly isn't a bleak picture and certainly not as bad as 2008.

COMMENT NOW