Indian Software and IT Services report by JPMorgan

India IT Services
Tech Bubbles & Pebbles: From Intel to Infosys -
Anchoring Indian IT's relative independence in the
global technology chain




• “Where are Indian IT firms positioned in the technology food chain?”
• “What are the global technology bellwether stocks whose outlook is a
precursor to that of Indian IT companies and why?”
• “Will weaker global IT spend translate into weaker spend for Indian IT firms?
The above questions assume importance in light of the discernibly weakening
consumer spending in the US/Europe which is seen impacting the OEMs (PC and
handset makers) and the semiconductor industry. Our US semis analyst,
Christopher Danely believes that all signs point to another semiconductor
downturn, reckoning that demand is softening from 85% of the semiconductor
industry. Checks indicate that PC OEMs (40% of semi revenues) have cut orders
to the semiconductor food chain. The communications end market (25% of semi
revenues) is also showing signs of weakness, as Cisco (covered by JPM Analyst
Rod Hall) missed F4Q10 consensus estimates and guided F1Q11E revenue below
consensus. In addition, several major wireless handset OEMs have provided below
seasonal guidance for 3Q10. Will this have down-the-road implications for
Indian IT?
• Not really worrisome for Indian tech, as per our analysis: The traditional
tech chain that links the hardware, software and services market is increasingly
getting decoupled. The hardware-software decoupling phenomenon is not new
and if anything, virtualization only accelerates this further. Also, primary driver
of IT offshore spending still relates more to the cost-cutting/cost-restructuring
agenda of enterprises, which is far more resilient. Indian IT’s direct exposure to
the consumer is low and is indirect at best through clients who, in turn, are
exposed to the consumer (e.g., Nokia, Dell, etc.) – a second order impact.
• What about correlation of Indian IT with software players such as
Oracle/SAP? Here, also, we observe that the correlation is weakening over
time (though stronger than one between Indian IT and semis/OEMs). This is
because a larger proportion of revenues for the larger Indian IT players in this
segment now depend more on relatively non-discretionary ERP support than
before. Also, ERP implementations/upgrades do not necessarily relate to new
license sales of Oracle/SAP (for example) as abundant implementation
opportunities for Indian IT players relate to the optimization of existing/legacy
ERPs.
• One of the highlights of our Note is our reading/interpretation of the tech
food chain all the way from Intel to Infosys.
• Investment view. We believe that Indian IT is at a sweet spot in terms of its
resiliency in the global chain and its ability to sustain a base-case revenue
growth in the high teens (16-18%) in FY12E. Abrupt shocks to enterprise IT
spending potentially precipitated by a double dip in the US economy would be
the primary spoiler for Indian IT, which we do not see materializing in a stable,
low global growth regime. That said, 20%-plus earnings growth in FY12E (20x
FY12E) is more than factored in current stock prices which constrains us from
taking a constructive view of meaningful upsides to top-tier stocks. TCS (OW)
remains our top pick among the large-caps in the sector.