IT and BPO Services C3Q10 Metric Madness: JPMorgan

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In this note, we compiled historical data on various operational metrics for IT and
BPO services firms and analyzed the company-specific and industry-wide trends. Here
we highlight any interesting 3Q10 observations based on the data repository:


• Growth metrics- Offshore IT services continues to lead. Offshore IT services
revenue growth continued to accelerate in C3Q and was driven by clients' spending
on discretionary projects and M&A integration work (TCS, INFY, and CTSH
reported 10-12% q/q revenue growth). Legacy IT services growth also improved
solidly (CAP’s FX adjusted growth turned positive) while BPO growth was steady
(G disappointed). While we expect offshore IT services’ growth premium to hold
over the near term, sustainability of such high growth rates could become
challenging in CY11 given the increasing base and less (or lack of) incremental
pent-up spending dollars. Hiring was strong across most IT services firms with
ACN and CAP continuing to increase their offshore labor mix. We expect CTSH
and VIT should continue to lead the industry growth rates in the near term, with
CSC, Logica and WNS being the laggards.

• Profitability- mixed gross margin trends. Mixed gross margin trends in the
offshore IT services group while legacy IT services and BPO margins improved due
to seasonality. We expect margin pressure from offshore wage inflation and
potentially declining utilization rates to be offset (fully or partially) by pricing
power and increasing offshore mix (for legacy ITS firms). However G&A expense
leverage (assuming revenue growth sustains) should help protect or expand
operating margins. We see gross margin expansion opportunities at ACN and CSC.
ACN continues to operate at high ROIC (although declining due to increasing cash
balance) while CSC’s, Logica’s, and BPO firms’ ROIC ratios are among the lowest
given the capital intensive nature of their business models.

• Productivity- pre-recession trends returning. Legacy ITS’ revenue per employee
further declined due to increasing offshore mix (specifically at ACN and CAP).
INFY now generates the highest EBIT per employee in the industry (previously
ACN). Most firms increased their employee utilization rates given the strong
demand environment, but we believe the rates should decline in C4Q. However,
INFY/SYNT can potentially maintain/increase their utilization rates. Industry-wide
attrition rates remained high with most offshore IT services firms incurring 20%+
rates (when calculated on the quarterly annualized basis). We however expect
industry wide attrition rates should decline over the near term.

• Revenue breakdown. Financial services growth significantly accelerated for IT
services firms, led by M&A integration, risk management, and regulatory
compliance work. CTSH’s and VRTU’s financial services verticals grew at the
fastest clip, while CAP reported sharp growth acceleration in the vertical. We
however expect higher growth in non-financial services verticals in CY11. European
growth for most firms was steady and better than feared, although it lagged
Americas’ growth in C3Q. We expect continued strong growth in Americas for most
firms. Customer concentration trends were mixed with continued high client
concentration for BPO and small/mid cap firms.


• Capital metrics. IT services firms’ cash balance steadily increased over the last two years
as firms preferred to keep some dry powder for acquisitions and/or buybacks/dividends.
Relative to various firms’ respective sizes, VRTU possesses the most excess cash, while
TCS operates with the lowest cash balance. CSC, Logica, and WNS have negative net
cash. IT services firms’ capital intensity remained high in C3Q10, while increasing for
BPO firms. We expect continued high capital intensity for offshore IT services and BPO
firms given the improving growth outlook over the near term. Industry-wide DSO was
high during the quarter. WNS and EXLS operate at low DSO levels while VIT and
European firms have high DSOs. ACN, relative to legacy IT services firms, operates at
much lower DSO level.