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Highlights
We see more compelling buying opportunities for key stocks in our coverage in the wake of the Japanesenuclear-
fear-induced pullback in stocks (see Exhibit 1). We especially think Accenture's stock is very
compelling ahead of its March 24th earnings report. Sapient's recent pullback is very overblown, in our
view. Cognizant is attractive, with Accenture's upcoming report a likely positive catalyst for sector
sentiment. Infosys could offer a positive trading opportunity, ahead of its initial FY12 guidance in April.
In today's piece, we outline seven pertinent reasons to support this "buying opportunity" argument for these
stocks, particularly for Accenture, which we featured as our best idea in our January 12th research
(Accenture, Cognizant, Infosys: Seeing Bullish Demand Progression; ACN Top Idea; Raising ACN, INFY,
CTSH Targets) and reinforced in our March 3rd research piece after another round of industry checks (IT
Services: Updates on Our Favorable Demand Progression Thesis and Stance on Accenture as Top Idea):
Reason #1 – Japan and Asia/Pacific are not big enough revenue sources for our covered stocks to
be a significant risk for them, as shown in Exhibits 2 & 3. We estimate only about 2-3% of
Accenture's and Visa's revenues are from Japan. And, Japan represents immaterial amounts of revenues
at Cognizant, Infosys, Sapient, ADP, Paychex, and MasterCard.
Reason #2 – We maintain our stance that Accenture's upcoming report for the February quarter
should show significant upside to consensus revenue and bookings. And we think Accenture's FY11
revenue growth guidance of 8-11% (in local currency) is substantially beatable (note this guidance was
raised from 7-10% in the fiscal Q1 earnings report). That said, despite this room for upside we see to the
FY11 outlook, we think it may be prudent for Accenture to keep its official FY11 guidance in place for
now and hold off on raising its guidance until later this year (e.g., to avoid setting an expectation that it
will "beat and raise" every quarter, and to foster the healthy psychology of investors feeling comfortable
that there's room for upside to guidance). See Exhibit 4 for a comparison of our Accenture estimates
(which we think are conservative) to consensus.
Reason #3 – Certain periods of fear in the past had relatively little impact on IT services demand,
and we anticipate the current fears about Japan's nuclear issues could have similarly low impact:
Outside of the global financial crisis of 2008-2009 (which shocked IT services clients into a mode of not
making decisions), we've witnessed other periods of fear in the past that have not rendered substantial
consequences to IT services demand. For example, past fears that had little impact on IT services
demand include: debt crisis in Greece in late 2009 and early 2010; swine (H1N1) flu in 2009; Avian
(bird) flu in Asia in 2003 and in Europe in 2005; and various terrorist attacks (excluding those in the US
on 9/11/01), such as the 7/7 London bombings in 2005 and the Madrid train bombings in 2004.
Reason #4 – We reiterate that a transformational phase of IT services demand has begun and is
unlikely to be stopped anytime soon, given the multi-quarter nature of transformational services work.
For instance, systems integration initiatives (e.g., ERP software deployment) at large companies often
take over a year, and stoppages of such initiatives midstream generally do not occur, unless very negative
circumstances hit close to home. To elaborate on this topic from our prior research:
How long will this phase of much-improved systems integration demand last? We see ingredients in
place for this phase of demand to last multiple quarters (e.g., more than one year), partly due to
substantial work that didn't get done during the financial crisis (i.e., pent-up demand). Also, we note
that large companies generally cannot implement systems and/or transform business processes in less
than 6 months (i.e., often takes a year or more). Moreover, we underscore our ongoing view that the
primary risk to systems integration demand is a major macro-shock to clients' decision making, while
periods of poor GDP growth (if it occurs without people being shocked by it) should not cause major
problems for the demand of top consulting / systems integration businesses.
Reason #5 – Latest industry checks reveal no cause for worry about supply chain effects (or ripple
effects) that could stem from issues in Japan: After completing a big round of industry checks for our
March 3rd research piece, we have further revisited demand trends over the past couple of days to see if
we can find any signs of demand issues stemming from Japan-induced fears. We hear general worries
from some investors that issues in Japan could cause supply chain disruptions for companies around the
world (i.e., for clients of IT services firms). However, it does not appear that such supply chain issues
(e.g., delays in getting parts) are prone to cause any significant disruption to systems integration and
application development deals at firms like Accenture, Cognizant, and Infosys, nor should such issues
cause disruption to multi-channel commerce, web advertising, and trading/risk management deals at
firms like Sapient.
Reason #6 – The systems integration and application development deals that are now being
initiated in this improved phase of demand are supported by a huge amount of planning work that
was completed in 2010, with this planning work evidenced by the major strength we saw throughout
2010 at several leading strategy consulting firms.
Reason #7 – Large companies (i.e., key clients of top IT services firms) are showing willingness to
invest in more transformational deals, which generally seem unlikely to be eschewed by turmoil in
Japan. We reiterate that we see momentum building in consulting / systems integration demand: Recall
our research emphasis that high-end consulting demand was very strong throughout CY10, reflecting
clients' efforts to plan new initiatives after having been substantially stalled amidst the decision-making
shock during the 2 years of the global financial crisis. After this significant planning work that has been
completed, we see strong evidence today that clients have moved into a mode where they are much more
willing to invest in transformational initiatives (i.e., deal types that are key to Accenture), with
implementations now moving forward.
Investment Conclusion
Summary view on Accenture (Recap)
We rate Accenture outperform (and our top idea). We see demand patterns progressing in Accenture's
favor, as we think strong management consulting demand (in 2010) has now progressed into improved
demand for systems integration deals (including more "transformational" initiatives), along with decent
prospects for outsourcing bookings to be strong in the February 2011 quarter. As a result, we see further
upside to the Street's revenue and EPS expectations. We also think Accenture can achieve its FY11 margin
expansion target, despite starting FY11 with Y/Y margin contraction in fiscal Q1.
Distinctive Accenture attributes against large tech stocks: Our January 12th research piece showed that
Accenture has distinctive attributes (revenue growth, ROIC) relative to other stocks that are trading at
high free cash flow yields, and we thus contend Accenture deserves a position high on investors' lists of
core tech stock holdings.
Favorable demand progression pattern: We forecast 11.6% revenue growth for ACN in FY11 (a
forecast that we think is conservative), and we contend ACN is secularly capable of 8-10% revenue
growth, and with this growth much less reliant on economic trends than is perceived (as explained in our
research on IT services cyclicality). Also, we reiterate that strong management consulting demand
(which we witnessed throughout 2010) will likely now progress in upcoming months into improved
demand for ACN's systems integration and outsourcing services. Stated differently, we anticipate a
favorable demand progression from clients' planning efforts into implementation projects and operational
support, as clients' appetites to invest have improved.
Above-consensus estimates: This favorable demand progression pattern is prone to enable Accenture to
achieve further upside to the Street's revenue expectations in FY11 (ending in August). As such, we
conservatively forecast FY11 revenue growth of 11.6%, which is 1.3% higher than consensus. And we
forecast FY11 EPS of $3.21, above consensus of $3.16 (which has nudged up recently from $3.14).
Growth resiliency: Also, while some worry about Accenture's revenue growth and bookings outlook in
light of economic uncertainties, we reiterate our view that demand improvement in the IT services
industry does NOT require substantial GDP improvement, but rather the absence of shocks to clients’
decision making — likely making leading IT services firms (e.g., Accenture, Cognizant) more resilient
than other tech firms that are more wed to GDP trends.
Margins fine: After reporting a Y/Y drop in operating margin in the November quarter, we think
Accenture will likely prove skeptics wrong by achieving its goal of 10-20 bps of margin expansion in
FY11.
Ratings across Computer Services stocks
We have outperform ratings on Sapient, Accenture, Cognizant, and ADP. We have market-perform ratings
on Visa, MasterCard, Paychex, and Infosys. And, we have an underperform rating on CSC.
Performance of Stocks Since Earthquake in Japan
Exhibit 1 shows the performance of Computer Services stocks (compared to the S&P 500 and Nasdaq)
from March 9 to March 16. Interestingly, since March 9, Accenture, Sapient, Cognizant, and Paychex
underperformed the S&P 500 by over 1%.
Especially for Accenture, Sapient, and Cognizant (the stocks we favor most due to prospects to report
fundamental upside), we see their recent pullbacks as compelling buying opportunities
Revenue Mix from Japan and Asia/Pacific
The exposure of Computer Services firms to Japan is quite low (see Exhibit 2), with a maximum revenue
exposure of 2-3% for Accenture (i.e., our estimate drawing from our Accenture FX model) and a similar
exposure of 2-3% for Visa (i.e., our estimate based on Nilson data).
Looking at exposure to the Asia/Pacific region (see Exhibit 3), though Accenture and Infosys have
meaningful exposure at 12.7% and ~10%, respectively, a significant portion of their Asia/Pacific revenue is
from Australia (rather than from Japan and surrounding areas).
Accenture: Our estimates versus consensus and guidance
Exhibit 4 conveys our Accenture estimates versus consensus and guidance.
Note: We maintain that our estimates for the February quarter and for FY11 are prone to be conservative.
February 2011 quarter
For the February 2011 quarter, we are forecasting 12.5% Y/Y revenue growth, which is higher than
consensus of 10.6%. Accenture's revenue guidance calls for $5.60 to $5.80 billion, with the high end of
this range implying +12.0% Y/Y revenue growth and the low end implying 8.2% Y/Y revenue growth.
We are forecasting February quarter EPS of $0.72, which is 1 cent higher than consensus of $0.71.
Fiscal year 2011 (ending August 2011)
We are forecasting 11.6% FY11 revenue growth, versus consensus of 10.3% (which has been upwardly
revised by 0.2 percentage points since January 12). Accenture's FY11 guidance calls for 8-11% revenue
growth (in local currency).
We are forecasting $3.21 in FY11 EPS, versus consensus of $3.16 (which has been upwardly revised by
2 cents since January 12). Accenture's FY11 EPS guidance range is $3.08-$3.16.
Fiscal year 2012 (ending August 2012)
For FY12, we are somewhat conservatively forecasting revenue growth of 7.0% (on top of our aboveconsensus
revenues for FY11) and EPS of $3.61, versus consensus of $3.53.
Our Related Research and Summary Points
Recent industry checks on Accenture and demand: Following an additional round of industry checks at
the end of Accenture's February quarter, our March 3rd research piece (IT Services: Updates on Our
Favorable Demand Progression Thesis and Stance on Accenture as Top Idea) underscored our favorable
demand progression thesis and positive stance on Accenture, as we think later-cycle systems integration
demand is kicking into gear. We see strong signs of demand momentum and believe Accenture has
moved into the "sweet spot" of its demand cycle, with clients now showing a propensity to invest in more
transformational systems integration deals (reflecting an important progression beyond the fast-payback
deals that were predominant earlier in the demand recovery cycle). And, barring a macro-shock to
clients' decision making, we see multiple reasons to expect that this strong phase for Accenture-type
systems integration demand should last multiple quarters. Other pertinent points from our March 3rd
piece:
"Short-listed" services firms should get disproportionate revenue lift: As the demand recovery
progresses, top services firms that have effectively gained share within the budgets of existing clients
(i.e., as clients have consolidated their suppliers over the past couple of years) should be boosted to
elevated revenues from core clients. In other words, during the financial crisis, we think top firms like
Accenture and Cognizant garnered a higher percentage of spending at a number of large, existing
clients (i.e., at the expense of lower-tier firms). So, as these existing clients add to their spending,
Accenture and Cognizant should naturally derive disproportionate growth.
BPO signings should be poised to show some improvement: We reiterate that Accenture's momentum
(over the last year) in the management/operational consulting arena has very likely positioned the
company to win certain types of outsourcing deals (e.g., industry-specific BPO deals). As a result,
Accenture's outsourcing business should achieve improved bookings in the February quarter.
Cloud demand has further progressed, but not key to next-12-months growth in the consulting /
systems integration market. Cloud-related spending to date has largely focused on data center
initiatives (e.g., virtualization) and relatively small "discovery" projects to help clients evaluate/plan
for the cloud era. We now see more evidence of software-related cloud initiatives (e.g., clients
engaging consultants to help in piloting cloud software usage). But, we still think it's premature in the
near term to expect major spending on cloud software deployment and integration initiatives.
HP's weakness should not be an issue: We think concerns in late February about Accenture, Cognizant,
Infosys, and Sapient stemming from HP's weak results were overblown. We think systems integration
demand is thriving; and we see no reason to alter our "favorable demand progression" thesis. And, we
think weakness in HP's services business is attributable to HP having a very different business mix and
company-specific issues, as we explained in our February 23rd research piece (Quick Take - Weakness at
HP Should Not Have Negative Implications for Accenture, Cognizant, Infosys, Sapient).
Favorable demand progression; ACN as top idea: Our evaluation of Accenture against other tech
stocks suggests its distinctive attributes may be underappreciated, and our January 12th research piece
(Accenture, Cognizant, Infosys: Seeing Bullish Demand Progression; ACN Top Idea; Raising ACN,
INFY, CTSH Targets) featured Accenture as our top idea. Moreover, in this research piece, we
explained our "favorable demand progression" thesis.
Leading indicators: As detailed in our November 12th research piece ("IT Services: Rebound Happened;
Cisco Brings Concerns; What Now? Still See Encouraging Leading Indicators for ACN, CTSH), we see
solid reasons to believe the leading indicators of discretionary services spending trends are still showing
generally positive signs; these reasons stem from our checks with key contacts in the consulting market
and our analysis of consulting bookings results, temp labor data, and staffing firms' growth trends.
Cloud Computing: While some are concerned that cloud computing could hurt demand for systems
integration services, we reiterate our research conclusion that cloud computing should be a net
opportunity for Accenture. For details, here's the link to our 4/7/2010 research piece on this topic:
Accenture: What Impact Will Cloud Computing Have on ACN's Demand & Business Model? Views,
Info Ahead of Analyst Day.
Valuation Methodology
Our target prices for IT services stocks are derived by applying multiples to our forward estimates of
earnings and cash flows. Our target multiples are determined based on our assessments of historical priceto-
forward-earnings multiples, after considering each company’s growth prospects relative to historical
levels. Our target multiples are also influenced by the results of our DCF analyses across various financial
scenarios for each company.
More specifically, for IT services and offshore services firms, our target share prices are derived by
applying the following P/E multiples to our calendar 2012 EPS estimates: Accenture 15.3x, Sapient 22.4x,
CSC 6.4x, Infosys 20.2x, and Cognizant 24.0x.
For processing companies, our target share prices are derived by applying the following P/E multiples to
our calendar 2011 EPS estimates: MA 13.5x, Visa 15.3x, ADP 20.1x, and PAYX 20.3x.
As an alternative method of calculating our latest $14.75 target share price on Sapient, we apply a target
P/E multiple of 18.4x to our 2012 EPS estimate with a 28% normalized tax rate assumed (i.e., EPS of 71
cents), while also giving Sapient valuation credit for its $1.67 of cash per share. This target multiple is
supported by Sapient's takeover prospects, substantial room for margin expansion, and long-term growth
prospects in attractive segments like multi-channel commerce, Internet advertising, and trading/risk
management.
As alternative method of calculating our target share price on CSC, we apply an EDS-takeover multiple
(i.e., FCF multiple of 12.05x) to our estimate of CSC's "normalized" free cash flow (i.e., FY10 FCF
excluding the impact of lower DSO).
Also, note that, in addition to prospects for stock appreciation, Paychex, ADP, CSC, and Accenture offer
meaningful dividend yields.
Risks
The primary risk to consulting names (Accenture and Sapient) achieving our target share prices is the
potential for pressures on discretionary services spending. In addition, negative economic news flow can
weigh on the sentiment (and valuation multiples) of consulting stocks, and Accenture's stock has a tendency
to be pressured by appreciation of the US dollar (due to Accenture's substantial international exposure).
The primary risks to IT outsourcing companies’ (e.g., CSC, HP/EDS, Perot) fundamentals include contract
restructurings/terminations (a significant risk for CSC) and the shift of IT outsourcing work to offshore
labor centers (a threat to CSC). Further, our research shows the emergence of the offshore/remote
infrastructure outsourcing business, which will enable Indian firms to move into the core market segment of
CSC, and this trend will add pressure to CSC. It is prone to cause some cannibalization of CSC’s existing
infrastructure outsourcing revenues and some share loss to Indian and niche players moving aggressively
into the offshore/remote infrastructure outsourcing business. We also maintain a concern about CSC’s high
balance-sheet accruals. The risk to our underperform rating on CSC is that restructuring efforts and new
strategies could drive EPS improvement and share price appreciation.
Risks facing our target prices on Indian IT services stocks (e.g., Infosys and Cognizant): We still maintain
longer-term concerns about rupee appreciation (see our 10/22/07 research call for an analysis of factors that
could affect future moves in the Indian rupee), margin contraction (due partly to increasing needs,
especially for Infosys, to invest in onshore capabilities and industry-specific solutions), tax rate
normalization (i.e., tax rates for top Indian firms should jump to north of 20% when the STPI tax haven in
India expires), and meaningful hurdles related to supply and competition.
An underlying risk to achieving our target prices on Paychex and ADP is cross-selling leverage failing to
materialize, causing expectations of long-term earnings growth to be revised. In addition, weak U.S.
employment growth can hurt the stocks' valuations, present a challenge to their margins, and incrementally
pressure their revenue growth. Downward pressures on interest rates can mar sentiment and reduce ADP’s
investment income from both client funds (float) and corporate investments (note that the yield on
Paychex's float portfolio does not have material room for downside).
A number of risks could prevent our target prices on MA and V from being realized, including:
We see a number of potential competitive threats, which could transpire over the long term, e.g.,
encroachment from mobile payments and alternative payment providers (e.g., PayPal), growth of
competitive international networks (e.g., China Union Pay), and some possibility of banks moving into
the card network business.
Regulatory change (e.g., related to interchange) is an ongoing risk, and substantial litigation is pending
against MA and V, with MA more exposed to possible future litigation liabilities since V has an escrow
fund and bank shareholder stock buffering its earnings exposure.
Weakness in consumer spending and any hiccups in the revolving credit market can hurt volume and
transactions growth.
MA and V can lose revenues if a card issuing bank converts to different a debit card brand, or shifts
issuance of credit cards from one brand to another. They can also lose revenues if merchants succeed in
shifting more debit volume from signature debit to PIN debit.
Obstacles to cross-border travel activity can hurt the cross-border revenues earned by MA and V.
Besides being affected by general spending activity, MA's and V's growth rates are materially affected by
moves in gas prices in the United States. For MA and V, gas purchases account for about 6% and 10%,
respectively, of U.S. payment volume (and likely account for higher percentages of U.S. transactions.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Highlights
We see more compelling buying opportunities for key stocks in our coverage in the wake of the Japanesenuclear-
fear-induced pullback in stocks (see Exhibit 1). We especially think Accenture's stock is very
compelling ahead of its March 24th earnings report. Sapient's recent pullback is very overblown, in our
view. Cognizant is attractive, with Accenture's upcoming report a likely positive catalyst for sector
sentiment. Infosys could offer a positive trading opportunity, ahead of its initial FY12 guidance in April.
In today's piece, we outline seven pertinent reasons to support this "buying opportunity" argument for these
stocks, particularly for Accenture, which we featured as our best idea in our January 12th research
(Accenture, Cognizant, Infosys: Seeing Bullish Demand Progression; ACN Top Idea; Raising ACN, INFY,
CTSH Targets) and reinforced in our March 3rd research piece after another round of industry checks (IT
Services: Updates on Our Favorable Demand Progression Thesis and Stance on Accenture as Top Idea):
Reason #1 – Japan and Asia/Pacific are not big enough revenue sources for our covered stocks to
be a significant risk for them, as shown in Exhibits 2 & 3. We estimate only about 2-3% of
Accenture's and Visa's revenues are from Japan. And, Japan represents immaterial amounts of revenues
at Cognizant, Infosys, Sapient, ADP, Paychex, and MasterCard.
Reason #2 – We maintain our stance that Accenture's upcoming report for the February quarter
should show significant upside to consensus revenue and bookings. And we think Accenture's FY11
revenue growth guidance of 8-11% (in local currency) is substantially beatable (note this guidance was
raised from 7-10% in the fiscal Q1 earnings report). That said, despite this room for upside we see to the
FY11 outlook, we think it may be prudent for Accenture to keep its official FY11 guidance in place for
now and hold off on raising its guidance until later this year (e.g., to avoid setting an expectation that it
will "beat and raise" every quarter, and to foster the healthy psychology of investors feeling comfortable
that there's room for upside to guidance). See Exhibit 4 for a comparison of our Accenture estimates
(which we think are conservative) to consensus.
Reason #3 – Certain periods of fear in the past had relatively little impact on IT services demand,
and we anticipate the current fears about Japan's nuclear issues could have similarly low impact:
Outside of the global financial crisis of 2008-2009 (which shocked IT services clients into a mode of not
making decisions), we've witnessed other periods of fear in the past that have not rendered substantial
consequences to IT services demand. For example, past fears that had little impact on IT services
demand include: debt crisis in Greece in late 2009 and early 2010; swine (H1N1) flu in 2009; Avian
(bird) flu in Asia in 2003 and in Europe in 2005; and various terrorist attacks (excluding those in the US
on 9/11/01), such as the 7/7 London bombings in 2005 and the Madrid train bombings in 2004.
Reason #4 – We reiterate that a transformational phase of IT services demand has begun and is
unlikely to be stopped anytime soon, given the multi-quarter nature of transformational services work.
For instance, systems integration initiatives (e.g., ERP software deployment) at large companies often
take over a year, and stoppages of such initiatives midstream generally do not occur, unless very negative
circumstances hit close to home. To elaborate on this topic from our prior research:
How long will this phase of much-improved systems integration demand last? We see ingredients in
place for this phase of demand to last multiple quarters (e.g., more than one year), partly due to
substantial work that didn't get done during the financial crisis (i.e., pent-up demand). Also, we note
that large companies generally cannot implement systems and/or transform business processes in less
than 6 months (i.e., often takes a year or more). Moreover, we underscore our ongoing view that the
primary risk to systems integration demand is a major macro-shock to clients' decision making, while
periods of poor GDP growth (if it occurs without people being shocked by it) should not cause major
problems for the demand of top consulting / systems integration businesses.
Reason #5 – Latest industry checks reveal no cause for worry about supply chain effects (or ripple
effects) that could stem from issues in Japan: After completing a big round of industry checks for our
March 3rd research piece, we have further revisited demand trends over the past couple of days to see if
we can find any signs of demand issues stemming from Japan-induced fears. We hear general worries
from some investors that issues in Japan could cause supply chain disruptions for companies around the
world (i.e., for clients of IT services firms). However, it does not appear that such supply chain issues
(e.g., delays in getting parts) are prone to cause any significant disruption to systems integration and
application development deals at firms like Accenture, Cognizant, and Infosys, nor should such issues
cause disruption to multi-channel commerce, web advertising, and trading/risk management deals at
firms like Sapient.
Reason #6 – The systems integration and application development deals that are now being
initiated in this improved phase of demand are supported by a huge amount of planning work that
was completed in 2010, with this planning work evidenced by the major strength we saw throughout
2010 at several leading strategy consulting firms.
Reason #7 – Large companies (i.e., key clients of top IT services firms) are showing willingness to
invest in more transformational deals, which generally seem unlikely to be eschewed by turmoil in
Japan. We reiterate that we see momentum building in consulting / systems integration demand: Recall
our research emphasis that high-end consulting demand was very strong throughout CY10, reflecting
clients' efforts to plan new initiatives after having been substantially stalled amidst the decision-making
shock during the 2 years of the global financial crisis. After this significant planning work that has been
completed, we see strong evidence today that clients have moved into a mode where they are much more
willing to invest in transformational initiatives (i.e., deal types that are key to Accenture), with
implementations now moving forward.
Investment Conclusion
Summary view on Accenture (Recap)
We rate Accenture outperform (and our top idea). We see demand patterns progressing in Accenture's
favor, as we think strong management consulting demand (in 2010) has now progressed into improved
demand for systems integration deals (including more "transformational" initiatives), along with decent
prospects for outsourcing bookings to be strong in the February 2011 quarter. As a result, we see further
upside to the Street's revenue and EPS expectations. We also think Accenture can achieve its FY11 margin
expansion target, despite starting FY11 with Y/Y margin contraction in fiscal Q1.
Distinctive Accenture attributes against large tech stocks: Our January 12th research piece showed that
Accenture has distinctive attributes (revenue growth, ROIC) relative to other stocks that are trading at
high free cash flow yields, and we thus contend Accenture deserves a position high on investors' lists of
core tech stock holdings.
Favorable demand progression pattern: We forecast 11.6% revenue growth for ACN in FY11 (a
forecast that we think is conservative), and we contend ACN is secularly capable of 8-10% revenue
growth, and with this growth much less reliant on economic trends than is perceived (as explained in our
research on IT services cyclicality). Also, we reiterate that strong management consulting demand
(which we witnessed throughout 2010) will likely now progress in upcoming months into improved
demand for ACN's systems integration and outsourcing services. Stated differently, we anticipate a
favorable demand progression from clients' planning efforts into implementation projects and operational
support, as clients' appetites to invest have improved.
Above-consensus estimates: This favorable demand progression pattern is prone to enable Accenture to
achieve further upside to the Street's revenue expectations in FY11 (ending in August). As such, we
conservatively forecast FY11 revenue growth of 11.6%, which is 1.3% higher than consensus. And we
forecast FY11 EPS of $3.21, above consensus of $3.16 (which has nudged up recently from $3.14).
Growth resiliency: Also, while some worry about Accenture's revenue growth and bookings outlook in
light of economic uncertainties, we reiterate our view that demand improvement in the IT services
industry does NOT require substantial GDP improvement, but rather the absence of shocks to clients’
decision making — likely making leading IT services firms (e.g., Accenture, Cognizant) more resilient
than other tech firms that are more wed to GDP trends.
Margins fine: After reporting a Y/Y drop in operating margin in the November quarter, we think
Accenture will likely prove skeptics wrong by achieving its goal of 10-20 bps of margin expansion in
FY11.
Ratings across Computer Services stocks
We have outperform ratings on Sapient, Accenture, Cognizant, and ADP. We have market-perform ratings
on Visa, MasterCard, Paychex, and Infosys. And, we have an underperform rating on CSC.
Performance of Stocks Since Earthquake in Japan
Exhibit 1 shows the performance of Computer Services stocks (compared to the S&P 500 and Nasdaq)
from March 9 to March 16. Interestingly, since March 9, Accenture, Sapient, Cognizant, and Paychex
underperformed the S&P 500 by over 1%.
Especially for Accenture, Sapient, and Cognizant (the stocks we favor most due to prospects to report
fundamental upside), we see their recent pullbacks as compelling buying opportunities
Revenue Mix from Japan and Asia/Pacific
The exposure of Computer Services firms to Japan is quite low (see Exhibit 2), with a maximum revenue
exposure of 2-3% for Accenture (i.e., our estimate drawing from our Accenture FX model) and a similar
exposure of 2-3% for Visa (i.e., our estimate based on Nilson data).
Looking at exposure to the Asia/Pacific region (see Exhibit 3), though Accenture and Infosys have
meaningful exposure at 12.7% and ~10%, respectively, a significant portion of their Asia/Pacific revenue is
from Australia (rather than from Japan and surrounding areas).
Accenture: Our estimates versus consensus and guidance
Exhibit 4 conveys our Accenture estimates versus consensus and guidance.
Note: We maintain that our estimates for the February quarter and for FY11 are prone to be conservative.
February 2011 quarter
For the February 2011 quarter, we are forecasting 12.5% Y/Y revenue growth, which is higher than
consensus of 10.6%. Accenture's revenue guidance calls for $5.60 to $5.80 billion, with the high end of
this range implying +12.0% Y/Y revenue growth and the low end implying 8.2% Y/Y revenue growth.
We are forecasting February quarter EPS of $0.72, which is 1 cent higher than consensus of $0.71.
Fiscal year 2011 (ending August 2011)
We are forecasting 11.6% FY11 revenue growth, versus consensus of 10.3% (which has been upwardly
revised by 0.2 percentage points since January 12). Accenture's FY11 guidance calls for 8-11% revenue
growth (in local currency).
We are forecasting $3.21 in FY11 EPS, versus consensus of $3.16 (which has been upwardly revised by
2 cents since January 12). Accenture's FY11 EPS guidance range is $3.08-$3.16.
Fiscal year 2012 (ending August 2012)
For FY12, we are somewhat conservatively forecasting revenue growth of 7.0% (on top of our aboveconsensus
revenues for FY11) and EPS of $3.61, versus consensus of $3.53.
Our Related Research and Summary Points
Recent industry checks on Accenture and demand: Following an additional round of industry checks at
the end of Accenture's February quarter, our March 3rd research piece (IT Services: Updates on Our
Favorable Demand Progression Thesis and Stance on Accenture as Top Idea) underscored our favorable
demand progression thesis and positive stance on Accenture, as we think later-cycle systems integration
demand is kicking into gear. We see strong signs of demand momentum and believe Accenture has
moved into the "sweet spot" of its demand cycle, with clients now showing a propensity to invest in more
transformational systems integration deals (reflecting an important progression beyond the fast-payback
deals that were predominant earlier in the demand recovery cycle). And, barring a macro-shock to
clients' decision making, we see multiple reasons to expect that this strong phase for Accenture-type
systems integration demand should last multiple quarters. Other pertinent points from our March 3rd
piece:
"Short-listed" services firms should get disproportionate revenue lift: As the demand recovery
progresses, top services firms that have effectively gained share within the budgets of existing clients
(i.e., as clients have consolidated their suppliers over the past couple of years) should be boosted to
elevated revenues from core clients. In other words, during the financial crisis, we think top firms like
Accenture and Cognizant garnered a higher percentage of spending at a number of large, existing
clients (i.e., at the expense of lower-tier firms). So, as these existing clients add to their spending,
Accenture and Cognizant should naturally derive disproportionate growth.
BPO signings should be poised to show some improvement: We reiterate that Accenture's momentum
(over the last year) in the management/operational consulting arena has very likely positioned the
company to win certain types of outsourcing deals (e.g., industry-specific BPO deals). As a result,
Accenture's outsourcing business should achieve improved bookings in the February quarter.
Cloud demand has further progressed, but not key to next-12-months growth in the consulting /
systems integration market. Cloud-related spending to date has largely focused on data center
initiatives (e.g., virtualization) and relatively small "discovery" projects to help clients evaluate/plan
for the cloud era. We now see more evidence of software-related cloud initiatives (e.g., clients
engaging consultants to help in piloting cloud software usage). But, we still think it's premature in the
near term to expect major spending on cloud software deployment and integration initiatives.
HP's weakness should not be an issue: We think concerns in late February about Accenture, Cognizant,
Infosys, and Sapient stemming from HP's weak results were overblown. We think systems integration
demand is thriving; and we see no reason to alter our "favorable demand progression" thesis. And, we
think weakness in HP's services business is attributable to HP having a very different business mix and
company-specific issues, as we explained in our February 23rd research piece (Quick Take - Weakness at
HP Should Not Have Negative Implications for Accenture, Cognizant, Infosys, Sapient).
Favorable demand progression; ACN as top idea: Our evaluation of Accenture against other tech
stocks suggests its distinctive attributes may be underappreciated, and our January 12th research piece
(Accenture, Cognizant, Infosys: Seeing Bullish Demand Progression; ACN Top Idea; Raising ACN,
INFY, CTSH Targets) featured Accenture as our top idea. Moreover, in this research piece, we
explained our "favorable demand progression" thesis.
Leading indicators: As detailed in our November 12th research piece ("IT Services: Rebound Happened;
Cisco Brings Concerns; What Now? Still See Encouraging Leading Indicators for ACN, CTSH), we see
solid reasons to believe the leading indicators of discretionary services spending trends are still showing
generally positive signs; these reasons stem from our checks with key contacts in the consulting market
and our analysis of consulting bookings results, temp labor data, and staffing firms' growth trends.
Cloud Computing: While some are concerned that cloud computing could hurt demand for systems
integration services, we reiterate our research conclusion that cloud computing should be a net
opportunity for Accenture. For details, here's the link to our 4/7/2010 research piece on this topic:
Accenture: What Impact Will Cloud Computing Have on ACN's Demand & Business Model? Views,
Info Ahead of Analyst Day.
Valuation Methodology
Our target prices for IT services stocks are derived by applying multiples to our forward estimates of
earnings and cash flows. Our target multiples are determined based on our assessments of historical priceto-
forward-earnings multiples, after considering each company’s growth prospects relative to historical
levels. Our target multiples are also influenced by the results of our DCF analyses across various financial
scenarios for each company.
More specifically, for IT services and offshore services firms, our target share prices are derived by
applying the following P/E multiples to our calendar 2012 EPS estimates: Accenture 15.3x, Sapient 22.4x,
CSC 6.4x, Infosys 20.2x, and Cognizant 24.0x.
For processing companies, our target share prices are derived by applying the following P/E multiples to
our calendar 2011 EPS estimates: MA 13.5x, Visa 15.3x, ADP 20.1x, and PAYX 20.3x.
As an alternative method of calculating our latest $14.75 target share price on Sapient, we apply a target
P/E multiple of 18.4x to our 2012 EPS estimate with a 28% normalized tax rate assumed (i.e., EPS of 71
cents), while also giving Sapient valuation credit for its $1.67 of cash per share. This target multiple is
supported by Sapient's takeover prospects, substantial room for margin expansion, and long-term growth
prospects in attractive segments like multi-channel commerce, Internet advertising, and trading/risk
management.
As alternative method of calculating our target share price on CSC, we apply an EDS-takeover multiple
(i.e., FCF multiple of 12.05x) to our estimate of CSC's "normalized" free cash flow (i.e., FY10 FCF
excluding the impact of lower DSO).
Also, note that, in addition to prospects for stock appreciation, Paychex, ADP, CSC, and Accenture offer
meaningful dividend yields.
Risks
The primary risk to consulting names (Accenture and Sapient) achieving our target share prices is the
potential for pressures on discretionary services spending. In addition, negative economic news flow can
weigh on the sentiment (and valuation multiples) of consulting stocks, and Accenture's stock has a tendency
to be pressured by appreciation of the US dollar (due to Accenture's substantial international exposure).
The primary risks to IT outsourcing companies’ (e.g., CSC, HP/EDS, Perot) fundamentals include contract
restructurings/terminations (a significant risk for CSC) and the shift of IT outsourcing work to offshore
labor centers (a threat to CSC). Further, our research shows the emergence of the offshore/remote
infrastructure outsourcing business, which will enable Indian firms to move into the core market segment of
CSC, and this trend will add pressure to CSC. It is prone to cause some cannibalization of CSC’s existing
infrastructure outsourcing revenues and some share loss to Indian and niche players moving aggressively
into the offshore/remote infrastructure outsourcing business. We also maintain a concern about CSC’s high
balance-sheet accruals. The risk to our underperform rating on CSC is that restructuring efforts and new
strategies could drive EPS improvement and share price appreciation.
Risks facing our target prices on Indian IT services stocks (e.g., Infosys and Cognizant): We still maintain
longer-term concerns about rupee appreciation (see our 10/22/07 research call for an analysis of factors that
could affect future moves in the Indian rupee), margin contraction (due partly to increasing needs,
especially for Infosys, to invest in onshore capabilities and industry-specific solutions), tax rate
normalization (i.e., tax rates for top Indian firms should jump to north of 20% when the STPI tax haven in
India expires), and meaningful hurdles related to supply and competition.
An underlying risk to achieving our target prices on Paychex and ADP is cross-selling leverage failing to
materialize, causing expectations of long-term earnings growth to be revised. In addition, weak U.S.
employment growth can hurt the stocks' valuations, present a challenge to their margins, and incrementally
pressure their revenue growth. Downward pressures on interest rates can mar sentiment and reduce ADP’s
investment income from both client funds (float) and corporate investments (note that the yield on
Paychex's float portfolio does not have material room for downside).
A number of risks could prevent our target prices on MA and V from being realized, including:
We see a number of potential competitive threats, which could transpire over the long term, e.g.,
encroachment from mobile payments and alternative payment providers (e.g., PayPal), growth of
competitive international networks (e.g., China Union Pay), and some possibility of banks moving into
the card network business.
Regulatory change (e.g., related to interchange) is an ongoing risk, and substantial litigation is pending
against MA and V, with MA more exposed to possible future litigation liabilities since V has an escrow
fund and bank shareholder stock buffering its earnings exposure.
Weakness in consumer spending and any hiccups in the revolving credit market can hurt volume and
transactions growth.
MA and V can lose revenues if a card issuing bank converts to different a debit card brand, or shifts
issuance of credit cards from one brand to another. They can also lose revenues if merchants succeed in
shifting more debit volume from signature debit to PIN debit.
Obstacles to cross-border travel activity can hurt the cross-border revenues earned by MA and V.
Besides being affected by general spending activity, MA's and V's growth rates are materially affected by
moves in gas prices in the United States. For MA and V, gas purchases account for about 6% and 10%,
respectively, of U.S. payment volume (and likely account for higher percentages of U.S. transactions.
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