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Global: Technology: IT Services-Consulting &
Outsourcing
Equity Research
Enterprise IT spending firmly intact; consultants benefit directly
Late cycle Services spending beginning to hit its stride
Following recent questions about the strength of enterprise IT spending,
and weak results from HP Services we have reconfirmed the building
blocks underlying our positive view on enterprise IT spending. Specifically,
our checks suggest the following: (1) IT spending intentions for 2011
remain firmly intact, with budget cycles shifting from maintenance spend
to growth initiatives which provides support for downstream services
spending. (2) Our global checks suggest healthy levels of contract signings
and active pipelines. (3) Increased spending intentions on systems
integration shows enterprises making the natural shift to services required
to tie together hardware and software platforms. (4) The secular shift to
global delivery continues with offshore companies poised for solid midteens
or higher revenue growth. Against this backdrop, we believe that the
evidence supporting our late-cycle view on Services spend remains intact,
with the consulting models hitting their stride on the back of enterprise IT
spend. Finally, the results from our latest IT Spending survey reinforces
strong spending intentions with both our total IT Spending Index and our
Tech Capital Spending Index back to recent highs.
Momentum in contract signings and pipeline activity remains
strong; European IT shows some pep; HP looks like an anomaly
We believe the strong consulting bookings and pipeline from Accenture
and an accelerating short-term signings trend for IBM are indicative of a
positive backdrop for discretionary spending. In addition, results and
comments from Capgemini and Atos Origin suggest a cyclical recovery in
Europe is underway. As for offshore, 4Q results from top vendors including
Cognizant Technology, Infosys and TCS reinforce our view that the secular
share shift in IT spend toward offshore delivery remains intact, and is not
just cyclical in nature. Conversely, HP’s weak Services results stand out as
an anomaly with recent cost initiatives, following the acquisition of EDS, a
key culprit in eroding HP’s competitive position in Services.
High corporate profits and new technology initiatives support our
positive view on enterprise IT spending; bullish on consultants
Our investment thesis remains unchanged. The confluence of positive
corporate profits, new technology investments in enterprise technologies
including cloud, mobility, interactive technologies, and social are expected
to drive sustained spending most directly benefitting our consulting
models including ACN (Buy), CTSH (CL-Buy), and SAPE (CL-Buy).
Late cycle Services spending beginning to hit its stride
Following recent questions about the strength of enterprise IT spending, and weak
results from HP Services we have reconfirmed the building blocks underlying our
positive view on enterprise IT spending. Specifically, our checks suggest the
following:
1. IT spending intentions for 2011 remain firmly intact, with budget cycles shifting from
maintenance spend to growth initiatives which provides support for downstream
services spending.
2. Our global checks suggest healthy levels of contract signings and active pipelines.
3. Increased spending intentions on systems integration shows enterprises making the
natural shift to services required to tie together hardware and software platforms.
4. The secular shift to global delivery continues with offshore companies poised for solid
mid-teens or higher revenue growth.
Against this backdrop, we believe that the evidence supporting our late-cycle view of
Services spend remains intact, with the consulting models hitting their stride on the back of
enterprise IT spend. Finally, the results from our latest IT spending survey reinforces strong
spending intentions with both our total IT spending index and our tech capital spending
index back to recent highs.
Momentum in contract signings and pipeline activity remains
strong; European IT shows some pep; HP looks like an anomaly
We believe the strong consulting bookings and pipeline from Accenture and an
accelerating short-term signings trend for IBM are indicative of a positive backdrop for
discretionary spending. In addition, results and comments from Capgemini and Atos Origin
suggest a cyclical recovery in Europe is underway. As for offshore, 4Q results from top
vendors including Cognizant Technology, Infosys and TCS reinforce our view that the
secular share shift in IT spend toward offshore delivery remains intact, and is not just
cyclical in nature. Conversely, HP’s weak Services results stand out as an anomaly with
recent cost initiatives, following the acquisition of EDS, as a key culprit in eroding HP’s
competitive position in Services.
Our latest IT survey reinforces strong spending intentions
Taken in mid-February, our latest IT spending indices continued to climb higher. Our total
IT Spending Index increased to the highest level since December 2006, while our Tech
Capital Spending Index reached its highest level since early 2007.
We maintain our 2011 IT spending growth forecast at 6%, as we remain mindful that 2011
spending growth faces tougher comparisons, hardware cycles are likely to ease, and
government austerity measures are also likely to dampen growth. However, we expect
continued strong momentum in enterprise IT spending driven by secular shifts such as
virtualization, cloud computing, and mobility to help offset these headwinds and keep
overall spending growth at roughly the historical norm.
In our view, the latest GS IT Spending Survey data are consistent with recently reported
results from the industry and key takeaways from our Technology and Internet conference,
all of which keep us highly confident that IT spending in 2011 is intact. We note the
following key IT Services takeaways from the latest survey:
• Positive trend in discretionary spend bodes well for consulting. Spending
intentions for 2011 remain firmly intact, with budget cycles running their course
and shifting from maintenance spend to growth initiatives and providing support
for downstream services spending. We see this most directly benefits
discretionary spending on IT consulting, systems integration, and application
development.
• Priority areas for spending consistent with industry developments. The uptick
in spending intentions on systems integration reflected in our latest survey shows
enterprises making the natural shift to integrate disparate systems following
recent spending around hardware and software.
• MNCs remains top of mind for CIOs, offshore gaining momentum. While
MNCs continue to dominate front-end mindshare followed by accounting
consultancies, the secular shift to offshore continues to run its course with
offshore companies gaining increased mindshare among corporate CIOs.
Key themes supporting our positive view on enterprise IT spend
We expect new technology spending initiatives, driven by both cyclical and secular
factors to drive sustained growth in IT spending in 2011. On a global basis we are
most bullish on select consulting and offshore models that are most directly exposed
to intact enterprise spending as new tech efforts take hold. The key themes
anchoring our investment view include:
Theme 1 – Cloud initiatives benefit consultants, but are a long-term risk to
traditional IT outsourcing models. We believe that a confluence of more nascent
technological forces will spur incremental enterprise demand and investments
required for downstream services spending as we move into 2011. Specifically, we
highlight technology trends on both the infrastructure and application sides such as
new data center architecture, virtualization, cloud computing, SaaS-based application
delivery, and mobile deployment as the most relevant near-term drivers for our
consulting models. That said we remain mindful that longer term some of the
cloud/utility based models and outsourcing breed could present a potential
deflationary risk to the traditional IT outsourcing models.
Theme 2 – Offshore secular prospects remain intact. Although new technology
investments remain paramount, they are also being balanced by a continued focus on
operating cost efficiency, resulting in sustained demand for offshore services and
global delivery of IT services. On a relative basis the offshore segment remains one of
the fastest growth segments across IT services, with our expectation of a long-term
industry growth rate pegged at 15%-20% over the next three years. Offshore’s
prospects are also bolstered by the evolution of the model to its latest iteration, with
cloud concepts, further global diversification, additional development of front-end skill
sets, and the pursuit of non-linear growth initiatives helping drive the growth
opportunities for this segment.
Theme 3 – Wireless and connected devices lead the charge into the enterprise.
Within the telecom IT sub-sector we find significant secular pockets of growth
anchored on the explosion of connected devices and mobile data, where high growth
and scarcity of investable options offer the potential for outsized returns. Against this
backdrop, we believe that the highest investment returns are currently offered by
developments in wireless and the growth of connected devices, and models that have
a high degree of automation to drive above-average operating leverage.
Theme 4 – Shift to digital marketing could augment IT services spending growth.
The collapse of the traditional line between the CIO and CMO and the ongoing changes
in consumer behavior, driven by the proliferation of mobile, social, and interactive
technologies, underpins a strong secular shift behind the twin waves of spend on
interactive marketing and digital technologies. We expect the shift to digital marketing
to fuel a significant consumer-driven growth opportunity for IT services companies as
enterprises advance their marketing efforts to newer, quicker, personalized and more
effective digital channels.
Recent industry trends confirm strong consulting momentum
Accenture and IBM results indicate robust Consulting momentum
Accenture registered near-record Consulting bookings and higher pipeline
Total bookings in the November quarter finished at $6.3 bn driven by strength in
Consulting bookings, which at $3.7 bn was the highest level in 10 quarters. On a TTM
basis, total bookings growth further accelerated to 7% yoy (in constant currency), up
from 2% in the August quarter.
Systems integration (SI) bookings were the highest in nine quarters and showing
increasing strength.
Accenture’s qualified pipeline for Consulting was up 25% yoy, and the company saw a
13% yoy increase in its backlog for the remaining nine months in FY11.
Accenture raised its FY11 constant currency revenue growth to 8-11% yoy (+7-10%
prior).
IBM Services’ bookings and backlog help support the company’s 2011 outlook
IBM’s 4Q10 Services signings finished at $22.1 bn and increased 18% yoy in constant
currency vs. a 6% yoy decline in 3Q10, with the strength driven by improvements in
both outsourcing (i.e. long-term) and transactional (i.e. short-term) signings.
Importantly, we view the sustained momentum in transaction signings as indicative of
solid consulting demand. For perspective, transactional signings grew 9% yoy in
constant currency, 5 pp above the 4% yoy increase in 3Q, and representing the third
consecutive quarter of improving yoy trend.
Total Services backlog of $142 bn was up 3% yoy in constant currency and improved
from flat yoy in 3Q.
Looking ahead, IBM expects continued modest improvement in Services revenue
growth throughout 2011.
Capgemini and Atos suggest European demand recovery underway
Capgemini reported better than expected 2H10 results and outlook
The company recently reported solid 2H10 results with revenues ahead of expectations
and in-line operating margins. Into 2011, Capgemini expects its revenue growth to
benefit from macro recovery, demand in high growth segments and emerging markets,
pricing increases and improved utilization.
Management guided to 2011 revenue growth of 9%-10% yoy (4%-5% organic), which
was ahead of consensus expectations. The GS European IT Services team raised its
2011-13 revenue estimates by 3%-4% following the report.
The company expects net headcount additions of 11,000 in 2011 with an
onshore/offshore mix of 4,000/7,000, signifying strong demand pick up in developed
markets.
By vertical, the key verticals delivering growth include financials, manufacturing and
retails, while public sector spending in the UK is expected to remain weak in the near
term. By geography, positive demand was noted in the US, France and Benelux.
Atos Origin’s strong bookings signify a cyclical upturn
The company reported a strong book/bill ratio of 125% in 4Q10, signifying an upturn in
the cyclical part of its business driven by improving macro conditions and strong
licenses growth of major European software vendors.
By geography, good demand momentum was noted in France and Benelux. France
continued to be stable while Benelux improved significantly and was down nominally
(-0.6% yoy) vs. 11% yoy decline in 1H.
Offshore’s secular ascent continues; focus on CTSH (CL-Buy)
One of the key themes anchoring our positive view of consulting is offshore’s
continued secular ascent. Consistent with this view we remain very bullish on large
cap growth engine CTSH (CL-Buy), which we expect to post 32% revenue growth in
2011 and 27% in 2012. Its growth profile is supported by strong front-end, strategic
account penetration, and financial services vertical concentration (43% of revenues).
CTSH recently presented at the GS Tech and Internet conference, and the
takeaways reinforce our positive view: (1) The secular share shift in IT spend toward
offshore delivery is on track and a multi-year trend is expected to power growth; the
growth prospects for CTSH are not just cyclical in nature. (2) Against this backdrop
CTSH reiterated its confidence in achieving its 2011 revenue growth target of 26% plus.
(3) Management noted that 2011 IT budget cycles are stable with better visibility vs. the
last two years. (4) Supply-side dynamics, including wages and employee attribution,
appear to be more stable compared to 2010 due to better supply/demand balance.
Positive results from top offshore peers also confirm a solid backdrop. Despite 4Q
being a seasonally weak quarter (due to fewer billing days), both Infosys (INFY.BO) and
TCS (TCS.BO) reported strong revenue performance with average revenue growth of
30% yoy (+7% qoq). Importantly, strong revenue results were driven by a combination
of positive volume growth and pricing improvements. Indications from both INFY and
TCS suggest modest 2011 budget growth, but a continued mix shift to offshore
resources supports strong pipeline activity.
HP Services weakness appears company specific
Against, a relatively positive backdrop, HP’s Services revenue surprisingly fell short of
expectations, with the weakness attributed to lower than expected short-term signings
and project-based revenues.
The weakness and management’s commentary stand out as a bit of an anomaly, which
is in stark contrast to recently reported results and the outlook from both its multinational
and offshore peers, including Accenture, IBM, Capgemini, Cognizant
Technology Solutions, Infosys, and TCS, all of whom have noted continued strength in
project-based work/short-term signings given a healthy demand backdrop and normal
budget cycles.
We view the weakness in HP Services revenue as company specific and a reflection of
the company’s reliance on cost cutting following the acquisition of EDS, in which HP
embarked on aggressive cost reduction efforts, which ultimately appears to have
eroded HP’s competitive position in Services.
We believe the shortfall in HP’s application services revenues also suggests continued
price deflation, and potential market-share loss given a less established and integrated
global delivery platform vs. some of the company’s peers who continue to enjoy
double-digit revenue growth.
Latest IT Spending Survey confirms a positive demand backdrop
Positive trend in discretionary spend bodes well for consulting
The survey results demonstrate a further uptick in respondents indicating increased
budgets for discretionary spending in the next six months.
This is consistent with our view that IT spending growth is being driven by corporate
profitability, which supports new discretionary spending, cloud build-out efforts and new
architecture initiatives, and offshore’s secular rise as cost efficiency remains in focus.
The percentage of respondents indicating that budgets for discretionary IT spending will
trend up in the next six months came in at 37%, up from 27% in the October 2010 survey
and above the average result of 23% over the previous ten surveys. In our view the survey
results and latest reported results from all major IT Service companies including Accenture,
Cognizant Technology Solutions, IBM Services, Infosys, TCS and others confirms a positive
demand backdrop for short-term signings and new pipeline activity; which in our view
ultimately make HP Services recent commentary and results stand out as a bit of an
anomaly and a reflection of a business that likely embarked on too much cost cutting and
not enough investment in growth.
The percentage of the survey respondents indicating that budgets will trend flat to up came
in at 80%, same as last survey, representing the highest level in the survey history. At the
same time, the percentage of respondents indicating that budgets for discretionary IT
spending will trend down in the next six months continues to suggest a benign
environment, coming in at 16%, slightly lower than October 2010 survey and at the lowest
level since August 2007.
In our view, the survey data reflects increasing confidence in a normal budget cycle in 2011
vs. a more wait-and-see mentality that we saw in most of 2010. This is consistent with
recently reported results from the industry and key takeaways from our Technology and
Internet conference, both of which keep us confident that IT spending in 2011 is intact, with
budgets expected to grow in the low-to-mid single digits.
Priority areas for spending consistent with industry developments
Consistent with industry developments, infrastructure (data center consolidation and
cloud initiatives), applications development (front-end applications and SaaS
deployments), and systems integration (ERP and other core applications) remain top
priority areas for CIOs over the next six months. In the past we have highlighted trends on
both the infrastructure and application sides such as data center and desktop virtualization,
cloud computing, and SaaS-based application delivery as the most relevant secular
demand drivers. As for industry-specific developments, we see various upgrade and
product cycles including smartphones, tablets and mobile deployment as having the
potential to drive further IT spending.
The findings in the survey were generally consistent with the previous survey results that
pointed to a similar stack-up of service lines poised to see increased spending in the next
six months (Exhibit 8). Specifically, infrastructure, application development, and systems
integration remain as the top spending priority areas with 52%, 51%, and 34% of
respondents, respectively. Perhaps most notable is the acceleration that we are seeing as
clients shift their spending from infrastructure initiatives to application development and
systems integration initiatives (these two items showed the most notable improvements
compared to our previous survey, with application development at a record level since we
started tracking this data). Note that a survey respondent may submit a response for one or
more service types for this particular question.
By service type, infrastructure was the top spending priority in the latest survey and was
cited by 52% of the respondents, down from 63% in the October 2010 survey. Indication of
increased spending for applications development represented 51% of the respondents, up
from 46% in the October survey. Percentage of respondents citing systems integration as a
top spending priority came in at 34% vs. 25% in October, the first positive sequential move
in the last five quarters. Interest for application maintenance also increased to 14% of
respondents versus 11% in the October survey.
Finally, 11% of the survey respondents cited business process outsourcing (BPO) as a top
priority spending area, up from 9% in the October survey and marking the third
consecutive quarter of increased interest. That said, BPO remains at the bottom of the list
in terms of spending priorities, which could be due to low CIO appetite for investing in
projects with a longer transition or payback period in the current environment, in our view.
Services spend responses indicative of a positive backdrop
This survey marks the first time we asked corporate CIOs where they expect to see
increased dollars from their overall IT services spend over the next six months –
domestic third-party service providers, in-house IT resources, or offshore service
providers. Note that a survey respondent can submit a response for one or more countries
for this particular question.
Overall, the first round of results appears to suggest that domestic third-party service
providers and in-house IT resources are likely to see increased services spend, having
garnered 56% and 53% of the survey responses, respectively. These compare with the 18%
of responses garnered by offshore service providers.
Although one data point does not make a trend and we will continue to monitor the
levels of responses in future surveys, we believe the result is indicative of a positive
enterprise IT spending backdrop, with all three categories of service providers
garnering more than 10% of responses for increased spend over the next six months.
In addition, we view the relatively lower percentage of responses garnered by offshore
service providers as a function of lower overall penetration of client spend for services (we
estimate at 15%-20% on average), not necessarily an indication of lower appetite for
offshore services, which would be inconsistent with recently reported industry results and
takeaways from the GS Tech and Internet conference.
MNCs remain top of mind for CIOs, offshore gaining momentum
In terms of consistent demonstration of industry knowledge, the latest results remain
consistent with the previous surveys—MNCs dominate front-end mindshare,
followed by accounting consultancies, which continue to garner more responses as
compared to the offshore tier-1 and BPO players. Note that a survey respondent may
submit a response for one or more companies for this particular question.
MNCs continue to maintain their top position, with 60% of the respondents citing these
companies, but down from 84% in the October survey. Accounting consultancies also
showed well and were cited by 39% of the respondents, versus 37% in the October survey.
Offshore tier-1 companies registered 30% of the respondent votes in the latest survey,
versus 24% in October, representing the third consecutive quarter of sequential uptick. The
positive momentum for the offshore tier-1 companies is consistent with recently reported
results, and it supports our view that the secular demand in offshore services remains
intact, with the tier-1 offshore companies increasingly focused on developing more robust
front-end skills including domain and industry expertise.
Among the MNCs, IBM Services continued to claim the top spot with 32% of the
respondents, followed by Accenture and HP Services among the publicly traded companies.
Among the accounting consultancies, with 16% of the respondents Deloitte continues to
garner the strongest results (trailing only IBM Services among all providers), while PwC
and KPMG also rated well with 13% and 10% of the respondents, respectively.
Among the offshore tier-1 companies, Wipro garnered the highest results at 10% of the
respondents (versus 5% in the October survey). Infosys garnered 8% of the respondents,
versus 7% from the October survey. TCS was cited by 7% of respondents, versus 6% in the
October survey. Patni and HCL Tech each had 2% of the responses, while Cognizant was
cited by 1% of the respondents. With Cognizant’s revenue growth still far outpacing the
majority of its offshore peers, we believe the low level of survey responses is likely a
function of the industry makeup of our CIO respondents being more diversified vs. the
company’s concentrated model focusing on the financial services and healthcare verticals
(together making up 68% of its total revenue).
Finally, offshore BPO companies continued to show the lowest percentage of responses
(none this survey). We suspect that the low result of offshore BPO companies could be
partly due to the make-up of our survey respondent panel, which consists of mostly
corporate CIOs that typically do not make direct spending decisions in BPO. Nevertheless,
it does at least confirm that the mindshare process for offshore BPO companies remains a
work in progress in order to have more extensive appeal and impact to client models.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Global: Technology: IT Services-Consulting &
Outsourcing
Equity Research
Enterprise IT spending firmly intact; consultants benefit directly
Late cycle Services spending beginning to hit its stride
Following recent questions about the strength of enterprise IT spending,
and weak results from HP Services we have reconfirmed the building
blocks underlying our positive view on enterprise IT spending. Specifically,
our checks suggest the following: (1) IT spending intentions for 2011
remain firmly intact, with budget cycles shifting from maintenance spend
to growth initiatives which provides support for downstream services
spending. (2) Our global checks suggest healthy levels of contract signings
and active pipelines. (3) Increased spending intentions on systems
integration shows enterprises making the natural shift to services required
to tie together hardware and software platforms. (4) The secular shift to
global delivery continues with offshore companies poised for solid midteens
or higher revenue growth. Against this backdrop, we believe that the
evidence supporting our late-cycle view on Services spend remains intact,
with the consulting models hitting their stride on the back of enterprise IT
spend. Finally, the results from our latest IT Spending survey reinforces
strong spending intentions with both our total IT Spending Index and our
Tech Capital Spending Index back to recent highs.
Momentum in contract signings and pipeline activity remains
strong; European IT shows some pep; HP looks like an anomaly
We believe the strong consulting bookings and pipeline from Accenture
and an accelerating short-term signings trend for IBM are indicative of a
positive backdrop for discretionary spending. In addition, results and
comments from Capgemini and Atos Origin suggest a cyclical recovery in
Europe is underway. As for offshore, 4Q results from top vendors including
Cognizant Technology, Infosys and TCS reinforce our view that the secular
share shift in IT spend toward offshore delivery remains intact, and is not
just cyclical in nature. Conversely, HP’s weak Services results stand out as
an anomaly with recent cost initiatives, following the acquisition of EDS, a
key culprit in eroding HP’s competitive position in Services.
High corporate profits and new technology initiatives support our
positive view on enterprise IT spending; bullish on consultants
Our investment thesis remains unchanged. The confluence of positive
corporate profits, new technology investments in enterprise technologies
including cloud, mobility, interactive technologies, and social are expected
to drive sustained spending most directly benefitting our consulting
models including ACN (Buy), CTSH (CL-Buy), and SAPE (CL-Buy).
Late cycle Services spending beginning to hit its stride
Following recent questions about the strength of enterprise IT spending, and weak
results from HP Services we have reconfirmed the building blocks underlying our
positive view on enterprise IT spending. Specifically, our checks suggest the
following:
1. IT spending intentions for 2011 remain firmly intact, with budget cycles shifting from
maintenance spend to growth initiatives which provides support for downstream
services spending.
2. Our global checks suggest healthy levels of contract signings and active pipelines.
3. Increased spending intentions on systems integration shows enterprises making the
natural shift to services required to tie together hardware and software platforms.
4. The secular shift to global delivery continues with offshore companies poised for solid
mid-teens or higher revenue growth.
Against this backdrop, we believe that the evidence supporting our late-cycle view of
Services spend remains intact, with the consulting models hitting their stride on the back of
enterprise IT spend. Finally, the results from our latest IT spending survey reinforces strong
spending intentions with both our total IT spending index and our tech capital spending
index back to recent highs.
Momentum in contract signings and pipeline activity remains
strong; European IT shows some pep; HP looks like an anomaly
We believe the strong consulting bookings and pipeline from Accenture and an
accelerating short-term signings trend for IBM are indicative of a positive backdrop for
discretionary spending. In addition, results and comments from Capgemini and Atos Origin
suggest a cyclical recovery in Europe is underway. As for offshore, 4Q results from top
vendors including Cognizant Technology, Infosys and TCS reinforce our view that the
secular share shift in IT spend toward offshore delivery remains intact, and is not just
cyclical in nature. Conversely, HP’s weak Services results stand out as an anomaly with
recent cost initiatives, following the acquisition of EDS, as a key culprit in eroding HP’s
competitive position in Services.
Our latest IT survey reinforces strong spending intentions
Taken in mid-February, our latest IT spending indices continued to climb higher. Our total
IT Spending Index increased to the highest level since December 2006, while our Tech
Capital Spending Index reached its highest level since early 2007.
We maintain our 2011 IT spending growth forecast at 6%, as we remain mindful that 2011
spending growth faces tougher comparisons, hardware cycles are likely to ease, and
government austerity measures are also likely to dampen growth. However, we expect
continued strong momentum in enterprise IT spending driven by secular shifts such as
virtualization, cloud computing, and mobility to help offset these headwinds and keep
overall spending growth at roughly the historical norm.
In our view, the latest GS IT Spending Survey data are consistent with recently reported
results from the industry and key takeaways from our Technology and Internet conference,
all of which keep us highly confident that IT spending in 2011 is intact. We note the
following key IT Services takeaways from the latest survey:
• Positive trend in discretionary spend bodes well for consulting. Spending
intentions for 2011 remain firmly intact, with budget cycles running their course
and shifting from maintenance spend to growth initiatives and providing support
for downstream services spending. We see this most directly benefits
discretionary spending on IT consulting, systems integration, and application
development.
• Priority areas for spending consistent with industry developments. The uptick
in spending intentions on systems integration reflected in our latest survey shows
enterprises making the natural shift to integrate disparate systems following
recent spending around hardware and software.
• MNCs remains top of mind for CIOs, offshore gaining momentum. While
MNCs continue to dominate front-end mindshare followed by accounting
consultancies, the secular shift to offshore continues to run its course with
offshore companies gaining increased mindshare among corporate CIOs.
Key themes supporting our positive view on enterprise IT spend
We expect new technology spending initiatives, driven by both cyclical and secular
factors to drive sustained growth in IT spending in 2011. On a global basis we are
most bullish on select consulting and offshore models that are most directly exposed
to intact enterprise spending as new tech efforts take hold. The key themes
anchoring our investment view include:
Theme 1 – Cloud initiatives benefit consultants, but are a long-term risk to
traditional IT outsourcing models. We believe that a confluence of more nascent
technological forces will spur incremental enterprise demand and investments
required for downstream services spending as we move into 2011. Specifically, we
highlight technology trends on both the infrastructure and application sides such as
new data center architecture, virtualization, cloud computing, SaaS-based application
delivery, and mobile deployment as the most relevant near-term drivers for our
consulting models. That said we remain mindful that longer term some of the
cloud/utility based models and outsourcing breed could present a potential
deflationary risk to the traditional IT outsourcing models.
Theme 2 – Offshore secular prospects remain intact. Although new technology
investments remain paramount, they are also being balanced by a continued focus on
operating cost efficiency, resulting in sustained demand for offshore services and
global delivery of IT services. On a relative basis the offshore segment remains one of
the fastest growth segments across IT services, with our expectation of a long-term
industry growth rate pegged at 15%-20% over the next three years. Offshore’s
prospects are also bolstered by the evolution of the model to its latest iteration, with
cloud concepts, further global diversification, additional development of front-end skill
sets, and the pursuit of non-linear growth initiatives helping drive the growth
opportunities for this segment.
Theme 3 – Wireless and connected devices lead the charge into the enterprise.
Within the telecom IT sub-sector we find significant secular pockets of growth
anchored on the explosion of connected devices and mobile data, where high growth
and scarcity of investable options offer the potential for outsized returns. Against this
backdrop, we believe that the highest investment returns are currently offered by
developments in wireless and the growth of connected devices, and models that have
a high degree of automation to drive above-average operating leverage.
Theme 4 – Shift to digital marketing could augment IT services spending growth.
The collapse of the traditional line between the CIO and CMO and the ongoing changes
in consumer behavior, driven by the proliferation of mobile, social, and interactive
technologies, underpins a strong secular shift behind the twin waves of spend on
interactive marketing and digital technologies. We expect the shift to digital marketing
to fuel a significant consumer-driven growth opportunity for IT services companies as
enterprises advance their marketing efforts to newer, quicker, personalized and more
effective digital channels.
Recent industry trends confirm strong consulting momentum
Accenture and IBM results indicate robust Consulting momentum
Accenture registered near-record Consulting bookings and higher pipeline
Total bookings in the November quarter finished at $6.3 bn driven by strength in
Consulting bookings, which at $3.7 bn was the highest level in 10 quarters. On a TTM
basis, total bookings growth further accelerated to 7% yoy (in constant currency), up
from 2% in the August quarter.
Systems integration (SI) bookings were the highest in nine quarters and showing
increasing strength.
Accenture’s qualified pipeline for Consulting was up 25% yoy, and the company saw a
13% yoy increase in its backlog for the remaining nine months in FY11.
Accenture raised its FY11 constant currency revenue growth to 8-11% yoy (+7-10%
prior).
IBM Services’ bookings and backlog help support the company’s 2011 outlook
IBM’s 4Q10 Services signings finished at $22.1 bn and increased 18% yoy in constant
currency vs. a 6% yoy decline in 3Q10, with the strength driven by improvements in
both outsourcing (i.e. long-term) and transactional (i.e. short-term) signings.
Importantly, we view the sustained momentum in transaction signings as indicative of
solid consulting demand. For perspective, transactional signings grew 9% yoy in
constant currency, 5 pp above the 4% yoy increase in 3Q, and representing the third
consecutive quarter of improving yoy trend.
Total Services backlog of $142 bn was up 3% yoy in constant currency and improved
from flat yoy in 3Q.
Looking ahead, IBM expects continued modest improvement in Services revenue
growth throughout 2011.
Capgemini and Atos suggest European demand recovery underway
Capgemini reported better than expected 2H10 results and outlook
The company recently reported solid 2H10 results with revenues ahead of expectations
and in-line operating margins. Into 2011, Capgemini expects its revenue growth to
benefit from macro recovery, demand in high growth segments and emerging markets,
pricing increases and improved utilization.
Management guided to 2011 revenue growth of 9%-10% yoy (4%-5% organic), which
was ahead of consensus expectations. The GS European IT Services team raised its
2011-13 revenue estimates by 3%-4% following the report.
The company expects net headcount additions of 11,000 in 2011 with an
onshore/offshore mix of 4,000/7,000, signifying strong demand pick up in developed
markets.
By vertical, the key verticals delivering growth include financials, manufacturing and
retails, while public sector spending in the UK is expected to remain weak in the near
term. By geography, positive demand was noted in the US, France and Benelux.
Atos Origin’s strong bookings signify a cyclical upturn
The company reported a strong book/bill ratio of 125% in 4Q10, signifying an upturn in
the cyclical part of its business driven by improving macro conditions and strong
licenses growth of major European software vendors.
By geography, good demand momentum was noted in France and Benelux. France
continued to be stable while Benelux improved significantly and was down nominally
(-0.6% yoy) vs. 11% yoy decline in 1H.
Offshore’s secular ascent continues; focus on CTSH (CL-Buy)
One of the key themes anchoring our positive view of consulting is offshore’s
continued secular ascent. Consistent with this view we remain very bullish on large
cap growth engine CTSH (CL-Buy), which we expect to post 32% revenue growth in
2011 and 27% in 2012. Its growth profile is supported by strong front-end, strategic
account penetration, and financial services vertical concentration (43% of revenues).
CTSH recently presented at the GS Tech and Internet conference, and the
takeaways reinforce our positive view: (1) The secular share shift in IT spend toward
offshore delivery is on track and a multi-year trend is expected to power growth; the
growth prospects for CTSH are not just cyclical in nature. (2) Against this backdrop
CTSH reiterated its confidence in achieving its 2011 revenue growth target of 26% plus.
(3) Management noted that 2011 IT budget cycles are stable with better visibility vs. the
last two years. (4) Supply-side dynamics, including wages and employee attribution,
appear to be more stable compared to 2010 due to better supply/demand balance.
Positive results from top offshore peers also confirm a solid backdrop. Despite 4Q
being a seasonally weak quarter (due to fewer billing days), both Infosys (INFY.BO) and
TCS (TCS.BO) reported strong revenue performance with average revenue growth of
30% yoy (+7% qoq). Importantly, strong revenue results were driven by a combination
of positive volume growth and pricing improvements. Indications from both INFY and
TCS suggest modest 2011 budget growth, but a continued mix shift to offshore
resources supports strong pipeline activity.
HP Services weakness appears company specific
Against, a relatively positive backdrop, HP’s Services revenue surprisingly fell short of
expectations, with the weakness attributed to lower than expected short-term signings
and project-based revenues.
The weakness and management’s commentary stand out as a bit of an anomaly, which
is in stark contrast to recently reported results and the outlook from both its multinational
and offshore peers, including Accenture, IBM, Capgemini, Cognizant
Technology Solutions, Infosys, and TCS, all of whom have noted continued strength in
project-based work/short-term signings given a healthy demand backdrop and normal
budget cycles.
We view the weakness in HP Services revenue as company specific and a reflection of
the company’s reliance on cost cutting following the acquisition of EDS, in which HP
embarked on aggressive cost reduction efforts, which ultimately appears to have
eroded HP’s competitive position in Services.
We believe the shortfall in HP’s application services revenues also suggests continued
price deflation, and potential market-share loss given a less established and integrated
global delivery platform vs. some of the company’s peers who continue to enjoy
double-digit revenue growth.
Latest IT Spending Survey confirms a positive demand backdrop
Positive trend in discretionary spend bodes well for consulting
The survey results demonstrate a further uptick in respondents indicating increased
budgets for discretionary spending in the next six months.
This is consistent with our view that IT spending growth is being driven by corporate
profitability, which supports new discretionary spending, cloud build-out efforts and new
architecture initiatives, and offshore’s secular rise as cost efficiency remains in focus.
The percentage of respondents indicating that budgets for discretionary IT spending will
trend up in the next six months came in at 37%, up from 27% in the October 2010 survey
and above the average result of 23% over the previous ten surveys. In our view the survey
results and latest reported results from all major IT Service companies including Accenture,
Cognizant Technology Solutions, IBM Services, Infosys, TCS and others confirms a positive
demand backdrop for short-term signings and new pipeline activity; which in our view
ultimately make HP Services recent commentary and results stand out as a bit of an
anomaly and a reflection of a business that likely embarked on too much cost cutting and
not enough investment in growth.
The percentage of the survey respondents indicating that budgets will trend flat to up came
in at 80%, same as last survey, representing the highest level in the survey history. At the
same time, the percentage of respondents indicating that budgets for discretionary IT
spending will trend down in the next six months continues to suggest a benign
environment, coming in at 16%, slightly lower than October 2010 survey and at the lowest
level since August 2007.
In our view, the survey data reflects increasing confidence in a normal budget cycle in 2011
vs. a more wait-and-see mentality that we saw in most of 2010. This is consistent with
recently reported results from the industry and key takeaways from our Technology and
Internet conference, both of which keep us confident that IT spending in 2011 is intact, with
budgets expected to grow in the low-to-mid single digits.
Priority areas for spending consistent with industry developments
Consistent with industry developments, infrastructure (data center consolidation and
cloud initiatives), applications development (front-end applications and SaaS
deployments), and systems integration (ERP and other core applications) remain top
priority areas for CIOs over the next six months. In the past we have highlighted trends on
both the infrastructure and application sides such as data center and desktop virtualization,
cloud computing, and SaaS-based application delivery as the most relevant secular
demand drivers. As for industry-specific developments, we see various upgrade and
product cycles including smartphones, tablets and mobile deployment as having the
potential to drive further IT spending.
The findings in the survey were generally consistent with the previous survey results that
pointed to a similar stack-up of service lines poised to see increased spending in the next
six months (Exhibit 8). Specifically, infrastructure, application development, and systems
integration remain as the top spending priority areas with 52%, 51%, and 34% of
respondents, respectively. Perhaps most notable is the acceleration that we are seeing as
clients shift their spending from infrastructure initiatives to application development and
systems integration initiatives (these two items showed the most notable improvements
compared to our previous survey, with application development at a record level since we
started tracking this data). Note that a survey respondent may submit a response for one or
more service types for this particular question.
By service type, infrastructure was the top spending priority in the latest survey and was
cited by 52% of the respondents, down from 63% in the October 2010 survey. Indication of
increased spending for applications development represented 51% of the respondents, up
from 46% in the October survey. Percentage of respondents citing systems integration as a
top spending priority came in at 34% vs. 25% in October, the first positive sequential move
in the last five quarters. Interest for application maintenance also increased to 14% of
respondents versus 11% in the October survey.
Finally, 11% of the survey respondents cited business process outsourcing (BPO) as a top
priority spending area, up from 9% in the October survey and marking the third
consecutive quarter of increased interest. That said, BPO remains at the bottom of the list
in terms of spending priorities, which could be due to low CIO appetite for investing in
projects with a longer transition or payback period in the current environment, in our view.
Services spend responses indicative of a positive backdrop
This survey marks the first time we asked corporate CIOs where they expect to see
increased dollars from their overall IT services spend over the next six months –
domestic third-party service providers, in-house IT resources, or offshore service
providers. Note that a survey respondent can submit a response for one or more countries
for this particular question.
Overall, the first round of results appears to suggest that domestic third-party service
providers and in-house IT resources are likely to see increased services spend, having
garnered 56% and 53% of the survey responses, respectively. These compare with the 18%
of responses garnered by offshore service providers.
Although one data point does not make a trend and we will continue to monitor the
levels of responses in future surveys, we believe the result is indicative of a positive
enterprise IT spending backdrop, with all three categories of service providers
garnering more than 10% of responses for increased spend over the next six months.
In addition, we view the relatively lower percentage of responses garnered by offshore
service providers as a function of lower overall penetration of client spend for services (we
estimate at 15%-20% on average), not necessarily an indication of lower appetite for
offshore services, which would be inconsistent with recently reported industry results and
takeaways from the GS Tech and Internet conference.
MNCs remain top of mind for CIOs, offshore gaining momentum
In terms of consistent demonstration of industry knowledge, the latest results remain
consistent with the previous surveys—MNCs dominate front-end mindshare,
followed by accounting consultancies, which continue to garner more responses as
compared to the offshore tier-1 and BPO players. Note that a survey respondent may
submit a response for one or more companies for this particular question.
MNCs continue to maintain their top position, with 60% of the respondents citing these
companies, but down from 84% in the October survey. Accounting consultancies also
showed well and were cited by 39% of the respondents, versus 37% in the October survey.
Offshore tier-1 companies registered 30% of the respondent votes in the latest survey,
versus 24% in October, representing the third consecutive quarter of sequential uptick. The
positive momentum for the offshore tier-1 companies is consistent with recently reported
results, and it supports our view that the secular demand in offshore services remains
intact, with the tier-1 offshore companies increasingly focused on developing more robust
front-end skills including domain and industry expertise.
Among the MNCs, IBM Services continued to claim the top spot with 32% of the
respondents, followed by Accenture and HP Services among the publicly traded companies.
Among the accounting consultancies, with 16% of the respondents Deloitte continues to
garner the strongest results (trailing only IBM Services among all providers), while PwC
and KPMG also rated well with 13% and 10% of the respondents, respectively.
Among the offshore tier-1 companies, Wipro garnered the highest results at 10% of the
respondents (versus 5% in the October survey). Infosys garnered 8% of the respondents,
versus 7% from the October survey. TCS was cited by 7% of respondents, versus 6% in the
October survey. Patni and HCL Tech each had 2% of the responses, while Cognizant was
cited by 1% of the respondents. With Cognizant’s revenue growth still far outpacing the
majority of its offshore peers, we believe the low level of survey responses is likely a
function of the industry makeup of our CIO respondents being more diversified vs. the
company’s concentrated model focusing on the financial services and healthcare verticals
(together making up 68% of its total revenue).
Finally, offshore BPO companies continued to show the lowest percentage of responses
(none this survey). We suspect that the low result of offshore BPO companies could be
partly due to the make-up of our survey respondent panel, which consists of mostly
corporate CIOs that typically do not make direct spending decisions in BPO. Nevertheless,
it does at least confirm that the mindshare process for offshore BPO companies remains a
work in progress in order to have more extensive appeal and impact to client models.
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