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IT Services
Short term and medium trend in IT industry
Post our meetings with the business heads of various top tier Indian IT services companies,
at the DB Access India Conference, we are convinced that the top tier Indian vendors are in
the midst of a robust demand environment largely on account of a proven delivery capability.
While this may last in the medium term, there are early signs that: (a) rapid adoption of
private cloud networks and (b) greater adoption of global delivery network (GDN) model by
continental European clients will propel the offshore IT services industry in general and the
top tier Indian vendors in particular into another hyper growth stage for the next 3-4 years.
We thus, continue with our overweight stance on the sector with Infosys and TCS being our
top picks amongst the large caps. With a niche telecom play in its standalone business and
upside from improved business prospects from Mahindra Satyam, we re-iterate our Buy
rating and top pick status for Tech Mahindra amongst the mid-caps.
In our view, some of the short and medium-term trends in the industry are as below:
Demand continues to be strong but limited pricing power
All the companies were unanimous in indicating a strong demand environment for offshore IT
service providers. While overall demand is largely broad based across all verticals, according
to the managements the three most important trends impacting this are:
Market share gains made by the Indian vendor’ vs local competition (not MNC) in the
USA and Europe. A case of vendor consolidation benefiting the Indian companies.
Increase in share of off shoring in the marginally increased 2011 IT budgets of clients.
This is helping high volume growth over the last few quarters which is likely to sustain.
Pricing power still doesn’t seem to have returned for the Indian vendors. While there
were divergent views on this, with Wipro indicating good success in winning coupon
rate increases from their customers, Infosys seemed most cautious on pricing increase.
It has managed to get only cost of living adjustment increases (~2%yoy) in most cases.
Telecom and Europe likely to drive spending in 2HCY11E
The laggards of 2010 are likely to turn the corner in a big way in 2HCY11E. For instance,
Infosys indicated that the pipeline in the telecom vertical is at its best in the last two years.
They are seeing good number of high double and triple digit US$mn deals. The investments
in continental Europe (especially Germany and France) made over the last two years are
paying off now. Breaking away from their self imposed aversion to offshoring, these regions
are now positively inclined to offshore. While all companies are witnessing this trend, TCS in
particular indicated that they are seeing good improvement in demand from key markets like
Nordics, Benelux, Germany and Switzerland.
High margins can be defended
Ability of the Indian vendors to sustain the high operating margins is a perpetual concern for
most investors. From our meetings, we could infer that almost all of these companies are
adopting different approaches to deal with this issue and barring any extraordinary changes in
the business environment should be able to hold or improve operating margins.
TCS seems to ahead of the pack here and is enjoying the benefits of the realignment of
its organisation structure it instituted in early 2008. Its operating margins since then have
moved up ~200bps since then.
Wipro seems to have taken a leaf out of TCS’s book and is attempting a similar exercise
now after dismantling its dual CEO structure recently.
On a smaller scale HCL Tech is realigning its employee pyramid and delivery structure to
arrest the margin declines witnessed over the last 6 quarters.
Infosys is following an altogether different path of improving its ‘absolute profitability’
per employee by moving up the value chain. This will entail a greater proportion of
revenues from discretionary spending related services like transformation and innovation
(67% of revenues) with annuity based revenues relegated to 33%. Organisation
realignment could be a consequence of this change in business approach.
Investment in cloud computing is a need of the hour
While the exact nature and extent of business impact from cloud computing is still not clear,
all the companies have no doubt in their mind that would be a game changer in the years to
come and are thus making proactive investments to build these capabilities. Most companies
are offering two types of services:
Services for the cloud (this is a big opportunity in the medium term) and
Services on the cloud (long-term growth driver).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
IT Services
Short term and medium trend in IT industry
Post our meetings with the business heads of various top tier Indian IT services companies,
at the DB Access India Conference, we are convinced that the top tier Indian vendors are in
the midst of a robust demand environment largely on account of a proven delivery capability.
While this may last in the medium term, there are early signs that: (a) rapid adoption of
private cloud networks and (b) greater adoption of global delivery network (GDN) model by
continental European clients will propel the offshore IT services industry in general and the
top tier Indian vendors in particular into another hyper growth stage for the next 3-4 years.
We thus, continue with our overweight stance on the sector with Infosys and TCS being our
top picks amongst the large caps. With a niche telecom play in its standalone business and
upside from improved business prospects from Mahindra Satyam, we re-iterate our Buy
rating and top pick status for Tech Mahindra amongst the mid-caps.
In our view, some of the short and medium-term trends in the industry are as below:
Demand continues to be strong but limited pricing power
All the companies were unanimous in indicating a strong demand environment for offshore IT
service providers. While overall demand is largely broad based across all verticals, according
to the managements the three most important trends impacting this are:
Market share gains made by the Indian vendor’ vs local competition (not MNC) in the
USA and Europe. A case of vendor consolidation benefiting the Indian companies.
Increase in share of off shoring in the marginally increased 2011 IT budgets of clients.
This is helping high volume growth over the last few quarters which is likely to sustain.
Pricing power still doesn’t seem to have returned for the Indian vendors. While there
were divergent views on this, with Wipro indicating good success in winning coupon
rate increases from their customers, Infosys seemed most cautious on pricing increase.
It has managed to get only cost of living adjustment increases (~2%yoy) in most cases.
Telecom and Europe likely to drive spending in 2HCY11E
The laggards of 2010 are likely to turn the corner in a big way in 2HCY11E. For instance,
Infosys indicated that the pipeline in the telecom vertical is at its best in the last two years.
They are seeing good number of high double and triple digit US$mn deals. The investments
in continental Europe (especially Germany and France) made over the last two years are
paying off now. Breaking away from their self imposed aversion to offshoring, these regions
are now positively inclined to offshore. While all companies are witnessing this trend, TCS in
particular indicated that they are seeing good improvement in demand from key markets like
Nordics, Benelux, Germany and Switzerland.
High margins can be defended
Ability of the Indian vendors to sustain the high operating margins is a perpetual concern for
most investors. From our meetings, we could infer that almost all of these companies are
adopting different approaches to deal with this issue and barring any extraordinary changes in
the business environment should be able to hold or improve operating margins.
TCS seems to ahead of the pack here and is enjoying the benefits of the realignment of
its organisation structure it instituted in early 2008. Its operating margins since then have
moved up ~200bps since then.
Wipro seems to have taken a leaf out of TCS’s book and is attempting a similar exercise
now after dismantling its dual CEO structure recently.
On a smaller scale HCL Tech is realigning its employee pyramid and delivery structure to
arrest the margin declines witnessed over the last 6 quarters.
Infosys is following an altogether different path of improving its ‘absolute profitability’
per employee by moving up the value chain. This will entail a greater proportion of
revenues from discretionary spending related services like transformation and innovation
(67% of revenues) with annuity based revenues relegated to 33%. Organisation
realignment could be a consequence of this change in business approach.
Investment in cloud computing is a need of the hour
While the exact nature and extent of business impact from cloud computing is still not clear,
all the companies have no doubt in their mind that would be a game changer in the years to
come and are thus making proactive investments to build these capabilities. Most companies
are offering two types of services:
Services for the cloud (this is a big opportunity in the medium term) and
Services on the cloud (long-term growth driver).
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