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IT Services: The News Flow
Gov't Shutdown, Indian Budget, Captive Centers
Attractive, INFY on Demand, and Opportunities in
Small/Medium Businesses
We summarize and analyze relevant IT services news from Thursday, Feb 17th,
through Wednesday, Mar 2nd. Included are announced contract awards, top news
items and summary valuation metrics.
• Continued headwinds in the federal IT services industry. The federal
government passed a continuing resolution (CR) to fund the agencies through Mar
18th thereby avoiding an immediate shutdown. The CR includes $4B in cuts on the
8 programs identified for significant cuts/terminations last year, while the remaining
programs will continue operating at current levels. Although we believe a shutdown
post Mar 18th is also unlikely and the government will likely pass another CR/
budget, uncertainty from the situation and the ongoing spending crunch at agencies
should hurt near-term growth rates of the federal IT services contractors. CSC has
the highest exposure to the US federal government in our coverage universe.
• India’s FY12 budget – little earnings impact relative to estimates. India's union
budget for FY12 increased the minimum-alternate-tax (MAT) from 15% to 18.5%.
We believe the firms have to pay the tax only if their overall tax rate is lower than
18.5%. The increase should not adversely impact any firm in our coverage universe
as all companies are expected to report a higher tax rate (than 18.5%) in CY11.
Moreover, the difference between MAT and the effective tax rate is reported as a
deferred tax asset/liability, which does not affect the tax rate or EPS but will impact
cash flows. The budget also confirmed STPI (software technology parks of India)
based tax holidays are set to expire from April 2011.
• Increased interest in clients’ in-house captive operations. A study by outsourcing
advisory firm, Zinnov consulting, indicates clients are increasingly setting up their
own captive operations in India. The number of new captive centers set up
reportedly increased from 5 in 2009 to 30 in 2010. The advisory firm believes clients
are increasingly doing more complex and innovative work out of these centers. We
believe many clients with captive centers pursue a hybrid model for IT services with
work distributed between vendors and in-house operations.
• INFY on demand, wage inflation. INFY reportedly believes FY11 growth
benefited from clients' pent-up spending and expects a relatively "moderate' growth
rate in FY12. The company also signed 2 large outsourcing contracts worth $100M
each in TCV and expects to sign 4-5 deals in the $50-100m TCV range in the March
quarter. The company also expects offshore wage inflation to moderate in FY12 and
plans to increase its compensation by 11-13% on average.
• Opportunities in small/medium businesses. NASSCOM, an Indian IT services and
BPO lobby, estimates 80% of new opportunities for Indian IT services/BPO firms in
this decade will stem from new regions, new services, new clients and new verticals.
Specifically, NASSCOM expects an increased focus on servicing small/medium
businesses over the cloud. Indian IT services firms have traditionally focused on
servicing Fortune 1,000/2,000 clients.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
IT Services: The News Flow
Gov't Shutdown, Indian Budget, Captive Centers
Attractive, INFY on Demand, and Opportunities in
Small/Medium Businesses
We summarize and analyze relevant IT services news from Thursday, Feb 17th,
through Wednesday, Mar 2nd. Included are announced contract awards, top news
items and summary valuation metrics.
• Continued headwinds in the federal IT services industry. The federal
government passed a continuing resolution (CR) to fund the agencies through Mar
18th thereby avoiding an immediate shutdown. The CR includes $4B in cuts on the
8 programs identified for significant cuts/terminations last year, while the remaining
programs will continue operating at current levels. Although we believe a shutdown
post Mar 18th is also unlikely and the government will likely pass another CR/
budget, uncertainty from the situation and the ongoing spending crunch at agencies
should hurt near-term growth rates of the federal IT services contractors. CSC has
the highest exposure to the US federal government in our coverage universe.
• India’s FY12 budget – little earnings impact relative to estimates. India's union
budget for FY12 increased the minimum-alternate-tax (MAT) from 15% to 18.5%.
We believe the firms have to pay the tax only if their overall tax rate is lower than
18.5%. The increase should not adversely impact any firm in our coverage universe
as all companies are expected to report a higher tax rate (than 18.5%) in CY11.
Moreover, the difference between MAT and the effective tax rate is reported as a
deferred tax asset/liability, which does not affect the tax rate or EPS but will impact
cash flows. The budget also confirmed STPI (software technology parks of India)
based tax holidays are set to expire from April 2011.
• Increased interest in clients’ in-house captive operations. A study by outsourcing
advisory firm, Zinnov consulting, indicates clients are increasingly setting up their
own captive operations in India. The number of new captive centers set up
reportedly increased from 5 in 2009 to 30 in 2010. The advisory firm believes clients
are increasingly doing more complex and innovative work out of these centers. We
believe many clients with captive centers pursue a hybrid model for IT services with
work distributed between vendors and in-house operations.
• INFY on demand, wage inflation. INFY reportedly believes FY11 growth
benefited from clients' pent-up spending and expects a relatively "moderate' growth
rate in FY12. The company also signed 2 large outsourcing contracts worth $100M
each in TCV and expects to sign 4-5 deals in the $50-100m TCV range in the March
quarter. The company also expects offshore wage inflation to moderate in FY12 and
plans to increase its compensation by 11-13% on average.
• Opportunities in small/medium businesses. NASSCOM, an Indian IT services and
BPO lobby, estimates 80% of new opportunities for Indian IT services/BPO firms in
this decade will stem from new regions, new services, new clients and new verticals.
Specifically, NASSCOM expects an increased focus on servicing small/medium
businesses over the cloud. Indian IT services firms have traditionally focused on
servicing Fortune 1,000/2,000 clients.
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