Indian IT Services :Continental Europe – opportunity in adversity: Deutsche Bank

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TCS and Wipro poised to gain as Europe strives to stretch its IT spends


Our conversations with 55 key IT decision makers in European companies
suggest that Indian vendors are on track to become strategic partners for their
key clients. TCS and Wipro were cited as the best positioned to deliver value as
European CTOs face budget constraints on ‘run-the-business’ spends. A key
challenge for Indian vendors is domain expertise – 60% of European IT spend is
on project-based services with a skew toward manufacturing, which is
different from the US where BFSI dominates in IT spends.
Key takeaways from our conversations with CTO for CY12E IT budgets
(a) Overall budgets will be flat to marginally lower, but share of offshoring
would increase to manage cost pressures. (b) ‘More-for-less‘ is the mantra for
IT spends on run-the-business so that companies do not compromise their
‘change-the-business’ spends. (c) Vendor consolidation is accelerating and
companies are partnering with their larger vendors in a more strategic manner.
Gaining domain expertise is key challenge for Indian vendors
Sixty percent of European IT spend is on higher-margin project-based services
such as system integration and package implementation, skewed toward
manufacturing companies. This compares to 45% spend on ADM, skewed
toward BFSI space – Indian vendors’ current stronghold. Nearshoring should
alleviate the issue in the medium term but in the long run, Indian vendors
should cultivate domain knowledge through their ranks. Skill shortages in
Europe are a structural positive factor, which should aid this transition.
TCS – Emerging as the most preferred offshore vendor in Europe
TCS featured most frequently among the top three IT vendors according to
most European customers we spoke with. It is likely to gain wallet share as its
clients consolidate spending. We believe this is the primary reason for TCS’
above-average revenue growth, which we believe will be sustained due to the
structural shift in client spending patterns.
Wipro – Clients recognize improvement in quality of its service delivery
Based on our conversations, we note (a) rising customer satisfaction with the
quality of Wipro’s service after the organization restructuring, (b) appreciable
decline in attrition at the individual project level – a key performance metric for
clients and (c) recognition of its inorganic initiatives to gain wallet share with
marquee clients.
TCS and Wipro are our preferred sector picks
TCS trades at 17x FY13E earnings (10% discount to its average trading multiple
for the last two years). Given its forecast earnings growth of 20% over FY12-
14, we believe the stock is attractively priced. We value the company at 20x
FY13E P/E and increase our target price marginally from INR1,280 to INR1,320.
We expect Wipro to deliver earnings CAGR of 21% over FY12-14. At 14x FY13E
P/E, the stock trades at an inexpensive valuation. We value Wipro at 19x FY13E
P/E and raise its target price from INR400 to INR510. We also marginally
increase our FY13E EPS for Infosys and raise its target price marginally from
INR2,950 to INR3,000. We retain our Hold rating on HCL Tech with no changes
to estimates or target price. Key risks: US and Europe recession impacting
technology spend and a higher-than-expected rupee appreciation.