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12 trends that could shape 2012
We define 12 trends that could collectively shape 2012 earnings for IT services players.
IT spend will remain opportunistic; we expect moderated volume growth but yoy decline
in reported realizations, even though rate-cards will likely remain stable.
Even on lower revenue growth + appreciating INR scenario in 2H12, we see no risks to
margin; modest wage hike (8-10%) + pyramid rationalisation will be the key levers.
Our 10-17% FY13 EPS growth forecasts for the Top4 players build moderating yields;
look out for increases in hedge positions over 1H12 for later period FX impact.
For 3Q12, we estimate 2-3% US$ revenue growth for the Top4 players; Infosys to see
minimal cross-currency impact/maximum INR depreciation benefit to PAT.
HCLT remains our pick on renewal deal opportunity theme; we also find Infosys as an
attractive mid-range play.
Renewal deal wins to be the key growth differentiator. We expect an ‘opportunistic’ CY12 IT
spend to restrict FY13 volume growth to 15-22% for the Top4 players. Market share gains in the
renewal deal pipeline will be a key differentiator of volume growth across players in our view (see
our note India IT services - The shape of things to come dated 12 Dec 2011). Note, deals worth
at-least US$47bn are up for renewal over CY12, on our estimates. Further deterioration in macro
environment remains a key risk to volume outlook.
Stable pricing, but realization could trend down. We do not expect rate-card cuts like in 2008-
09; however, increased client scrutiny of vendor practices to push up ‘effective’ pricing + higher
share of lower priced application/infrastructure management services in volume pipeline could
drive a 2-3% drop in blended realization for the Top4 players in FY13. Players’ desperation (for
volume growth) to be key to industry’s pricing discipline in 2012, in our view.
No risk to margin, even ex-currency. Fresher hiring (for FY13 joining) is tracking FY12 (68,000
versus 65,000 for TCS and Infosys combined). FY13 wage hikes will likely be lower; these should
help manage margin in an appreciating INR scenario over 2H12. We expect 13-172bp EBITDA
margin drop for Top4 (building 0-4% yoy INR appreciation). Likely moderation in yields could be a
drag on EPS print (note 11% share of non-operating income to 1H12 PAT for Top4).
3QFY12 results preview – All about currency. We estimate 3-4% qoq volume growth though
cross-currency impact could restrict reported US$ revenue growth to 2-3% for the Top4 players.
INR depreciation will likely flow into Infosys/TCS margins (+212bp/228bp); but reinvestments/
hedge losses could restrict upside for HCLT/Wipro. Focus on deal wins momentum, realization
changes ex-currency and changes in hedge positions for cues to FY13 outlook.
12/12 – Twelve trends that would shape 2012
#1. CY12 IT budgets – size may not matter. Early vendors and industry analysts’ commentary
suggest flat to marginal increase in 2012 IT budgets (opex + capex). We believe the focus on the
size of IT budgets is misplaced given the quarterly review cycles being followed across most
clients on IT budget/spend since 2008-09. Also, while overall budget/spend may not rise in 2012,
we expect spend on services and offshoring to increase as spend on hardware continues to get
opportunistic. We do not see a PC refresh cycle coming in (on back of likely Windows 8 OS
launch in 2012); mass upgrade of end-user hardware is getting out of favour, in our view. Rising
adoption of virtualization and ‘private clouds’ (not withstanding the hype) should also limit spend
on storage/server hardware, in our view.
#2. Renewal deal opportunity will be key driver of medium-term volume growth. We expect
renewal deal market will continue to open up for Indian vendors. Given macro uncertainties, we
expect CY12 to have higher share of relatively smaller deals, a positive for Indian vendors; firsttime
buyers, especially in Europe, could form a significant share. We see a pipeline of at-least
249 deals (worth US$47bn) due for renewal over CY12 that could convert to US$6bn opportunity
for large offshore vendors. (See our note, India IT services - The shape of things to come, dated
12 December 2011 for a longer term analysis and structural implications of this opportunity). We
expect annuity deals could contribute c26% of incremental revenues for Top4 players in FY13.
#3. CY12/FY13 – volume growth could take a breather. Ex-annuity deals, the slower decisionmaking,
especially in discretionary spend led/longer pay-back projects, as indicated by vendors
since 2Q12, could affect 1HCY12 volumes, in our view. Our channel checks indicate contraction
in non-RFP project size as well as the funnel (from 15-20 man-month to 5-10 man-month
projects) that collectively formed a substantial share of traditional qoq guidance outperformance
reported by the players.
#4. Discretionary spend will likely remain opportunistic, with concentration on programs such
as compliance and risk management in Financial Services. We believe spend on Dodd Frank Act
compliance among US operational banks will likely pick-up from 2HCY12 as rule finalization
crosses critical mass (only 19% of rules had been defined by 1st December 2011). We expect this
could translate into a US$5bn opportunity for Indian offshore players over FY13-15; also, it could
be concentrated, at least in the initial phase, among players that have moved ahead in
developing domain expertise around it (Infosys and Cognizant).
#5. 2008-09 rate-card renegotiations are unlikely to come back; the current BT re-bid process
is an exception, in our view. Drying up of bench across players – average utilization for the Top4
Indian offshore players was up 221bp in 2Q12 from 2Q09 – lowers the pressure on vendors to
secure volume, in our view. We believe the renegotiation discussions are more around delivery
models (onsite/offshore), pricing structures (effort versus output/outcome based), and value
drivers (absolute cost savings/total cost of delivery). We believe vendors’ desperation (for volume
growth) will be key to industry’s pricing discipline in 2012.
#6. Reported realizations could still see stress. We expect near-term reported realizations
could come under pressure from 3 factors:
Review and monitoring of normal vendor practices to push up ‘effective’ pricing (for instance,
making only higher bill rate resources available for staff-augmentation projects or negotiating
different rates with different businesses of the same client). Our checks also indicate a rise in
cases of clients’ reconciling invoices with original contracts for under-delivery/over payments;
Rise in vendor consolidation – given increased offshoring over 2008-11; we believe the latest
consolidation could involve offshore players across a larger client base thus restricting net
volume upside. Interestingly, we also hear case of ‘reverse’ shifts – replacing contract
employees from offshore service providers with local temp resources – however, it is largely
restricted to onsite staff augmentation works;
Tougher renegotiations/increased demand for cost savings in application maintenance
contracts; a likely increase in share of application management + IT outsourcing deals in the
volume pipeline could affect blended realization print.
#7. Adoption of alternate delivery/pricing model to pick-up. Growing acceptance to explore
alternate delivery/pricing models should drive platform adoption, in our view, a positive for
players’ long-term profitability (though transition costs could affect near-term profitability). Note
TCS’ US$2.2bn platform deal win from FriendsLife (Diligenta acquired 8 additional clients over
2008-11) and Infosys’ recently launched InfosysEdge, a Cloud-based platforms suite (c20 clients
in 2Q12).
#8. Onsite hiring could remain on an up-trend. Increasing share of transformational/large
outsourcing engagements, which typically have multi-location delivery requirements, could result
in a continued up-trend in onsite hiring. However, while we do not see a ‘program’ shift (like
FY08/09), we do expect a net offshore move from project centric shifts for lower total cost of
delivery (and management of visa (non)availability/onsite visibility issues).
#9. Pyramid normalization + lower wage hike to aid margin management. Pressure on percapita
manpower costs could ease in FY13 as the distortion in employee pyramid corrects. Percapita
delivery manpower costs, especially for Infosys and TCS, trended up and were at peak in
1Q12, post the annual wage hike, as the top of employee pyramid became heavier over FY08-11
(5 years+ experience employee share expanded to 42% in 2Q12 for Infosys from 4Q08 lows of
26%) under the successive impact of first, the fall in attrition over FY08-10 following the GFC
induced demand slump, and then lateral centric hiring to match the demand spike in FY11 even
as low campus offers (made over 2009) kept the fresher tap dry. We believe the industry-wide
surge in attrition in FY11 was centric around 3-5 years experience profile (note the 2% fall in
share in 3-5 years band for Infosys in FY11).
Strong FY12 fresher hiring (37,000/28,000 for TCS/Infosys) + stable wages for FY13 campus
offers (for 4 successive years, unlike past cycles and our expectations) + modest wage hikes (we
expect 8-10%) should check expansion in effective wage costs.
#10. Softer rates could impact earnings growth. A likely softening in interest rates (our
economist expects end- CY12 G-Sec yield at 7.5% vs. 8.5% currently) could lower cash yields
and affect reported FY13 EPS growth. Rising cash and cash equivalent levels for Tier1 players
(collectively up to US$8.6bn in 2Q12 from US$3.7bn in 4Q07) and concurrent uptrend in yields
(8.8% in 2H12 from 6.6% in FY11) has pushed up non-operating income contribution to PAT
(11% of PBT in 1H12 from 4% in FY07, ex-forex gains/losses, collectively for Top 3 companies).
#11. Currency movement – from tailwinds to headwinds? While INR depreciation will likely be
a major margin tailwind in 2H FY12, our economist expects INR to appreciate over 2012 (9% on
period-end basis) on better domestic growth/ inflation dynamics. This could imply 0-4% effective
appreciation for FY13/FY12. Concurrently, while 2H FY12 could see cross-currency headwinds
(2.5% of revenues), FY13 could see a reversal (2% gains) based on our economist’s forecast of
US dollar depreciating against most major currencies.
#12. Time for inorganic play? Last and may be controvertible, we expect a large acquisition by
a Top4 Indian player of a US/European IT outsourcing firm in 2012. We see growing need for
Indian players to build local/multi-location execution capacities to service increasingly complex
deal structures. An acquisition could also be a consequential/dependent route to expand into
relatively unexplored Continental European markets.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
12 trends that could shape 2012
We define 12 trends that could collectively shape 2012 earnings for IT services players.
IT spend will remain opportunistic; we expect moderated volume growth but yoy decline
in reported realizations, even though rate-cards will likely remain stable.
Even on lower revenue growth + appreciating INR scenario in 2H12, we see no risks to
margin; modest wage hike (8-10%) + pyramid rationalisation will be the key levers.
Our 10-17% FY13 EPS growth forecasts for the Top4 players build moderating yields;
look out for increases in hedge positions over 1H12 for later period FX impact.
For 3Q12, we estimate 2-3% US$ revenue growth for the Top4 players; Infosys to see
minimal cross-currency impact/maximum INR depreciation benefit to PAT.
HCLT remains our pick on renewal deal opportunity theme; we also find Infosys as an
attractive mid-range play.
Renewal deal wins to be the key growth differentiator. We expect an ‘opportunistic’ CY12 IT
spend to restrict FY13 volume growth to 15-22% for the Top4 players. Market share gains in the
renewal deal pipeline will be a key differentiator of volume growth across players in our view (see
our note India IT services - The shape of things to come dated 12 Dec 2011). Note, deals worth
at-least US$47bn are up for renewal over CY12, on our estimates. Further deterioration in macro
environment remains a key risk to volume outlook.
Stable pricing, but realization could trend down. We do not expect rate-card cuts like in 2008-
09; however, increased client scrutiny of vendor practices to push up ‘effective’ pricing + higher
share of lower priced application/infrastructure management services in volume pipeline could
drive a 2-3% drop in blended realization for the Top4 players in FY13. Players’ desperation (for
volume growth) to be key to industry’s pricing discipline in 2012, in our view.
No risk to margin, even ex-currency. Fresher hiring (for FY13 joining) is tracking FY12 (68,000
versus 65,000 for TCS and Infosys combined). FY13 wage hikes will likely be lower; these should
help manage margin in an appreciating INR scenario over 2H12. We expect 13-172bp EBITDA
margin drop for Top4 (building 0-4% yoy INR appreciation). Likely moderation in yields could be a
drag on EPS print (note 11% share of non-operating income to 1H12 PAT for Top4).
3QFY12 results preview – All about currency. We estimate 3-4% qoq volume growth though
cross-currency impact could restrict reported US$ revenue growth to 2-3% for the Top4 players.
INR depreciation will likely flow into Infosys/TCS margins (+212bp/228bp); but reinvestments/
hedge losses could restrict upside for HCLT/Wipro. Focus on deal wins momentum, realization
changes ex-currency and changes in hedge positions for cues to FY13 outlook.
12/12 – Twelve trends that would shape 2012
#1. CY12 IT budgets – size may not matter. Early vendors and industry analysts’ commentary
suggest flat to marginal increase in 2012 IT budgets (opex + capex). We believe the focus on the
size of IT budgets is misplaced given the quarterly review cycles being followed across most
clients on IT budget/spend since 2008-09. Also, while overall budget/spend may not rise in 2012,
we expect spend on services and offshoring to increase as spend on hardware continues to get
opportunistic. We do not see a PC refresh cycle coming in (on back of likely Windows 8 OS
launch in 2012); mass upgrade of end-user hardware is getting out of favour, in our view. Rising
adoption of virtualization and ‘private clouds’ (not withstanding the hype) should also limit spend
on storage/server hardware, in our view.
#2. Renewal deal opportunity will be key driver of medium-term volume growth. We expect
renewal deal market will continue to open up for Indian vendors. Given macro uncertainties, we
expect CY12 to have higher share of relatively smaller deals, a positive for Indian vendors; firsttime
buyers, especially in Europe, could form a significant share. We see a pipeline of at-least
249 deals (worth US$47bn) due for renewal over CY12 that could convert to US$6bn opportunity
for large offshore vendors. (See our note, India IT services - The shape of things to come, dated
12 December 2011 for a longer term analysis and structural implications of this opportunity). We
expect annuity deals could contribute c26% of incremental revenues for Top4 players in FY13.
#3. CY12/FY13 – volume growth could take a breather. Ex-annuity deals, the slower decisionmaking,
especially in discretionary spend led/longer pay-back projects, as indicated by vendors
since 2Q12, could affect 1HCY12 volumes, in our view. Our channel checks indicate contraction
in non-RFP project size as well as the funnel (from 15-20 man-month to 5-10 man-month
projects) that collectively formed a substantial share of traditional qoq guidance outperformance
reported by the players.
#4. Discretionary spend will likely remain opportunistic, with concentration on programs such
as compliance and risk management in Financial Services. We believe spend on Dodd Frank Act
compliance among US operational banks will likely pick-up from 2HCY12 as rule finalization
crosses critical mass (only 19% of rules had been defined by 1st December 2011). We expect this
could translate into a US$5bn opportunity for Indian offshore players over FY13-15; also, it could
be concentrated, at least in the initial phase, among players that have moved ahead in
developing domain expertise around it (Infosys and Cognizant).
#5. 2008-09 rate-card renegotiations are unlikely to come back; the current BT re-bid process
is an exception, in our view. Drying up of bench across players – average utilization for the Top4
Indian offshore players was up 221bp in 2Q12 from 2Q09 – lowers the pressure on vendors to
secure volume, in our view. We believe the renegotiation discussions are more around delivery
models (onsite/offshore), pricing structures (effort versus output/outcome based), and value
drivers (absolute cost savings/total cost of delivery). We believe vendors’ desperation (for volume
growth) will be key to industry’s pricing discipline in 2012.
#6. Reported realizations could still see stress. We expect near-term reported realizations
could come under pressure from 3 factors:
Review and monitoring of normal vendor practices to push up ‘effective’ pricing (for instance,
making only higher bill rate resources available for staff-augmentation projects or negotiating
different rates with different businesses of the same client). Our checks also indicate a rise in
cases of clients’ reconciling invoices with original contracts for under-delivery/over payments;
Rise in vendor consolidation – given increased offshoring over 2008-11; we believe the latest
consolidation could involve offshore players across a larger client base thus restricting net
volume upside. Interestingly, we also hear case of ‘reverse’ shifts – replacing contract
employees from offshore service providers with local temp resources – however, it is largely
restricted to onsite staff augmentation works;
Tougher renegotiations/increased demand for cost savings in application maintenance
contracts; a likely increase in share of application management + IT outsourcing deals in the
volume pipeline could affect blended realization print.
#7. Adoption of alternate delivery/pricing model to pick-up. Growing acceptance to explore
alternate delivery/pricing models should drive platform adoption, in our view, a positive for
players’ long-term profitability (though transition costs could affect near-term profitability). Note
TCS’ US$2.2bn platform deal win from FriendsLife (Diligenta acquired 8 additional clients over
2008-11) and Infosys’ recently launched InfosysEdge, a Cloud-based platforms suite (c20 clients
in 2Q12).
#8. Onsite hiring could remain on an up-trend. Increasing share of transformational/large
outsourcing engagements, which typically have multi-location delivery requirements, could result
in a continued up-trend in onsite hiring. However, while we do not see a ‘program’ shift (like
FY08/09), we do expect a net offshore move from project centric shifts for lower total cost of
delivery (and management of visa (non)availability/onsite visibility issues).
#9. Pyramid normalization + lower wage hike to aid margin management. Pressure on percapita
manpower costs could ease in FY13 as the distortion in employee pyramid corrects. Percapita
delivery manpower costs, especially for Infosys and TCS, trended up and were at peak in
1Q12, post the annual wage hike, as the top of employee pyramid became heavier over FY08-11
(5 years+ experience employee share expanded to 42% in 2Q12 for Infosys from 4Q08 lows of
26%) under the successive impact of first, the fall in attrition over FY08-10 following the GFC
induced demand slump, and then lateral centric hiring to match the demand spike in FY11 even
as low campus offers (made over 2009) kept the fresher tap dry. We believe the industry-wide
surge in attrition in FY11 was centric around 3-5 years experience profile (note the 2% fall in
share in 3-5 years band for Infosys in FY11).
Strong FY12 fresher hiring (37,000/28,000 for TCS/Infosys) + stable wages for FY13 campus
offers (for 4 successive years, unlike past cycles and our expectations) + modest wage hikes (we
expect 8-10%) should check expansion in effective wage costs.
#10. Softer rates could impact earnings growth. A likely softening in interest rates (our
economist expects end- CY12 G-Sec yield at 7.5% vs. 8.5% currently) could lower cash yields
and affect reported FY13 EPS growth. Rising cash and cash equivalent levels for Tier1 players
(collectively up to US$8.6bn in 2Q12 from US$3.7bn in 4Q07) and concurrent uptrend in yields
(8.8% in 2H12 from 6.6% in FY11) has pushed up non-operating income contribution to PAT
(11% of PBT in 1H12 from 4% in FY07, ex-forex gains/losses, collectively for Top 3 companies).
#11. Currency movement – from tailwinds to headwinds? While INR depreciation will likely be
a major margin tailwind in 2H FY12, our economist expects INR to appreciate over 2012 (9% on
period-end basis) on better domestic growth/ inflation dynamics. This could imply 0-4% effective
appreciation for FY13/FY12. Concurrently, while 2H FY12 could see cross-currency headwinds
(2.5% of revenues), FY13 could see a reversal (2% gains) based on our economist’s forecast of
US dollar depreciating against most major currencies.
#12. Time for inorganic play? Last and may be controvertible, we expect a large acquisition by
a Top4 Indian player of a US/European IT outsourcing firm in 2012. We see growing need for
Indian players to build local/multi-location execution capacities to service increasingly complex
deal structures. An acquisition could also be a consequential/dependent route to expand into
relatively unexplored Continental European markets.
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