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Citi India IT Services Tour Takeaways
Mellow Macro, Mixed Micro
Is there too much focus on IT budgets? — Focus on IT budgets seems to be
overrated, according to most companies. While budgets being largely flattish sets the
tone/direction for CY12, vendors do not have clarity on how the spending patterns will
evolve (depends on a stable macro). With project cycles getting shorter and the macro
being volatile, companies expect greater volatility in quarterly growth.
Is Nasscom's forecast of 11-14% growth realistic? — While it is too early to take a
firm view, most companies did agree that it was a realistic starting point and Nasscom
has also said it will review it at a later stage. Cognizant has guided to at least 23%
growth - however, we view that as a case of market share gains, in line with
Cognizant's performance over the past few years. Mid-teens BPO growth should also
be achievable for industry leaders, based on the net of signed contracts, wallet share
gains and promised productivity improvements.
Where can vendors look for growth? — With the current macro environment putting
pressure on several European companies with a high cost structure, there seems to be
an increasing acceptance of greater offshoring. Local investments/hiring by vendors
and culture seem to be key decision-making factors for buyers, over pricing.
Is there a risk to pricing? — Third-party advisory firms are talking of the market being
very competitive and customers demanding more, though not always in the form of
aggressive pricing. Supply remains tight, and we believe will protect any downside to
pricing, unless there is a catastrophic scenario that impacts demand.
Are discretionary spends slowing? — Most clients acknowledged slower decision
making with key trends being: (1) Short term high-ROI projects continue to do well; (2)
“Enterprise solutions” is doing well, particularly around areas like Business
Intelligence/analytics; (3) Larger rollouts are fewer and are being broken down into
phases; (4) Consolidation of “Run The Business” to fund critical discretionary projects.
Are parts of the business getting commoditized? — Interestingly, there is
consensus that parts of the traditional ADM business are getting commoditized and
companies need to focus on value-addition/newer engagement models/non-linearity to
do well in future. The market is moving towards outcome-based models and companies
will need to innovate to do well. There was near-consensus on investment areas –
Analytics, Cloud, Mobility, Platforms etc; execution here is key.
Our view — (1) The structural story of Indian IT continues, although near-term decision
making could continue to be slow; (2) While a tight supply could support pricing, it
could put pressure on margins – offshore wage inflation to be high single digits next
year; (3) Non-linearity and new engagement models to become more important given
supply constraints and commoditization of part of the ADM work. Our top picks are
CTSH/EXLS in US IT/BPO, WPRO/HCLT in India IT and CAP/ATOS in European IT.
Top-Down Bleak; Bottoms-Up A Mixed Bag
Citi hosted clients on a 4-day (21-24 Feb) IT services tour across Bangalore,
Chennai, NCR and Mumbai. We met a cross-section of companies –
Indian/European/US-listed IT Services/BPO companies, third-party advisors,
supply-side consultants etc. Post the trip, we address the key relevant queries that
came up in our investor interactions.
The top-down outlook of most participants was mellow – IT budgets across
the board are flattish/slightly down. While recent data points in the US are
relatively positive, companies are unclear about the sustainability. This has led to
continued uncertainty in the velocity of spending. With constraints of flat budgets,
CIOs are resorting to rationalization of relatively commoditized services like ADM
to self-fund tactical discretionary projects with higher visibility of RoIs.
However, bottom-up it was a mixed bag
– Positives: (1) Higher traction of offshoring in Europe after several years of
investments in these markets. (2) There is good traction in Insurance,
Manufacturing and Healthcare verticals. (3) Attrition and wage inflation
(expected to be in high single digits for the year) are largely under control. (4)
Client recognition of supply constraints acts as a support for pricing.
– Negatives: (1) Majority of the companies expect BFS to grow slower than
company averages. (2) Large-scale discretionary projects are not happening –
new ERP license income while up, may not translate into higher services
revenues due to an adverse mix. (3) Non-linearity seems to be a while away.
In Search of the Next Leg of Growth
Is there too much investor focus on IT budgets? — Focus on IT budgets
seems to be overrated, based on our conversations with most companies. While
budgets in most cases are largely flattish and mostly decided, there was
consensus on the fact that spending is key. Much of the spending is secure "Run
the Business" activity. There are also projects that are mandatory (e.g.
Regulatory) and Highly Strategic (e.g. Mobile Banking). Beyond this "Must
Happen" work, all incremental spends will be determined by the macro outlook,
as the year progresses. While budgets set the tone/direction, quantum of spends
will depend on how clients feel about their business outlook and that can change
materially over the year, as has been witnessed in past years.
Where is pricing headed? Companies across the board agreed that pricing was
stable, and likely to remain at these levels. While recent data points, particularly
from the US, are positive, clients are uncertain about the sustainability. If the
macro outlook were to remain uncertain, there could be risks to standard cost-ofliving-
based increases.
What is the outlook on BFS? The Banking & Financial Services vertical is
expected to grow, but slower than company averages - BFS in Europe largely
caters to the investment banking segment, which is more global than retail
banking, which has a strong local focus. Thus growth is more dependent on the
macro outlook. There are no challenges in budget closures/ spending in the retail
banking segment. Regulatory spend, while expected to be a medium-term driver,
is yet to practically translate into higher revenues.
Are there any other vertical-specific trends? (1) Insurance, Manufacturing and
Healthcare are seeing good traction. (2) The telecom equipment segment
remains weak. (3) Retail saw a slowdown towards the end of 2011. These are the
broad trends we picked up, while there are differences among companies based
on their relative capabilities and penetration across verticals.
Are discretionary spends slowing? While there is no denying that longer term
transformational projects are very few, buyers continue to roll out shorter term
tactical projects with a clear visibility on RoIs. Even the few large projects are
now increasingly being broken into smaller phases with RoIs at each phase
being monitored before proceeding to the next. In a scenario where budgets are
flattish, CIOs are looking to self-fund these discretionary projects by rationalizing
maintenance spends and simplifying/consolidating the number of apps.
Is there corresponding slowdown in SAP/Oracle demand? New ERP license
income has recovered well and is back to pre-recession levels. However, a lot of
growth is in Business Intelligence. This resultant change in mix has led to lower
services demand since BI/CRM does not have the same multiplier effect as
traditional core ERP.
Who will gain market share? We interacted with third-party advisors on the
subject of vendor consolidation, which has driven market share gains over the
last few years. Trends suggest that consolidation is likely to continue and favor
tier 1 vendors more (partly as clients focus their energies on working with top few
strategic vendors). HCLT also highlighted the huge rebid opportunity of ~$207b
over the next 5 years – largely in BFSI and Manufacturing verticals.
Offshore players vs. multinationals? There seems to be a convergence in
business models with European vendors increasing their offshore presence and
Indian vendors hiring locally to build an onsite platform. The jury is still out on
which way the market is headed – interactions suggest that Indian vendors have
a more integrated offshore platform which, coupled with difficulties in building up
scale due to supply constraints, will continue to benefit in the near to medium
term. First-time outsourcers are still found to prefer MNCs.
How are the companies pursuing non-linearity? Non-linear models of
engagement are being necessitated by commoditization of services and supply
constraints. Vendors seem to strongly believe in an asset-light model and are
focused on building services around product IPs. But companies agreed that it
takes multiple years to build up non-linear revenues organically, making them
explore inorganic growth opportunities as well. However, benefits are likely to be
a while away, kicking in post integration between services/platforms/BPO etc.
Does integrated IT/BPO make sense? The camp seems evenly split on this
one with traditional BPO companies claiming to accrue more productivity savings
for their buyers, thus helping them gain market shares. Interestingly, traditional
model continues to benefit in most cases given buyer segments in an
organization are different for IT and BPO. We believe that as the industry
matures and buyers rationalize/simplify procurement, greater integration will be
encouraged. Savings are likely to accrue more back-ended.
New areas like analytics, cloud and mobility? There was near-consensus on
investment areas - Analytics, Cloud, Mobility, Platforms etc. With the onset of
solutions like mobile wallet and a 4G rollout, India is likely to hold good potential
for mobility. Spends in analytics are likely to driven by the need to transition
traditional solutions to a real-time basis. Executing scalable strategies will be key.
Supply-Side Hurdles
Is there more to the visa hurdle than mere rhetoric? Of late, media reports
are highlighting increases in visa rejections - protectionist policies and scale
playing a part in the rise. Companies accept that these issues are likely to persist
and perhaps increase in the run-up to the US elections, and are looking to ramp
up local hiring and re-badging customer resources. While not directly impacting
margins by way of a higher cost, companies expect this to impact utilizations with
local hires being less flexible to move across locations. In the short term, vendors
with a higher mix of L1 visas are likely to be more impacted.
What about right skilled manpower? Clients and vendors alike agree that
quality supply is a significant constraint, especially as scale builds up. This has
resulted in higher training requirements. With macro trends suggesting
reasonable uncertainty and with customer spend getting more short-cycle,
companies are adopting more flexible recruitment policies (direct hiring in favor of
campus hiring).
Is constrained supply a support for pricing? IT unemployment is running low
in most markets and quality supply is small. This will result in some kind of
support on pricing - clients realize that quality of vendor resources is likely to
suffer if they are too aggressive on pricing.
Will wage inflation play havoc on margins? There seems to be a consensus
view that wage hikes for the year are likely to be in the high single digits range –
keeping up with inflation. Companies are also seeing attrition stabilizing. With an
increase in scale, companies are looking to expand to tier 2 cities in India to
moderate expenses and rein in attrition. If executed successfully, this might be
beneficial in the medium term.
The European Conundrum
Is the crisis driving increased offshoring in Europe? Europe has been a
traditionally difficult market for offshoring due to language and labor barriers. With
the current macro environment exerting pressure on several European
companies with a high cost structure, there seems to be an increasing
acceptance towards greater offshoring. Offshoring seemed to have picked up the
most in the Nordics (recent deals by TDC and Statoil), followed by Germany,
Belenux and France. Companies mentioned that enquiries were also coming in
from traditionally conservative countries like Italy.
Europe an enigma? Europe is a market with very different dynamics compared
with the US - (1) Higher share of investment banking – being more Englishspeaking
and international than retail banking, which is more localized. (2) Higher
share of onsite with a need for more front-ending consultants. (3) Higher billing
rates. (4) More consensus-driven decision making cycles – need more pilot tests.
Can vendors take huge price cuts for market share gains? The offshoring
decision in Europe seems to be driven more by cultural compatibilities with the
vendor than pricing. The investments made by the vendor (local hiring, offices,
vintage, number of employees) seem to be a crucial factor in clinching these
deals, along with their ability to transition the projects quickly.
Is M&A activity likely to accelerate? With Europe being a more localized
market than the US, Indian vendors are looking at quickly ramping up local
presence. While this could also come from transitioning and re-badging customer
resources, M&A remains a key option available. Companies are also exploring
M&A options to build select competencies/product IPs.
Other Key Factors
How will the cash be utilized? Companies in general seemed reluctant to
increase dividend payouts in the near future with an increasing need for
investments – in ramping up presence in new growth areas like Europe and in
exploring non-linear models of engagement.
And how does one prepare for such volatility in currencies? While the
general view was that the rupee is more likely to depreciate, companies continue
with their variable hedging policies. Near term benefits from rupee depreciation
are likely to be reinvested in the business, especially by the smaller players, for
ramping up presence in new geographies and for newer models of engagement.
What about China? As per third party advisors and companies, difficulties still
persist in building a scalable practice in China. Getting the right kind of supply
continues to be a challenge and costs are at relatively elevated levels. Indian
vendors are however, still looking to build auxiliary bases to complement their
India presence in the longer term.
Our top picks are CTSH/EXLS in US IT/BPO, WPRO/HCLT in India IT and
CAP/ATOS (ATOS.PA; €42.79; 1) in European IT.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Citi India IT Services Tour Takeaways
Mellow Macro, Mixed Micro
Is there too much focus on IT budgets? — Focus on IT budgets seems to be
overrated, according to most companies. While budgets being largely flattish sets the
tone/direction for CY12, vendors do not have clarity on how the spending patterns will
evolve (depends on a stable macro). With project cycles getting shorter and the macro
being volatile, companies expect greater volatility in quarterly growth.
Is Nasscom's forecast of 11-14% growth realistic? — While it is too early to take a
firm view, most companies did agree that it was a realistic starting point and Nasscom
has also said it will review it at a later stage. Cognizant has guided to at least 23%
growth - however, we view that as a case of market share gains, in line with
Cognizant's performance over the past few years. Mid-teens BPO growth should also
be achievable for industry leaders, based on the net of signed contracts, wallet share
gains and promised productivity improvements.
Where can vendors look for growth? — With the current macro environment putting
pressure on several European companies with a high cost structure, there seems to be
an increasing acceptance of greater offshoring. Local investments/hiring by vendors
and culture seem to be key decision-making factors for buyers, over pricing.
Is there a risk to pricing? — Third-party advisory firms are talking of the market being
very competitive and customers demanding more, though not always in the form of
aggressive pricing. Supply remains tight, and we believe will protect any downside to
pricing, unless there is a catastrophic scenario that impacts demand.
Are discretionary spends slowing? — Most clients acknowledged slower decision
making with key trends being: (1) Short term high-ROI projects continue to do well; (2)
“Enterprise solutions” is doing well, particularly around areas like Business
Intelligence/analytics; (3) Larger rollouts are fewer and are being broken down into
phases; (4) Consolidation of “Run The Business” to fund critical discretionary projects.
Are parts of the business getting commoditized? — Interestingly, there is
consensus that parts of the traditional ADM business are getting commoditized and
companies need to focus on value-addition/newer engagement models/non-linearity to
do well in future. The market is moving towards outcome-based models and companies
will need to innovate to do well. There was near-consensus on investment areas –
Analytics, Cloud, Mobility, Platforms etc; execution here is key.
Our view — (1) The structural story of Indian IT continues, although near-term decision
making could continue to be slow; (2) While a tight supply could support pricing, it
could put pressure on margins – offshore wage inflation to be high single digits next
year; (3) Non-linearity and new engagement models to become more important given
supply constraints and commoditization of part of the ADM work. Our top picks are
CTSH/EXLS in US IT/BPO, WPRO/HCLT in India IT and CAP/ATOS in European IT.
Top-Down Bleak; Bottoms-Up A Mixed Bag
Citi hosted clients on a 4-day (21-24 Feb) IT services tour across Bangalore,
Chennai, NCR and Mumbai. We met a cross-section of companies –
Indian/European/US-listed IT Services/BPO companies, third-party advisors,
supply-side consultants etc. Post the trip, we address the key relevant queries that
came up in our investor interactions.
The top-down outlook of most participants was mellow – IT budgets across
the board are flattish/slightly down. While recent data points in the US are
relatively positive, companies are unclear about the sustainability. This has led to
continued uncertainty in the velocity of spending. With constraints of flat budgets,
CIOs are resorting to rationalization of relatively commoditized services like ADM
to self-fund tactical discretionary projects with higher visibility of RoIs.
However, bottom-up it was a mixed bag
– Positives: (1) Higher traction of offshoring in Europe after several years of
investments in these markets. (2) There is good traction in Insurance,
Manufacturing and Healthcare verticals. (3) Attrition and wage inflation
(expected to be in high single digits for the year) are largely under control. (4)
Client recognition of supply constraints acts as a support for pricing.
– Negatives: (1) Majority of the companies expect BFS to grow slower than
company averages. (2) Large-scale discretionary projects are not happening –
new ERP license income while up, may not translate into higher services
revenues due to an adverse mix. (3) Non-linearity seems to be a while away.
In Search of the Next Leg of Growth
Is there too much investor focus on IT budgets? — Focus on IT budgets
seems to be overrated, based on our conversations with most companies. While
budgets in most cases are largely flattish and mostly decided, there was
consensus on the fact that spending is key. Much of the spending is secure "Run
the Business" activity. There are also projects that are mandatory (e.g.
Regulatory) and Highly Strategic (e.g. Mobile Banking). Beyond this "Must
Happen" work, all incremental spends will be determined by the macro outlook,
as the year progresses. While budgets set the tone/direction, quantum of spends
will depend on how clients feel about their business outlook and that can change
materially over the year, as has been witnessed in past years.
Where is pricing headed? Companies across the board agreed that pricing was
stable, and likely to remain at these levels. While recent data points, particularly
from the US, are positive, clients are uncertain about the sustainability. If the
macro outlook were to remain uncertain, there could be risks to standard cost-ofliving-
based increases.
What is the outlook on BFS? The Banking & Financial Services vertical is
expected to grow, but slower than company averages - BFS in Europe largely
caters to the investment banking segment, which is more global than retail
banking, which has a strong local focus. Thus growth is more dependent on the
macro outlook. There are no challenges in budget closures/ spending in the retail
banking segment. Regulatory spend, while expected to be a medium-term driver,
is yet to practically translate into higher revenues.
Are there any other vertical-specific trends? (1) Insurance, Manufacturing and
Healthcare are seeing good traction. (2) The telecom equipment segment
remains weak. (3) Retail saw a slowdown towards the end of 2011. These are the
broad trends we picked up, while there are differences among companies based
on their relative capabilities and penetration across verticals.
Are discretionary spends slowing? While there is no denying that longer term
transformational projects are very few, buyers continue to roll out shorter term
tactical projects with a clear visibility on RoIs. Even the few large projects are
now increasingly being broken into smaller phases with RoIs at each phase
being monitored before proceeding to the next. In a scenario where budgets are
flattish, CIOs are looking to self-fund these discretionary projects by rationalizing
maintenance spends and simplifying/consolidating the number of apps.
Is there corresponding slowdown in SAP/Oracle demand? New ERP license
income has recovered well and is back to pre-recession levels. However, a lot of
growth is in Business Intelligence. This resultant change in mix has led to lower
services demand since BI/CRM does not have the same multiplier effect as
traditional core ERP.
Who will gain market share? We interacted with third-party advisors on the
subject of vendor consolidation, which has driven market share gains over the
last few years. Trends suggest that consolidation is likely to continue and favor
tier 1 vendors more (partly as clients focus their energies on working with top few
strategic vendors). HCLT also highlighted the huge rebid opportunity of ~$207b
over the next 5 years – largely in BFSI and Manufacturing verticals.
Offshore players vs. multinationals? There seems to be a convergence in
business models with European vendors increasing their offshore presence and
Indian vendors hiring locally to build an onsite platform. The jury is still out on
which way the market is headed – interactions suggest that Indian vendors have
a more integrated offshore platform which, coupled with difficulties in building up
scale due to supply constraints, will continue to benefit in the near to medium
term. First-time outsourcers are still found to prefer MNCs.
How are the companies pursuing non-linearity? Non-linear models of
engagement are being necessitated by commoditization of services and supply
constraints. Vendors seem to strongly believe in an asset-light model and are
focused on building services around product IPs. But companies agreed that it
takes multiple years to build up non-linear revenues organically, making them
explore inorganic growth opportunities as well. However, benefits are likely to be
a while away, kicking in post integration between services/platforms/BPO etc.
Does integrated IT/BPO make sense? The camp seems evenly split on this
one with traditional BPO companies claiming to accrue more productivity savings
for their buyers, thus helping them gain market shares. Interestingly, traditional
model continues to benefit in most cases given buyer segments in an
organization are different for IT and BPO. We believe that as the industry
matures and buyers rationalize/simplify procurement, greater integration will be
encouraged. Savings are likely to accrue more back-ended.
New areas like analytics, cloud and mobility? There was near-consensus on
investment areas - Analytics, Cloud, Mobility, Platforms etc. With the onset of
solutions like mobile wallet and a 4G rollout, India is likely to hold good potential
for mobility. Spends in analytics are likely to driven by the need to transition
traditional solutions to a real-time basis. Executing scalable strategies will be key.
Supply-Side Hurdles
Is there more to the visa hurdle than mere rhetoric? Of late, media reports
are highlighting increases in visa rejections - protectionist policies and scale
playing a part in the rise. Companies accept that these issues are likely to persist
and perhaps increase in the run-up to the US elections, and are looking to ramp
up local hiring and re-badging customer resources. While not directly impacting
margins by way of a higher cost, companies expect this to impact utilizations with
local hires being less flexible to move across locations. In the short term, vendors
with a higher mix of L1 visas are likely to be more impacted.
What about right skilled manpower? Clients and vendors alike agree that
quality supply is a significant constraint, especially as scale builds up. This has
resulted in higher training requirements. With macro trends suggesting
reasonable uncertainty and with customer spend getting more short-cycle,
companies are adopting more flexible recruitment policies (direct hiring in favor of
campus hiring).
Is constrained supply a support for pricing? IT unemployment is running low
in most markets and quality supply is small. This will result in some kind of
support on pricing - clients realize that quality of vendor resources is likely to
suffer if they are too aggressive on pricing.
Will wage inflation play havoc on margins? There seems to be a consensus
view that wage hikes for the year are likely to be in the high single digits range –
keeping up with inflation. Companies are also seeing attrition stabilizing. With an
increase in scale, companies are looking to expand to tier 2 cities in India to
moderate expenses and rein in attrition. If executed successfully, this might be
beneficial in the medium term.
The European Conundrum
Is the crisis driving increased offshoring in Europe? Europe has been a
traditionally difficult market for offshoring due to language and labor barriers. With
the current macro environment exerting pressure on several European
companies with a high cost structure, there seems to be an increasing
acceptance towards greater offshoring. Offshoring seemed to have picked up the
most in the Nordics (recent deals by TDC and Statoil), followed by Germany,
Belenux and France. Companies mentioned that enquiries were also coming in
from traditionally conservative countries like Italy.
Europe an enigma? Europe is a market with very different dynamics compared
with the US - (1) Higher share of investment banking – being more Englishspeaking
and international than retail banking, which is more localized. (2) Higher
share of onsite with a need for more front-ending consultants. (3) Higher billing
rates. (4) More consensus-driven decision making cycles – need more pilot tests.
Can vendors take huge price cuts for market share gains? The offshoring
decision in Europe seems to be driven more by cultural compatibilities with the
vendor than pricing. The investments made by the vendor (local hiring, offices,
vintage, number of employees) seem to be a crucial factor in clinching these
deals, along with their ability to transition the projects quickly.
Is M&A activity likely to accelerate? With Europe being a more localized
market than the US, Indian vendors are looking at quickly ramping up local
presence. While this could also come from transitioning and re-badging customer
resources, M&A remains a key option available. Companies are also exploring
M&A options to build select competencies/product IPs.
Other Key Factors
How will the cash be utilized? Companies in general seemed reluctant to
increase dividend payouts in the near future with an increasing need for
investments – in ramping up presence in new growth areas like Europe and in
exploring non-linear models of engagement.
And how does one prepare for such volatility in currencies? While the
general view was that the rupee is more likely to depreciate, companies continue
with their variable hedging policies. Near term benefits from rupee depreciation
are likely to be reinvested in the business, especially by the smaller players, for
ramping up presence in new geographies and for newer models of engagement.
What about China? As per third party advisors and companies, difficulties still
persist in building a scalable practice in China. Getting the right kind of supply
continues to be a challenge and costs are at relatively elevated levels. Indian
vendors are however, still looking to build auxiliary bases to complement their
India presence in the longer term.
Our top picks are CTSH/EXLS in US IT/BPO, WPRO/HCLT in India IT and
CAP/ATOS (ATOS.PA; €42.79; 1) in European IT.
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