IT: Is offshoring passé? :: Ambit

Is offshoring passé?
FY12 has been tough for Indian IT offshoring names as industry
growth expectations for the Indian firms are now converging to
that of larger global peers. The industry that was born as a
disruptive innovation in the 1980s and grew inexorably in the
early 1990s seems to be struggling to innovate as it matures. Do
recent trends spell an early demise? We think not. Recent
changes point more to the evolution of a new generation of
offshore outsourcing and hence new a set of winners.

��


FY12 was a very forgettable year for the Indian IT offshoring industry driven by
the confluence of weakening market conditions, loss of competitiveness to
MNC competitors and maturity of current key end markets (US and UK).
Indeed, our updated proprietary customer database (elaborated in our 9 Dec
2011 note ‘Who wins in a downturn?’) suggests weaker demand outlook for
each of the Top four Indian IT firms (see overleaf for charts). Is this then the
death knell for Indian IT offshoring?
Inflexion point rather than demise
The current phase of the market has seen a substantial increase in
infrastructure led deals (26% of contracts awarded) and stagnation of
application led offshoring deals (25% of contracts awarded in CY11). This
industry inflexion point in our view is one of the key reasons for the diversity of
performance between various Indian IT firms and for the convergence of
industry growth rates. Firms that can negotiate this industry evolution better
are more likely to outgrow the industry and emerge as winners.
Survival of the fittest
Sector growth has slowed down for Indian IT firms due to weaker economic
conditions and due to the maturity of geographical or industry verticals (such
as US Financial Services). However, firms positioned to grow from a structure,
focus and geographical perspective will continue to dominate and grow
earnings faster than the underlying market:
 Structure for success: Firms that can sustain delivery competence and
efficiency with size, develop stronger C-suite relationships to deal with
falling importance of client IT departments and leverage local and
nearshore talent successfully to deal with the rising reluctance towards
pure offshoring are likely to be best positioned going forward.
 Focus areas for success: With the growing prominence of IT
infrastructure management deals, companies with a long track record are
few and far between. Furthermore, slowing growth necessitates greater
investment in business development (particularly hunting skills) and
creating strong beachheads in emerging markets such as Latin America
and APAC that are likely to drive demand in the longer term.
With best-in-class delivery, strength in infrastructure deals and emerging
markets we find TCS (TCS IN, $45bn, BUY, 9% upside) best placed from a
structure and focus perspective. HCL Tech (HCLT IN, $6.0bn, BUY, 20%
upside) comes next best and is attractive from a valuation perspective. With
sub-optimal delivery, lack of strength in infrastructure, emerging markets and
weak hunting credentials Infosys (INFO IN, $25bn, SELL, 3% upside) comes
next. Despite reasonable focus on infrastructure and emerging markets,
Wipro (WPRO IN, $17bn, SELL, 15% downside) appears weakest from a
structural perspective comes last. Our changes to estimates reflect the current
environment and relative competitive advantages.