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Growing from strength to strength
We see material expansion in the
addressable enterprise applications
market for Indian IT companies
Expect robust earnings growth of +20%
in FY12; current valuations not stretched
Reiterate OW on INFO, TCS and HCLT
IT demand has surprised positively in 2010. We believe this
strength is likely to carry forward as we expect a +25% topline
growth (USD) in FY12. While strength in the vertical
markets (such as Banking and Retail) is increasingly evident,
we believe the street has yet to appreciate multiple positive
trends in the horizontal markets, such as enterprise
applications (EAS). These trends reinforce our positive
outlook on the sector and provide further confidence to our
estimates, which are modestly higher than consensus.
EAS, the largest horizontal market (next only to custom
applications market) is likely to remain buoyant in 2011/12.
Improving new license sale of software companies, such as
SAP/Oracle is a positive read-across for Indian IT. However, that’s
not just the positive news. We expect material expansion in the
addressable EAS market due to secular trends such as consolidation
(M&A) in the global software market, software stack war amongst
mega software companies and strong pipeline of new product
releases. While all the top-4 companies should benefit from these
trends, we see Infosys and HCLT to be the key beneficiaries.
Expect Telecom to recover as newer frontiers of growth
accelerate overall growth: We expect a revival in the Telecom
market (led by offshoring in the wireless market) to complement
the strength in the banking sector in FY12. Additionally, new
frontiers of growth such as Healthcare (HC), Retail, Energy &
Utilities (>20% of revs) are likely to accelerate overall growth of
the sector. Along with offshore adoption, regulatory requirements
in HC and demand for front-end solutions, analytics & digital
marketing in retail should fuel stronger IT spend, in our view.
Estimates/Valuation: We estimate robust earnings growth of
+20% in FY12 (revenue growth of +25% (USD terms), stable
EBITDA margins and a one-time increase in the tax rate (due to
STPI tax exemption sunset). In view of the robust earnings growth
outlook, we believe current valuations are not stretched and stock
returns should be “at least” in line with earnings growth. We are
OW on INFO, TCS and HCLT.
Investment Summary
We see material expansion in the addressable enterprise
applications market (EAS) for Indian IT companies
This expansion in the horizontal market complements our positive
view on most vertical demand markets
We remain positive on the overall demand outlook
IT demand has surprised positively in 2010, with
the top-four IT companies growing 23% in the
year. We believe this strength is likely to carry
forward as we expect a +27% top-line growth
(USD) in FY12. While strength in the vertical
markets (such as Banking and Retail) is
increasingly being evident, we believe the street
has yet to appreciate multiple positive trends in
the horizontal markets, such as EAS (Enterprise
Applications Services).
EAS, the largest horizontal market (next to
custom applications market) is likely to remain
buoyant in 2011/12. We expect material
expansion in the addressable EAS market due
to not just an improving software license sale
but various secular trends such as
consolidation (M&A), software stack war (see
page 10 for details) and strong line-up of new
product releases. These trends reinforce our
positive outlook on the sector and provide further
confidence to our estimates, which are modestly
higher than consensus
Enterprise applications market to remain
buoyant in 2011/12 (EAS > 20% of revenues)
Improving new license sale by mega software
companies such as SAP and Oracle is a positive
development for the downstream IT services
providers, such as Indian IT companies. In this
report, we illustrate how it’s not just the license
sale, but many trends in the software market
which are increasing the demand for IT services.
The global software market is going through
significant consolidation, which is increasing the
addressable market for large services providers
who have strategic relationships with mega
software providers. Furthermore, software stack
war and strong focus on innovation and therefore
the release of new products and newer versions of
legacy applications are resulting in higher spend
by customers. This should benefit downstream
Indian IT companies, in our view, who would
provide implementation, maintenance and
enhancement services around these products to
the customers. While all top-four companies
should benefit from these trends, we see Infosys
and HCLT to be the key beneficiaries.
Incumbent dominant demand markets looking up
(BFSI + Telecom = c50% of revenues)
BFSI: We believe regulations such as Dodd-Frank,
Basel II/III etc are likely to influence numerous IT
changes in the financial/banking systems over the
coming years. Furthermore, spending on risk
management initiatives by BFSI institutions such
as anti-money laundering are ever increasing, even
after years of investing due to changing regulatory
regime and significant cost of non-compliance or
reported incidence. The CARD Act, 2009, is
another illustration of multi-year implementation as
regulatory requirements remain dynamic,
warranting IT application changes, data
collection/integration work, report generation and
know-your-customer systems.
Telecom: The telecom sector, which represents
around 20% of the Indian IT sector’s revenues, has
been a laggard in the recent recovery. For the top-4
Indian IT companies, revenues from the telecom
sector have declined from 22% in 1Q FY08 to 15%
in 2Q FY11. This is about to change – we expect
these revenues to accelerate in FY12-13 and grow at
least in line with the overall Indian IT sector.
Telecom companies will increasingly cut wireless
costs in a bid to preserve cash needed to invest in
their next-generation networks. Much of this will
be done through outsourcing, which will benefit
Indian IT companies. At the same time, TSPs
(Telecom Service Providers), keen to monetise the
surge in data use, are starting to offer consumers
more varied plans, moving away from the “all you
can eat” packages. This will require new billing
systems and other customer services, which will
also benefit the Indian IT sector.
Newer markets adding the spice (Retail + Energy
& Utilities + Healthcare > 20% of revs)
New frontiers of growth such as Healthcare and
Retail have provided stronger revenue growth in the
recent quarters. While offshore adoption is the
primary driver across these markets, regulatory
requirements in healthcare and demand for front-end
solutions, analytics and digital marketing is fuelling
stronger IT spend in the retail market.
Sector outlook and valuation
As per the latest HSBC demand index value and
anecdotal evidence from the leading indicators of the
sector IT services demand is on track. We estimate
robust earnings growth of 20% in FY12 (revenue
growth of +25% (USD terms), stable EBITDA
margins and a one-time increase in the tax rate (due
to STPI tax exemption sunset).
In view of the robust earnings growth outlook, we
believe current valuations are not stretched and stock
returns should be “at least” be in line with earnings
growth. While TCS is likely to outperform peers in
4QFY11 as well, we believe Infosys should catch up
in FY12 and should grow at least inline with TCS, in
our view. We are OW on Infosys, TCS and Wipro.
Risks: INR appreciation and wage inflation are key
risks to our margin forecasts for the sector. Macroeconomic
slowdown and any protectionist
legislation in US could pose a risk to our top-line
growth estimates.
INR/USD risk: We have assumed INR45 for our
FY12/13 estimates. INR appreciation is a key risk
for the sector. Every percent change in the
INR/USD rate impacts EBITDA margins by
c40bps and earnings by 2-5% for the top-4
companies in the sector.
Enterprise Applications
Second largest horizontal demand market for Indian IT
While improving product license sale is noteworthy, latest trends
in the global software market, such as software stack war…
…software vendor consolidation and product innovation
significantly expands the addressable EAS market, in our view
Enterprise applications market (EAS) is the
largest horizontal demand market for Indian IT
services companies, next only to custom
applications market. Enterprise software
providers, such as SAP, Oracle, IBM, Microsoft
and TIBCO, sell software product licenses, which
are implemented and maintained by Indian IT
services companies.
Performance check
Revenue growth from the EAS market has been
modestly stronger than the overall revenue growth
for the top-four Indian IT companies (we have
considered the past 5 quarters, since the
beginning of recovery for this analysis).
Contribution from EAS to the total revenues has
therefore increased from 18.8% of revenues in
2QFY10 to 19.2% in 3QFY11.
In our view, the outlook remains bright. Not
only because the software license sale by large
software companies such as SAP/Oracle has
improved in the recent quarters, but also due
to many secular trends in the software market,
which warrant positive bias for downstream
IT services.
Consolidation (M&A) in the global software
market, software stack war and strong pipeline of
new products/versions has significantly expanded
the addressable EAS market for Indian companies
and reinforce our positive outlook on the revenues
from this market.
EAS outlook – positive secular
trends
As mentioned above, Indian IT companies
provide downstream implementation and
maintenance services to software products. In that
regard, the value and number of licences sold is a
key leading indicator for IT services providers.
Software license sale has been improving…
Software license sale of the leading software
companies, such as SAP and Oracle has been
improving in the recent quarter (see chart 2.3 and
2.4), which is a positive news for IT services
companies.
SAP reported a robust license sale of 35% y-o-y
(25% in constant currency) in 4Q10. Large deals
(>EUR5m) are back and contributed 25% of the
total license sale in 4Q and is an indication of
large implementations coming back to the table.
SAP management clarified that this is not pent-up
demand and they see sustained revival in the
large-ticket traditional ERP work back on the
table. In the developed markets, even if clients are
not upgrading the ERPs, they are consolidating
their edge applications, such as CRM, Analytics,
procurement etc on the the SAP suite. New ERP
licenses are also sold in markets such as Retail,
HealthCare, banking and financial services, and
new services such as energy efficiency.
It is noteworthy to look at the significant absolute
value of the license sale (as it is more relevant for
Indian IT companies), considering that 4Q is
seasonally the strongest quarter and contributed
46% of the annual license sale in 2010.
…but it’s not just about license sale
It is not just the license sale which is making us more
positive on the EAS market outlook. We identify
evolving trends in the enterprise software market
which are increasing the addressable market for the
Indian IT companies. These are likely to result in
stronger growth for Indian vendors
We discuss these trends in detail in this section:
A. Consolidation in the software
market has increased the
addressable market
Enterprise software market has gone through
significant M&A activity in the past 10 years,
resulting in polarisation of the software market.
Oracle’s M&A history is illustrative
To illustrate the extent of consolidation, Oracle in
the past six years has made over 70 acquisitions,
spending nearly USD45bn. In the process, Oracle
has consolidated many large software companies
such as PeopleSoft (HRM1), Siebel (CRM2),
Hyperion (Analytics), Agile (SCM3) and BEA
(Middleware). IBM and SAP have been equally
active with IBM gobbling up Cognos
(BI/Analytics), Ascential (Data Integration),
Netezza (Data warehousing) etc and SAP picking
up BOBJ4 (BI5/Analytics) and Sybase.
How Indian vendors will benefit?
Indian vendors, usually have strategic
partnerships with the large software providers
such as SAP and Oracle. As large companies
acquire smaller software companies and
integrate the product portfolio, the addressable
market for IT services vendors expand as well.
Taking Infosys as the example, the company has
nearly 45% of its EAS revenues coming from the
Oracle market, 35% from the SAP market and
near 20% from other software companies such as
TIBCO and Microsoft.
IBM has already earmarked USD20bn for
acquisitions in the coming years.
We believe as consolidation continues, the
opportunities for IT services companies would
continue to increase and expand the
addressable market.
B. Software stack war is further
expanding opportunities for large IT
services vendors
While this is partially linked to the above
discussed consolidation in the software market,
software giants have over the recent past focused
on building a full stack of offerings (refer chart
2.7 and 2.8).
Both inorganic and in-house initiatives are being
made to achieve an end-to-end stack of solutions.
SAP’s acquisition of Sybase to target the database
market and Oracle’s Sun acquisition are classic
examples of the stack war imminent in the global
software market.
In the past few years, significant consolidation has
happened in the software industry. Business
Intelligence, for instance, believes there are hardly
any standalone companies left in the market. All
the top companies such as Business Objects
(BOBJ), Cognos, and Hyperion have been
acquired by large software providers looking to
cross-sell BI/Analytics into their existing client
base of enterprise software.
Software stacks would mean more cross-sell of
applications, market share shifts and
expansion of the software market – all positive
read-across for the Indian IT industry.
C. Data growth is driving innovation =
higher demand for downstream IT
services
Daily data volume globally has grown
exponentially in the past few years. Growing
cloud computing, social media, mobile
computing, RFID/sensors etc are generating
significant volume of data. It is not only critical to
capture this data but to also effectively (both in
terms of speed and sense) analyse this data to
identify business/market trends.
Global software companies, such as Oracle and SAP
are therefore investing in new database and
analytical solutions to address the above mentioned
data deluge. Oracle’s Exadata and SAP’s in-memory
databases are attempts to accelerate the analytical
processing and therefore a strong boost to the BI and
business Analytics market.
Indian IT companies are not only involved with
software companies to develop these solutions but
are also the likely beneficiaries of the growing
demand for transactional and analytical solutions.
D. Software upgrades
One of the key areas of growth for software
product companies (and so as for IT services
companies) is the continuous upgrade of legacy
products. Software products companies on a
regular basis upgrade their older version of
software with new functionality and technology.
The up-gradation process requires assistance from
channel partners such as Infosys, TCS etc to help
customers perform the upgrade/transition
seamlessly with minimum business disruption.
Successful adoption of any new version of
software therefore results in stronger demand
for IT services (upgrade/transition). In that
context, the continuous innovation by large
software providers such as Oracle and SAP has
resulted in stronger growth for IT services.
For instance, Oracle in 2009, introduced its latest
version of database "Database 11g release 2" and
middleware "Fusion Middleware 11g R2". Both the
products have witnessed strong traction and upgrade
cycle has been stronger than the previous upgrade
cycle, particularly for middleware solution.
E. Market share shifts/Market
expansion
Introduction of new solutions/functionalities by
software providers also is resulting in market
share gains by the innovator or in some instances
expansion of market. Oracle, for instance, has
100,000 middleware customers and nearly 20,000
application customers, which means there is an
opportunity to cross-sell enterprise applications to
the existing middleware customers. This might
result in dislodging existing solutions or a firsttime
buy by a customer, both of which should be
positive developments for an IT services provider.
Vertical Demand Markets
Telecom
Telecom sector has been a laggard in the recent recovery
We expect stronger capex/spending on new services and cost
rationalisation by TSPs to result in a recovery in IT spending in
2011 and beyond
This further improves top-line visibility for Indian IT
The telecom sector, which represents 20% of
revenues for the overall Indian IT sector, has
remained a laggard in the recent recovery. For the
top-four Indian IT companies, telecom revenues
have declined from 22% in 1Q FY08 to 15% in
2Q FY11. We believe these revenues are likely to
accelerate in FY12 as telecom companies increase
capital investment and cut operational expenses
further, particularly in wireless.
Operational efficiency the key
driver
Telecom companies typically spend c3-4% of
revenues on IT systems and OSS/BSS services
(Operation support services / Business support
services). According to research from Insight
Research Corporation, the OSS/BSS services market
was cUSD42bn in 2007 and is expected to increase
at a CAGR of 8.5% to cUSD63bn by 2014.
The focus on next generation technology is
causing TSPs to rationalise and standardise
their existing legacy networks. This will reduce
the maintenance burden and free up capital for
next generation networks that can be overlaid on
the old ones. Outsourcing is increasingly the
preferred route for this process.
Wireless overtaking wireline
Wireline has dominated outsourcing in the
telecom market. As wireline growth stagnated,
companies focused on efficiency gains. For
wireless, the growth market, the emphasis has
been on launching new services and adding
subscribers rather than cost cutting. We believe
this is changing and wireless will soon become
the dominant outsourcing theme.
In turn, this should also lead to stronger growth in
BSS (customer facing, analytics) than OSS, where
significant consolidation and efficiency gains
have already been achieved.
Spend on new functionalities &
initiatives to increase
In terms of new initiatives by Telcom Services
Providers (TSPs), there are multiple ways it
impacts IT spending:
Maintenance investment is usually focused on
increasing the number of towers, civil work,
equipment repair or replacement. Usually, 2-
3% of the maintenance capex is focused on IT.
IT systems (new billing systems, launch of
new services/plan).
Capital investment in new technology such as
LTE/4G: Along with maintenance capex,
telecom companies invest in new
technologies to remain competitive.
Historically, there have been significant
upgrades (e.g. 2G to 3G in early 2000), which
have resulted in significant increase in capex
by TSPs. Telecom companies in the west are
on the cusp of investing in 4G/LTE.
While investments in 4G and new technologies
could result in strong pick-up in capital
expenditure by TSPs, we believe Indian IT
companies are likely to benefit from the
increasing focus by TSPs on introducing new
services and functionalities for their customers.
A deluge of data traffic could drive
investments in new billing systems
Smartphone penetration has continued to rise rapidly
and every successive generation of these devices has
led to consumption of ever greater bandwidth.
In numerical terms, a typical voice user might
uses the equivalent of circa 5MB of network
capacity per hour. This means a customer making
five hours of voice calls per month consumes
around 25MB. By comparison, feature phones or
email-only BlackBerrys use up to 3x more than a
voice-only customer.
Estimates vary considerably, but the typical
iPhone user uses up to 500MB per month, which
is 5-6x the usage of a non-smartphone data user.
Wireless laptops typically consume even greater
bandwidth, perhaps as much as 2GB per month,
or 4x that of an iPhone.
A laptop user requires 80x the capacity of a basic
voice customer – and bear in mind that most
laptop owners also have a smartphone. Put the
laptop and smartphone together and the increased
usage is more likely to be 100-fold.
Against this backdrop, it is hardly surprising that
mobile data traffic continues to grow at a
prodigious rate:
AT&T notes a 50x increase in data traffic
over the past three years (AT&T CEO R
Stephenson on CNBC, 15 June 2010).
O2 UK’s CEO, Ronan Dunne, said in June
that data traffic is continuing to double every
four months.
TeliaSonera stated at its Q2 2010 results that
there had been a roughly three-fold increase
in data volumes between 2008 and 2009; the
company expects 2010 traffic to double year
on year.
It is fair to say that data pricing policies have
lacked variety, with flat “all you can eat”
packages being the norm. After years of
disappointment about data growth, operators
appear to have been surprised by the sudden
increase in demand.
There are signs that operators are now beginning
to employ a better approach in terms of price
segmentation. This includes charging more for
data bundles that prioritise the customer’s data
packets when the network is heavily loaded. This
effectively mimics the traditional peak/off-peak
tariff model.
The problem with the “all you can eat” approach
is that there is little incentive to stimulate greater
consumption by lighter users or encourage those
hogging excessive capacity from cutting back.
This strategy has its origins in the excessively
expensive 3G auctions held during the internet
bubble. Given the prices paid, expectations for
data services were tremendously high, in line with
the level of disappointment.
In retrospect, the initial speeds achieved by 3G were
inadequate, as were the handsets. Today, the arrival
of devices like the iPhone in tandem with
infrastructure capable of providing decent bandwidth
has changed the landscape dramatically.
In the intervening years, the lack of uptake was a big
embarrassment to the operators. In an effort to
stimulate usage, they introduced pricing plans with
tariffs that were not intended to curtail usage. So,
when data demand did take off, operators were left
with completely inappropriate pricing structures.
It is clearly time for a rethink. In particular, we
think operators should begin tailoring their
offerings to the needs of their different users, their
ability to pay and their cost to service. This entails
segmentation of the customer base, which – as
any pricing textbook will tell you – is crucial if a
company is to achieve the best prices for its
products or services.
Without segmentation, operators are pricing at the
lowest common denominator rather than at levels
that reflect the potentially much higher value that
individual segments place on a given service.
Segmentation also enables operators to map their
costs to supply with customer demand and thereby
maximise profitability.
Banking & Fin Services
Regulation/compliance-led IT spending is likely to grow again in
2011, along with continued cost cutting led offshore growth
Expect discretionary services to contribute near one-third of the
+25% growth expectation in 2011, with a positive bias
We remain positive on the long-term growth fundamentals
Banking and Financial
Services (BFS)
Compliance/financial regulation-led IT spending,
M&A integration work and cost-cutting-led
offshoring have been the backbone of robust
revenue growth from the banking and financial
services (BFSI) market in the past 12 months
(+22% vs. 18% overall revenue growth). We are
often asked by investors whether and to what
extent this spending is sustainable. Based on our
conversation with the Regional BFSI Heads of
large IT companies and many sector experts, we
expect these three drivers to add over 70% of the
expected +25% overall revenue growth from the
BFSI market in 2011. Macro-recovery driven
discretionary spending, therefore remains the key
to the potential upside on the current estimates;
we remain positively disposed to the same.
We expect sustained growth in
compliance/regulation-led IT spending in 2011.
We believe regulations such as Dodd-Frank, Basel
II/III etc are likely to influence numerous IT
changes in the financial/banking systems over the
coming years. Furthermore, spending on risk
management initiatives by BFSI institutions such
as anti-money laundering are ever increasing,
even after years of investing due to changing
regulatory regime and significant cost of noncompliance
or reported incidence. The CARD
Act, 2009, is another illustration of multi-year
implementation as regulatory requirements remain
dynamic, warranting IT application changes, data
collection/integration work, report generation and
know-your-customer systems.
Overall, we expect revenues from the BFSI market
to grow +25% in 2011. We estimate compliance and
regulation-related IT spending will still contribute
27% of incremental revenues. M&A-related
integration IT work is likely to decline by c30% y-oy,
and contribute c16% of the incremental revenues
compared to its one-third contribution LTM.
Overall, the three growth levers
(regulation/M&A/cost cutting) will contribute the
majority of growth = c70% of the incremental
revenues, which means we assume discretionary
spending picks up and contributes the rest.
Insurance
Similar to the banking and financial services
industry, we find regulatory pressure and market
consolidation the key drivers of IT spending in
2011 for Insurance industry as well. While
insurance companies in the west are struggling to
grow, we expect robust growth in IT spending as
insurance companies focus on increasing
outsourcing (driven by consolidation and cost
cutting) and implementation of new regulations
(most of which have a deadline of 2012).
Demand drivers:
Regulations galore: Multiple seminal
regulations around retail distribution, restricted
advice, personal accounts, capital adequacy
(Solvancy II) have 2012 deadlines and 2011
therefore is likely to see aggressive investment
to adhere to these regulatory deadlines
Market consolidation: The insurance
industry in the west (particularly in UK) lacks
organic growth and is reliant on M&A to
grow the top-line. M&A creates multiple
integration opportunities for IT services
companies as the acquirer looks to achieve
promised synergies by consolidating and
rationalization of platforms.
Consolidation in the closed-book L&P (life
and pension insurance) has been apparent
(success of TCS's Diligenta is a classic
example) in the recent past as providers find it
hard to survive in light of declining profits.
However, we are also finding increasingly
consolidation in the open-book insurance
market as well, to drive operational efficiencies
and profitability. This is creating M&A
integration and offshoring opportunities.
New verticals of growth
Retail, Energy & Utilities and Healthcare markets have been the
new verticals of growth in the recent quarter
These new frontiers of growth are likely to remain strong and…
…provide spice to the steady growth in the traditional markets
Healthcare
Healthcare has been a relatively under-penetrated
market for outsourcing/offshoring. In the recent
quarters, Indian IT companies have been able to
grow strongly in the market and in our view the
growth is likely to continue in the coming quarters
as well.
IT spend from the healthcare market in 2010 is
estimated at cUSD83bn and is likely to grow in
2011 and beyond due to seminal regulations and
multiple healthcare reforms imminent in the US.
To highlight few growth drivers:
Conversion of reimbursement codes from
current standard ICD-9 to ICD-10
US government focus on healthcare reforms,
such as adoption push for EHR (Electronic
health record).
Cost rationalisation: Driven by consolidation
and challenges faced on the patents front,
pharmaceutical companies are increasingly
adopting offshoring to cut down the
operational costs and improve profitability.
Cognisant and HCLT’s success in the healthcare
market in 2010 is noteworthy. Last year, HCLT
signed large outsourcing contracts with
GlaxoSmithKline (over USD100m) and with
Merck (USD500m).
Retail
Retail has been one of the fastest growing
businesses in the last few quarters (for all the top
four companies) and now contributes c13% of the
sector revenues.
We expect the structural growth momentum to
continue, due to these reasons.
Continued offshore adoption by retailers and
CPG (consumer product) companies
Companies cutting down on the back-office
spending on ERP and redeploying the
resources on front-end solutions around
marketing and sales. Companies are spending
more on business intelligence, marketing,
integration of social networking websites and
other avenues of understanding customer
buying behaviour, resulting in higher
spending on IT outsourcing and off-shoring.
Digital marketing and improving in-store
buying for customers are also areas of focus
and increasing technology spend by retailers.
Continued macro-improvement, resulting in
continued positive news in retail sales in
developed economies.
Will supply be a
bottleneck?
Long term supply side concerns unwarranted
Tier II and II cities to see increased proportion of delivery centres
Increase in proportion of non-linear revenues to help ease supply
side pressure further
Supply side concerns
unwarranted
One common concern across investors has been
the likely shortage of manpower to cater to the
strong volume growth in the near term and long
term. Overall, according to data provided by
NASSCOM and our interaction with most IT
companies, the supply side is unlikely to be a
bottleneck of growth in the long term. While the
number of technical graduates (out-turn) increased
to 700,000 in FY11 from 450,000 in FY08,
notably, intake of technical students in FY11 has
been 1.6m6, up from 700,000 in FY06 (greater
than two-fold increase). Interestingly, with
increasing awareness, employability in the
technical graduate pool has increased over the
years and India currently has the highest
employable workforce of all the emerging
markets.
Furthermore, the focus on Tier II and Tier III
cities as the delivery centres would not only ease
supply pressure, but also reduce operational costs
by a further 30-35%. A higher proportion of SEZs
is being opened in these cities to attract
investments by IT companies. Nearly 58% of the
existing workforce belongs to tier II/III cities,
who given a chance would be willing to relocate
to their home towns. Currently, 30% of the SEZs
are in these cities and government has a strong
push to increase this proportion further.
Non-linear revenue growth to help
matters further
Non-linearity and the desire to de-link revenue
growth from headcount growth has been the key
theme in the sector recently. Particularly, top-four
Indian IT companies are investing in standard
tools, reusable services, outcome based pricing
(from per head pricing), platform leverage
(“solutionised” services) and higher valued added
services to achieve non-linearity in revenues.
Initial success is visible with nearly 10% of
revenues for these companies having nonlinear
characteristics. Remote Maintenance services
(RIM), for instance, which accounted for 25% of
the incremental export revenues in the past four
years saw a five-fold increase in revenues in this
period, while the number of employees increased
by four-fold. We believe, while non-linearity will
continue to gradually increase in the coming
quarters, the inflection point would be driven by
the success in platform-based services, which
might take 2-5 years to achieve critical scale.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Growing from strength to strength
We see material expansion in the
addressable enterprise applications
market for Indian IT companies
Expect robust earnings growth of +20%
in FY12; current valuations not stretched
Reiterate OW on INFO, TCS and HCLT
IT demand has surprised positively in 2010. We believe this
strength is likely to carry forward as we expect a +25% topline
growth (USD) in FY12. While strength in the vertical
markets (such as Banking and Retail) is increasingly evident,
we believe the street has yet to appreciate multiple positive
trends in the horizontal markets, such as enterprise
applications (EAS). These trends reinforce our positive
outlook on the sector and provide further confidence to our
estimates, which are modestly higher than consensus.
EAS, the largest horizontal market (next only to custom
applications market) is likely to remain buoyant in 2011/12.
Improving new license sale of software companies, such as
SAP/Oracle is a positive read-across for Indian IT. However, that’s
not just the positive news. We expect material expansion in the
addressable EAS market due to secular trends such as consolidation
(M&A) in the global software market, software stack war amongst
mega software companies and strong pipeline of new product
releases. While all the top-4 companies should benefit from these
trends, we see Infosys and HCLT to be the key beneficiaries.
Expect Telecom to recover as newer frontiers of growth
accelerate overall growth: We expect a revival in the Telecom
market (led by offshoring in the wireless market) to complement
the strength in the banking sector in FY12. Additionally, new
frontiers of growth such as Healthcare (HC), Retail, Energy &
Utilities (>20% of revs) are likely to accelerate overall growth of
the sector. Along with offshore adoption, regulatory requirements
in HC and demand for front-end solutions, analytics & digital
marketing in retail should fuel stronger IT spend, in our view.
Estimates/Valuation: We estimate robust earnings growth of
+20% in FY12 (revenue growth of +25% (USD terms), stable
EBITDA margins and a one-time increase in the tax rate (due to
STPI tax exemption sunset). In view of the robust earnings growth
outlook, we believe current valuations are not stretched and stock
returns should be “at least” in line with earnings growth. We are
OW on INFO, TCS and HCLT.
Investment Summary
We see material expansion in the addressable enterprise
applications market (EAS) for Indian IT companies
This expansion in the horizontal market complements our positive
view on most vertical demand markets
We remain positive on the overall demand outlook
IT demand has surprised positively in 2010, with
the top-four IT companies growing 23% in the
year. We believe this strength is likely to carry
forward as we expect a +27% top-line growth
(USD) in FY12. While strength in the vertical
markets (such as Banking and Retail) is
increasingly being evident, we believe the street
has yet to appreciate multiple positive trends in
the horizontal markets, such as EAS (Enterprise
Applications Services).
EAS, the largest horizontal market (next to
custom applications market) is likely to remain
buoyant in 2011/12. We expect material
expansion in the addressable EAS market due
to not just an improving software license sale
but various secular trends such as
consolidation (M&A), software stack war (see
page 10 for details) and strong line-up of new
product releases. These trends reinforce our
positive outlook on the sector and provide further
confidence to our estimates, which are modestly
higher than consensus
Enterprise applications market to remain
buoyant in 2011/12 (EAS > 20% of revenues)
Improving new license sale by mega software
companies such as SAP and Oracle is a positive
development for the downstream IT services
providers, such as Indian IT companies. In this
report, we illustrate how it’s not just the license
sale, but many trends in the software market
which are increasing the demand for IT services.
The global software market is going through
significant consolidation, which is increasing the
addressable market for large services providers
who have strategic relationships with mega
software providers. Furthermore, software stack
war and strong focus on innovation and therefore
the release of new products and newer versions of
legacy applications are resulting in higher spend
by customers. This should benefit downstream
Indian IT companies, in our view, who would
provide implementation, maintenance and
enhancement services around these products to
the customers. While all top-four companies
should benefit from these trends, we see Infosys
and HCLT to be the key beneficiaries.
Incumbent dominant demand markets looking up
(BFSI + Telecom = c50% of revenues)
BFSI: We believe regulations such as Dodd-Frank,
Basel II/III etc are likely to influence numerous IT
changes in the financial/banking systems over the
coming years. Furthermore, spending on risk
management initiatives by BFSI institutions such
as anti-money laundering are ever increasing, even
after years of investing due to changing regulatory
regime and significant cost of non-compliance or
reported incidence. The CARD Act, 2009, is
another illustration of multi-year implementation as
regulatory requirements remain dynamic,
warranting IT application changes, data
collection/integration work, report generation and
know-your-customer systems.
Telecom: The telecom sector, which represents
around 20% of the Indian IT sector’s revenues, has
been a laggard in the recent recovery. For the top-4
Indian IT companies, revenues from the telecom
sector have declined from 22% in 1Q FY08 to 15%
in 2Q FY11. This is about to change – we expect
these revenues to accelerate in FY12-13 and grow at
least in line with the overall Indian IT sector.
Telecom companies will increasingly cut wireless
costs in a bid to preserve cash needed to invest in
their next-generation networks. Much of this will
be done through outsourcing, which will benefit
Indian IT companies. At the same time, TSPs
(Telecom Service Providers), keen to monetise the
surge in data use, are starting to offer consumers
more varied plans, moving away from the “all you
can eat” packages. This will require new billing
systems and other customer services, which will
also benefit the Indian IT sector.
Newer markets adding the spice (Retail + Energy
& Utilities + Healthcare > 20% of revs)
New frontiers of growth such as Healthcare and
Retail have provided stronger revenue growth in the
recent quarters. While offshore adoption is the
primary driver across these markets, regulatory
requirements in healthcare and demand for front-end
solutions, analytics and digital marketing is fuelling
stronger IT spend in the retail market.
Sector outlook and valuation
As per the latest HSBC demand index value and
anecdotal evidence from the leading indicators of the
sector IT services demand is on track. We estimate
robust earnings growth of 20% in FY12 (revenue
growth of +25% (USD terms), stable EBITDA
margins and a one-time increase in the tax rate (due
to STPI tax exemption sunset).
In view of the robust earnings growth outlook, we
believe current valuations are not stretched and stock
returns should be “at least” be in line with earnings
growth. While TCS is likely to outperform peers in
4QFY11 as well, we believe Infosys should catch up
in FY12 and should grow at least inline with TCS, in
our view. We are OW on Infosys, TCS and Wipro.
Risks: INR appreciation and wage inflation are key
risks to our margin forecasts for the sector. Macroeconomic
slowdown and any protectionist
legislation in US could pose a risk to our top-line
growth estimates.
INR/USD risk: We have assumed INR45 for our
FY12/13 estimates. INR appreciation is a key risk
for the sector. Every percent change in the
INR/USD rate impacts EBITDA margins by
c40bps and earnings by 2-5% for the top-4
companies in the sector.
Enterprise Applications
Second largest horizontal demand market for Indian IT
While improving product license sale is noteworthy, latest trends
in the global software market, such as software stack war…
…software vendor consolidation and product innovation
significantly expands the addressable EAS market, in our view
Enterprise applications market (EAS) is the
largest horizontal demand market for Indian IT
services companies, next only to custom
applications market. Enterprise software
providers, such as SAP, Oracle, IBM, Microsoft
and TIBCO, sell software product licenses, which
are implemented and maintained by Indian IT
services companies.
Performance check
Revenue growth from the EAS market has been
modestly stronger than the overall revenue growth
for the top-four Indian IT companies (we have
considered the past 5 quarters, since the
beginning of recovery for this analysis).
Contribution from EAS to the total revenues has
therefore increased from 18.8% of revenues in
2QFY10 to 19.2% in 3QFY11.
In our view, the outlook remains bright. Not
only because the software license sale by large
software companies such as SAP/Oracle has
improved in the recent quarters, but also due
to many secular trends in the software market,
which warrant positive bias for downstream
IT services.
Consolidation (M&A) in the global software
market, software stack war and strong pipeline of
new products/versions has significantly expanded
the addressable EAS market for Indian companies
and reinforce our positive outlook on the revenues
from this market.
EAS outlook – positive secular
trends
As mentioned above, Indian IT companies
provide downstream implementation and
maintenance services to software products. In that
regard, the value and number of licences sold is a
key leading indicator for IT services providers.
Software license sale has been improving…
Software license sale of the leading software
companies, such as SAP and Oracle has been
improving in the recent quarter (see chart 2.3 and
2.4), which is a positive news for IT services
companies.
SAP reported a robust license sale of 35% y-o-y
(25% in constant currency) in 4Q10. Large deals
(>EUR5m) are back and contributed 25% of the
total license sale in 4Q and is an indication of
large implementations coming back to the table.
SAP management clarified that this is not pent-up
demand and they see sustained revival in the
large-ticket traditional ERP work back on the
table. In the developed markets, even if clients are
not upgrading the ERPs, they are consolidating
their edge applications, such as CRM, Analytics,
procurement etc on the the SAP suite. New ERP
licenses are also sold in markets such as Retail,
HealthCare, banking and financial services, and
new services such as energy efficiency.
It is noteworthy to look at the significant absolute
value of the license sale (as it is more relevant for
Indian IT companies), considering that 4Q is
seasonally the strongest quarter and contributed
46% of the annual license sale in 2010.
…but it’s not just about license sale
It is not just the license sale which is making us more
positive on the EAS market outlook. We identify
evolving trends in the enterprise software market
which are increasing the addressable market for the
Indian IT companies. These are likely to result in
stronger growth for Indian vendors
We discuss these trends in detail in this section:
A. Consolidation in the software
market has increased the
addressable market
Enterprise software market has gone through
significant M&A activity in the past 10 years,
resulting in polarisation of the software market.
Oracle’s M&A history is illustrative
To illustrate the extent of consolidation, Oracle in
the past six years has made over 70 acquisitions,
spending nearly USD45bn. In the process, Oracle
has consolidated many large software companies
such as PeopleSoft (HRM1), Siebel (CRM2),
Hyperion (Analytics), Agile (SCM3) and BEA
(Middleware). IBM and SAP have been equally
active with IBM gobbling up Cognos
(BI/Analytics), Ascential (Data Integration),
Netezza (Data warehousing) etc and SAP picking
up BOBJ4 (BI5/Analytics) and Sybase.
How Indian vendors will benefit?
Indian vendors, usually have strategic
partnerships with the large software providers
such as SAP and Oracle. As large companies
acquire smaller software companies and
integrate the product portfolio, the addressable
market for IT services vendors expand as well.
Taking Infosys as the example, the company has
nearly 45% of its EAS revenues coming from the
Oracle market, 35% from the SAP market and
near 20% from other software companies such as
TIBCO and Microsoft.
IBM has already earmarked USD20bn for
acquisitions in the coming years.
We believe as consolidation continues, the
opportunities for IT services companies would
continue to increase and expand the
addressable market.
B. Software stack war is further
expanding opportunities for large IT
services vendors
While this is partially linked to the above
discussed consolidation in the software market,
software giants have over the recent past focused
on building a full stack of offerings (refer chart
2.7 and 2.8).
Both inorganic and in-house initiatives are being
made to achieve an end-to-end stack of solutions.
SAP’s acquisition of Sybase to target the database
market and Oracle’s Sun acquisition are classic
examples of the stack war imminent in the global
software market.
In the past few years, significant consolidation has
happened in the software industry. Business
Intelligence, for instance, believes there are hardly
any standalone companies left in the market. All
the top companies such as Business Objects
(BOBJ), Cognos, and Hyperion have been
acquired by large software providers looking to
cross-sell BI/Analytics into their existing client
base of enterprise software.
Software stacks would mean more cross-sell of
applications, market share shifts and
expansion of the software market – all positive
read-across for the Indian IT industry.
C. Data growth is driving innovation =
higher demand for downstream IT
services
Daily data volume globally has grown
exponentially in the past few years. Growing
cloud computing, social media, mobile
computing, RFID/sensors etc are generating
significant volume of data. It is not only critical to
capture this data but to also effectively (both in
terms of speed and sense) analyse this data to
identify business/market trends.
Global software companies, such as Oracle and SAP
are therefore investing in new database and
analytical solutions to address the above mentioned
data deluge. Oracle’s Exadata and SAP’s in-memory
databases are attempts to accelerate the analytical
processing and therefore a strong boost to the BI and
business Analytics market.
Indian IT companies are not only involved with
software companies to develop these solutions but
are also the likely beneficiaries of the growing
demand for transactional and analytical solutions.
D. Software upgrades
One of the key areas of growth for software
product companies (and so as for IT services
companies) is the continuous upgrade of legacy
products. Software products companies on a
regular basis upgrade their older version of
software with new functionality and technology.
The up-gradation process requires assistance from
channel partners such as Infosys, TCS etc to help
customers perform the upgrade/transition
seamlessly with minimum business disruption.
Successful adoption of any new version of
software therefore results in stronger demand
for IT services (upgrade/transition). In that
context, the continuous innovation by large
software providers such as Oracle and SAP has
resulted in stronger growth for IT services.
For instance, Oracle in 2009, introduced its latest
version of database "Database 11g release 2" and
middleware "Fusion Middleware 11g R2". Both the
products have witnessed strong traction and upgrade
cycle has been stronger than the previous upgrade
cycle, particularly for middleware solution.
E. Market share shifts/Market
expansion
Introduction of new solutions/functionalities by
software providers also is resulting in market
share gains by the innovator or in some instances
expansion of market. Oracle, for instance, has
100,000 middleware customers and nearly 20,000
application customers, which means there is an
opportunity to cross-sell enterprise applications to
the existing middleware customers. This might
result in dislodging existing solutions or a firsttime
buy by a customer, both of which should be
positive developments for an IT services provider.
Vertical Demand Markets
Telecom
Telecom sector has been a laggard in the recent recovery
We expect stronger capex/spending on new services and cost
rationalisation by TSPs to result in a recovery in IT spending in
2011 and beyond
This further improves top-line visibility for Indian IT
The telecom sector, which represents 20% of
revenues for the overall Indian IT sector, has
remained a laggard in the recent recovery. For the
top-four Indian IT companies, telecom revenues
have declined from 22% in 1Q FY08 to 15% in
2Q FY11. We believe these revenues are likely to
accelerate in FY12 as telecom companies increase
capital investment and cut operational expenses
further, particularly in wireless.
Operational efficiency the key
driver
Telecom companies typically spend c3-4% of
revenues on IT systems and OSS/BSS services
(Operation support services / Business support
services). According to research from Insight
Research Corporation, the OSS/BSS services market
was cUSD42bn in 2007 and is expected to increase
at a CAGR of 8.5% to cUSD63bn by 2014.
The focus on next generation technology is
causing TSPs to rationalise and standardise
their existing legacy networks. This will reduce
the maintenance burden and free up capital for
next generation networks that can be overlaid on
the old ones. Outsourcing is increasingly the
preferred route for this process.
Wireless overtaking wireline
Wireline has dominated outsourcing in the
telecom market. As wireline growth stagnated,
companies focused on efficiency gains. For
wireless, the growth market, the emphasis has
been on launching new services and adding
subscribers rather than cost cutting. We believe
this is changing and wireless will soon become
the dominant outsourcing theme.
In turn, this should also lead to stronger growth in
BSS (customer facing, analytics) than OSS, where
significant consolidation and efficiency gains
have already been achieved.
Spend on new functionalities &
initiatives to increase
In terms of new initiatives by Telcom Services
Providers (TSPs), there are multiple ways it
impacts IT spending:
Maintenance investment is usually focused on
increasing the number of towers, civil work,
equipment repair or replacement. Usually, 2-
3% of the maintenance capex is focused on IT.
IT systems (new billing systems, launch of
new services/plan).
Capital investment in new technology such as
LTE/4G: Along with maintenance capex,
telecom companies invest in new
technologies to remain competitive.
Historically, there have been significant
upgrades (e.g. 2G to 3G in early 2000), which
have resulted in significant increase in capex
by TSPs. Telecom companies in the west are
on the cusp of investing in 4G/LTE.
While investments in 4G and new technologies
could result in strong pick-up in capital
expenditure by TSPs, we believe Indian IT
companies are likely to benefit from the
increasing focus by TSPs on introducing new
services and functionalities for their customers.
A deluge of data traffic could drive
investments in new billing systems
Smartphone penetration has continued to rise rapidly
and every successive generation of these devices has
led to consumption of ever greater bandwidth.
In numerical terms, a typical voice user might
uses the equivalent of circa 5MB of network
capacity per hour. This means a customer making
five hours of voice calls per month consumes
around 25MB. By comparison, feature phones or
email-only BlackBerrys use up to 3x more than a
voice-only customer.
Estimates vary considerably, but the typical
iPhone user uses up to 500MB per month, which
is 5-6x the usage of a non-smartphone data user.
Wireless laptops typically consume even greater
bandwidth, perhaps as much as 2GB per month,
or 4x that of an iPhone.
A laptop user requires 80x the capacity of a basic
voice customer – and bear in mind that most
laptop owners also have a smartphone. Put the
laptop and smartphone together and the increased
usage is more likely to be 100-fold.
Against this backdrop, it is hardly surprising that
mobile data traffic continues to grow at a
prodigious rate:
AT&T notes a 50x increase in data traffic
over the past three years (AT&T CEO R
Stephenson on CNBC, 15 June 2010).
O2 UK’s CEO, Ronan Dunne, said in June
that data traffic is continuing to double every
four months.
TeliaSonera stated at its Q2 2010 results that
there had been a roughly three-fold increase
in data volumes between 2008 and 2009; the
company expects 2010 traffic to double year
on year.
It is fair to say that data pricing policies have
lacked variety, with flat “all you can eat”
packages being the norm. After years of
disappointment about data growth, operators
appear to have been surprised by the sudden
increase in demand.
There are signs that operators are now beginning
to employ a better approach in terms of price
segmentation. This includes charging more for
data bundles that prioritise the customer’s data
packets when the network is heavily loaded. This
effectively mimics the traditional peak/off-peak
tariff model.
The problem with the “all you can eat” approach
is that there is little incentive to stimulate greater
consumption by lighter users or encourage those
hogging excessive capacity from cutting back.
This strategy has its origins in the excessively
expensive 3G auctions held during the internet
bubble. Given the prices paid, expectations for
data services were tremendously high, in line with
the level of disappointment.
In retrospect, the initial speeds achieved by 3G were
inadequate, as were the handsets. Today, the arrival
of devices like the iPhone in tandem with
infrastructure capable of providing decent bandwidth
has changed the landscape dramatically.
In the intervening years, the lack of uptake was a big
embarrassment to the operators. In an effort to
stimulate usage, they introduced pricing plans with
tariffs that were not intended to curtail usage. So,
when data demand did take off, operators were left
with completely inappropriate pricing structures.
It is clearly time for a rethink. In particular, we
think operators should begin tailoring their
offerings to the needs of their different users, their
ability to pay and their cost to service. This entails
segmentation of the customer base, which – as
any pricing textbook will tell you – is crucial if a
company is to achieve the best prices for its
products or services.
Without segmentation, operators are pricing at the
lowest common denominator rather than at levels
that reflect the potentially much higher value that
individual segments place on a given service.
Segmentation also enables operators to map their
costs to supply with customer demand and thereby
maximise profitability.
Banking & Fin Services
Regulation/compliance-led IT spending is likely to grow again in
2011, along with continued cost cutting led offshore growth
Expect discretionary services to contribute near one-third of the
+25% growth expectation in 2011, with a positive bias
We remain positive on the long-term growth fundamentals
Banking and Financial
Services (BFS)
Compliance/financial regulation-led IT spending,
M&A integration work and cost-cutting-led
offshoring have been the backbone of robust
revenue growth from the banking and financial
services (BFSI) market in the past 12 months
(+22% vs. 18% overall revenue growth). We are
often asked by investors whether and to what
extent this spending is sustainable. Based on our
conversation with the Regional BFSI Heads of
large IT companies and many sector experts, we
expect these three drivers to add over 70% of the
expected +25% overall revenue growth from the
BFSI market in 2011. Macro-recovery driven
discretionary spending, therefore remains the key
to the potential upside on the current estimates;
we remain positively disposed to the same.
We expect sustained growth in
compliance/regulation-led IT spending in 2011.
We believe regulations such as Dodd-Frank, Basel
II/III etc are likely to influence numerous IT
changes in the financial/banking systems over the
coming years. Furthermore, spending on risk
management initiatives by BFSI institutions such
as anti-money laundering are ever increasing,
even after years of investing due to changing
regulatory regime and significant cost of noncompliance
or reported incidence. The CARD
Act, 2009, is another illustration of multi-year
implementation as regulatory requirements remain
dynamic, warranting IT application changes, data
collection/integration work, report generation and
know-your-customer systems.
Overall, we expect revenues from the BFSI market
to grow +25% in 2011. We estimate compliance and
regulation-related IT spending will still contribute
27% of incremental revenues. M&A-related
integration IT work is likely to decline by c30% y-oy,
and contribute c16% of the incremental revenues
compared to its one-third contribution LTM.
Overall, the three growth levers
(regulation/M&A/cost cutting) will contribute the
majority of growth = c70% of the incremental
revenues, which means we assume discretionary
spending picks up and contributes the rest.
Insurance
Similar to the banking and financial services
industry, we find regulatory pressure and market
consolidation the key drivers of IT spending in
2011 for Insurance industry as well. While
insurance companies in the west are struggling to
grow, we expect robust growth in IT spending as
insurance companies focus on increasing
outsourcing (driven by consolidation and cost
cutting) and implementation of new regulations
(most of which have a deadline of 2012).
Demand drivers:
Regulations galore: Multiple seminal
regulations around retail distribution, restricted
advice, personal accounts, capital adequacy
(Solvancy II) have 2012 deadlines and 2011
therefore is likely to see aggressive investment
to adhere to these regulatory deadlines
Market consolidation: The insurance
industry in the west (particularly in UK) lacks
organic growth and is reliant on M&A to
grow the top-line. M&A creates multiple
integration opportunities for IT services
companies as the acquirer looks to achieve
promised synergies by consolidating and
rationalization of platforms.
Consolidation in the closed-book L&P (life
and pension insurance) has been apparent
(success of TCS's Diligenta is a classic
example) in the recent past as providers find it
hard to survive in light of declining profits.
However, we are also finding increasingly
consolidation in the open-book insurance
market as well, to drive operational efficiencies
and profitability. This is creating M&A
integration and offshoring opportunities.
New verticals of growth
Retail, Energy & Utilities and Healthcare markets have been the
new verticals of growth in the recent quarter
These new frontiers of growth are likely to remain strong and…
…provide spice to the steady growth in the traditional markets
Healthcare
Healthcare has been a relatively under-penetrated
market for outsourcing/offshoring. In the recent
quarters, Indian IT companies have been able to
grow strongly in the market and in our view the
growth is likely to continue in the coming quarters
as well.
IT spend from the healthcare market in 2010 is
estimated at cUSD83bn and is likely to grow in
2011 and beyond due to seminal regulations and
multiple healthcare reforms imminent in the US.
To highlight few growth drivers:
Conversion of reimbursement codes from
current standard ICD-9 to ICD-10
US government focus on healthcare reforms,
such as adoption push for EHR (Electronic
health record).
Cost rationalisation: Driven by consolidation
and challenges faced on the patents front,
pharmaceutical companies are increasingly
adopting offshoring to cut down the
operational costs and improve profitability.
Cognisant and HCLT’s success in the healthcare
market in 2010 is noteworthy. Last year, HCLT
signed large outsourcing contracts with
GlaxoSmithKline (over USD100m) and with
Merck (USD500m).
Retail
Retail has been one of the fastest growing
businesses in the last few quarters (for all the top
four companies) and now contributes c13% of the
sector revenues.
We expect the structural growth momentum to
continue, due to these reasons.
Continued offshore adoption by retailers and
CPG (consumer product) companies
Companies cutting down on the back-office
spending on ERP and redeploying the
resources on front-end solutions around
marketing and sales. Companies are spending
more on business intelligence, marketing,
integration of social networking websites and
other avenues of understanding customer
buying behaviour, resulting in higher
spending on IT outsourcing and off-shoring.
Digital marketing and improving in-store
buying for customers are also areas of focus
and increasing technology spend by retailers.
Continued macro-improvement, resulting in
continued positive news in retail sales in
developed economies.
Will supply be a
bottleneck?
Long term supply side concerns unwarranted
Tier II and II cities to see increased proportion of delivery centres
Increase in proportion of non-linear revenues to help ease supply
side pressure further
Supply side concerns
unwarranted
One common concern across investors has been
the likely shortage of manpower to cater to the
strong volume growth in the near term and long
term. Overall, according to data provided by
NASSCOM and our interaction with most IT
companies, the supply side is unlikely to be a
bottleneck of growth in the long term. While the
number of technical graduates (out-turn) increased
to 700,000 in FY11 from 450,000 in FY08,
notably, intake of technical students in FY11 has
been 1.6m6, up from 700,000 in FY06 (greater
than two-fold increase). Interestingly, with
increasing awareness, employability in the
technical graduate pool has increased over the
years and India currently has the highest
employable workforce of all the emerging
markets.
Furthermore, the focus on Tier II and Tier III
cities as the delivery centres would not only ease
supply pressure, but also reduce operational costs
by a further 30-35%. A higher proportion of SEZs
is being opened in these cities to attract
investments by IT companies. Nearly 58% of the
existing workforce belongs to tier II/III cities,
who given a chance would be willing to relocate
to their home towns. Currently, 30% of the SEZs
are in these cities and government has a strong
push to increase this proportion further.
Non-linear revenue growth to help
matters further
Non-linearity and the desire to de-link revenue
growth from headcount growth has been the key
theme in the sector recently. Particularly, top-four
Indian IT companies are investing in standard
tools, reusable services, outcome based pricing
(from per head pricing), platform leverage
(“solutionised” services) and higher valued added
services to achieve non-linearity in revenues.
Initial success is visible with nearly 10% of
revenues for these companies having nonlinear
characteristics. Remote Maintenance services
(RIM), for instance, which accounted for 25% of
the incremental export revenues in the past four
years saw a five-fold increase in revenues in this
period, while the number of employees increased
by four-fold. We believe, while non-linearity will
continue to gradually increase in the coming
quarters, the inflection point would be driven by
the success in platform-based services, which
might take 2-5 years to achieve critical scale.
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