India IT Services Honey, it’s all about the immigration bill these days ::JPMorgan

 The four largest offshore IT Services players (TCS, Cognizant, Infosys and
Wipro) presented at the JPM TMT conference in Boston last week (May 14-
16). Investor focus in the US overwhelmingly stayed put on the immigration
bill and its consequences for the Indian IT industry.
 We continue to think that the net impact of the immigration bill (more
specifically, the proposed provisions/clauses relating to visas and visa
holders) is a net negative for the offshore IT Services industry. It seems
that at the minimum, the net impact would be higher costs (increased visa
costs and realignment of non-immigrant visa wages), which is something it
seems that the various players are reconciled with and agreeable to.

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 It is the “outplacement” clause that will likely be the intense subject of
their negotiation with the various stake holders including the
lawmakers. Also, IT vendors expect that their clients would weigh in at the
appropriate time, as they make the case to their clients that the outplacement
clause will impact clients through restriction to access of visas (50:50 rule
seems much less onerous by comparison).
 Broadly, companies expect the Senate version of the bill to go through
essentially unchanged, but remain optimistic that the House version will
be less onerous. The companies emphasized that there is a scarcity of
qualified IT labor in the US, and the unintended consequence of the bill
would only make the labor situation worse including elevating costs for
clients and pushing more work to offshore locations. As the visa bill induces
greater offshorization over time as an offsetting mechanism, it is only likely
to defeat the purpose of the bill, which is to create more local jobs in the US.
The debate could go into 2014, but Cognizant and TCS have made it very
clear that it is business as usual for them and their clients now.
 Firms that are faring well (Cognizant/TCS) see the industry demand as
healthy while those troubled/struggling (Infosys) continue to trot out the
usual mantra in seeing it as challenging. Both Cognizant and TCS see
discretionary spending ticking up. TCS expressed confidence that even the
beleaguered telecom vertical could grow in FY14 (versus FY13). In contrast,
Infosys continues to trot out the same mantra – macro-challenges, weakness
in discretionary spending, aggressive price posturing by peers. It could
benefit from more candid messaging, in our view.
 Of the lot, Cognizant is perhaps most impacted by the bill, as it
currently stands, with its CY14 EPS impacted by as much as 25%
(taking all the factors into account including outplacement). TCS the
next, while Wipro/HCLT relatively better placed. Details of working
inside. Cognizant is most impacted primarily because of: (a) its lower
margins, and (b) its higher % of revenues from the US (at 78%, it is by far
the most exposed to the US geography than peers). In any case, we see
FY15/CY14 EPS of all the four firms getting impacted by double-digit in %
terms.


There are four factors at play here imposed by the current
visa bill as we understand it
Factor 1:
Higher visa costs (incremental cost of visas is now USD 10,000 for firms with over
50% non-immigrant visa workers in their US worker population) – remember that
this applies to the existing visa stock as well as most visas expiring within 3 years.
 Impact on margins – 60 to 160 bps.
Factor 2:
Complying with the 50:50 rule (localization) and likely wage re-alignment policies
(4 levels of H1B visas is now collapsed into 3 and most offshore IT Services firms
likely to start at level 2 of the new 3-tier H1B pay system) –
 Implied wage inflation could be 15-30% depending on how much below the
new average payable firms are at now.
Factor 3:
Offsetting factors present themselves such as green card sponsorship, ability to pass
on some costs to clients and increasing the offshore content of delivery (TCS could
offset more than peers).
Factor 4:
Outplacement clause which debars sending H1B sponsored employees of H1Bdependent
firms (i.e. those with over 15% of US employees as H1B employees) to
client sites in the US (some interpret this as extending to any type of presence in the
US and not just client delivery centers, a harsher interpretation). This is a
revenue/business model issue that can be partly offset through greater localization/
near-shore centers. This is what worries the companies the most and is likely to be
most debated.
From this snapshot summary table below, Cognizant may be the most
vulnerable to the bill as it currently stands with its CY14 EPS impacted by as
much as 25% (taking all the factors into account). TCS the next and
Wipro/HCLT relatively better placed. Details of working are given inside.
Cognizant is most vulnerable primarily because of: (a) its lower margins, and (b) its
higher % of revenues from the US (at 78%, it is by far the most exposed to the US
geography than peers).


Other points of discussion
What are the arguments/actions that the offshore IT Services industry can &
will employ in their negotiation with the stake-holders (including with the law
makers)?
One, unemployment in the US tech industry is rather low (3-4%). The
consequence of this is that it is actually hard to find available talent as needed. This
shortage gets quite drastic and pronounced in many areas of the US (the Bay area is a
notable exception).
Two, the US education system does not turn out enough, qualified engineering
graduates. The consequence is that the US will have to depend on import of foreign
skilled technology professionals to offset this gap. As an offsetting measure, vendors
will commit themselves to promote and fund STEM (Science, Technology,
Engineering and Mathematics) initiatives at the college level and will commit to
intensified training for homegrown professionals in the US, this is a long-horizon
strategy with long-term benefits (it does not do anything to meet demand for
technical professionals in the US in the near-to-medium term).
Three, the bill, as it currently stands, is a bit inconsistent in places. On the one
hand, the bill envisages raising the visa cap (H1B); yet, on the other hand, it seeks to
block access to visas through the “outplacement” clause.
Four, the bill may have unintended consequences. In potentially inducing greater
offshoring, it may actually restrict the objective of creating local jobs in the US.
Five, obtain the intervention of the US corporate in lobbying against some of the
provisions in this bill. Right now, IT Services firms are engaged in building
awareness among their clients of the consequences of the various measures proposed
in this bill (especially, the outplacement clause).
Six, impress upon the Government of India through industry bodies (such as
Nasscom) the consequences of this bill. The importance of the Indian IT Services
industry to the Indian economy cannot be under-estimated. This sector accounts for
over 5% of India’s GDP and nearly 8-10% on an incremental basis and exerts a
considerable multiplier impact through consumption, real estate expansion and
growth of ancillary industries (such as transportation and food).