Sector Technical Watch Periodical technical report on Banking & IT sectors :: HDFC Securities

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India IT services :4QFY15F preview: Nomura Research

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Technology: A quarter of unconventional strength ::Kotak Sec, report

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A quarter of unconventional strength. We draw four key inferences from the December 2014 quarter results—(1) the quarter will assuage demand concerns of the Street, (2) the relevance of USD revenue growth numbers will reduce, (3) importance of large deals is evident in numbers of HCLT and Wipro. This can provide strong growth in certain quarters but also means volatility in quarterly performance, and (4) companies are evolving to tackle increasing complexities of the business. We maintain our constructive view on the sector. Infosys and Tech Mahindra are our top picks

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Technology: Crosses - an additional headwind in FY2016E :: Kotak Sec, report

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Crosses—an additional headwind in FY2016E. INR has appreciated by 13-26% in the past 12 months against EUR, GBP, AUD and other currencies. Without the compensatory benefit of INR depreciation against USD, Indian IT can face margin headwinds of 60-75 bps in FY2016 at spot rates. Offsets from currency headwinds are limited to either pricing (not easy) or growth (new contracts at higher price). We maintain our constructive view on the sector—rupee appreciation is the key risk to our call. Infosys and Tech Mahindra are our top picks.


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IT-Sector technical watch :: HDFC Securities

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Information Technology ƒ Twin blow: Cross-currency impact and seasonal weakness… ƒ :Q3FY15 Result Preview : ICICI Securities, report

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IT Sector Preview – Q3FY15 :: HDFC Securities

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IT Services, Lean Quarter; Order Book Visibility Remains Key monitorable.... :: IndiaNivesh, link

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IT - Seasonality, Cross Currency The Spoilsports - Result Preview Q3FY15 :: Edelweiss, link

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Technology: 3QFY15E preview: currency to sway results ::Kotak Securities

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3QFY15E preview: currency to sway results. 3QFY15 will have cross-currency
headwinds of 160-220 bps besides the usual seasonal weakness, resulting in muted
0-1.2% US dollar revenue growth. Commentary on the magnitude of increase and
timely closure of IT budgets and deal pipelines will be important—we expect 2015 to be
similar to 2014, if not better, in terms of growth. Stock prices corrected 5-10% over the
past month and offer reasonable upsides of 12-20% from current levels. Infosys and
Tech Mahindra are our top picks in the sector.

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‘Cloud’ on the Tech Sector :: HDFC Sec

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IT Sector Q2FY15 Result Preview :: IndiaNivesh

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Indian IT Services Q2FY15 Result Preview
Robust order book; Seasonal up‐tick may lead to strong $‐revenue growth...
Seasonally Strong Quarter ‐ TCS, TechM, HCLT to lead $‐revenue growth…
We expect leading growth in our Tier‐I coverage universe for TCS (+7.6% Q/Q), TechM (+3.7% Q/Q), and
HCLT (+3.6% Q/Q). Despite company‐specific issues revenue growth for Infosys (+2.8% Q/Q) and Wipro
(+2.7% Q/Q) relatively could be better than historical average. We expect Infosys to maintain its annual
revenue growth guidance of 7‐9%. Wipro’s Q3FY15 revenue guidance is expected to be in the range of 2.5‐
4.5% Q/Q. Cross‐currency movements are likely to impact revenue growth by 60‐90bp Q/Q across the top‐
tier. We expect  Infosys/TCS/TechM to report ~60/141/187 bps Q/Q improvement in EBITDA margins led
by higher revenue growth, INR depreciation and absence of one off costs (e.g. visa costs). However, EBITDA
margins will decline sequentially for Wipro and HCL Tech on account of wage hikes. Robust order backlog,
improving visibility in US markets and higher off‐shoring from Europe to lead $‐revenue growth in Q2FY15.
KPIT & SQS ‐ Mid‐cap growth leaders…
In our mid‐tier coverage, we expect KPIT and SQS to lead $‐revenue growth followed by Mastek. On back
of revival in SAP demand and strong order backlog, we expect KPIT to report leading $‐revenue growth of
3.5% Q/Q. On back of favourable growth momentum in testing services, SQS is likely to deliver 2.6% Q/Q $‐
revenue growth. Due to continuous scale down by key client, we expect 1.9% Q/Q $‐revenue de‐growth in
NIIT Tech. Also muted show from insurance and government vertical, Mastek could post only 1.1% $‐
revenue growth. Amongst mid‐cap companies, we expect Mastek to see ~381 bps improvement in margins
sequentially aided by revenue growth and absence of one off costs.    
Key Monitorables:  ‐  (I) Infosys  ‐  FY15 $‐revenue outlook, (II) BFSI, Manufacturing and Retail vertical
outlook, (III) Commentary on discretionary spend, (IV) TCS – future demand outlook and commentary on
margin front post Mitsubishi Corp’s ITF merger, (V) Wipro – Q3FY15 $‐revenue guidance, (VI) HCLT –
Outlook of software segment and margin commentary, (VII) TechM – Key deal wins/synergies & cross‐
selling opportunity (VIII) NIIT Tech – EBITDA margin commentary, Fresh Order intake & revenue growth,
(IX) KPIT – free cash flow generation/Top Client performance, and (X) Mastek – Insurance vertical
performance, and (xI) SQS – progress on integration front.  
Prefer Mastek & KPIT…
We prefer Mid‐cap over larger‐cap as major positives are already factored in the price for Tier‐I coverage
universe. The strong revenue performance and valuation discount (v/s peers) leaves some room for re‐
rating opportunity in case of HCLTech and TechM. Infosys underperform relative to its peers could narrow
down on back of global recovery and stability towards the top management. However, the top
management focus areas to deliver industry average growth (Product or Services) remains the key
question. TCS is a consistent performer and we expect its impressive performance to continue, but current
valuations factors major positives. After re‐organization & de‐merger of non‐IT segment, Wipro is returning
to industry level growth and sustenance could lead to re‐rating. We prefer KPIT on back of strong order
book and SAP segment revival. Mastek could be a significant value creator in long‐run  ‐  de‐merger of
Insurance and Services business separately is the first step towards that direction.
Key risk: Strengthening rupee (v/s USD) and deceleration in US and Europe economic revival.

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IT - Growth Momentum to Continue; Q2FY15 Result Preview: Edelweiss PDF link

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We expect Q2FY15 to extend the growth momentum seen in Q1FY15, riding improving visibility in the US markets and higher off-shoring from Europe. This, coupled with a seasonally strong quarter, induces us to forecast sequential growth of 3.0-7.2% for the top-4 IT players - Tata Consultancy Services (TCS), Infosys, Wipro and HCL Technologies (HCLT) - in Q2FY15. TCS is expected to lead the pack with ~7.2% QoQ growth (4.5% organic plus 2.7% from consolidation of IT Frontier Corporation). HCLT is likely to post 3.6% growth, while Infosys and Wipro are likely to clock 3.0% growth each. We expect Infosys to maintain its annual revenue guidance of 7-9%. Investors will keenly track Infosys’s commentary regarding changes in its strategy going ahead under the new CEO, Dr. Vishal Sikka. As for sector commentaries on demand outlook for the year, deal pipeline, discretionary spend particularly on consulting side remain key monitorables.

Q2FY15: Growth momentum to sustain

While Q1FY15 set the tone for a better FY15 than FY14, Q2FY15 (a seasonally strong quarter) is likely to witness the growth momentum to continue backed by improving visibility in the US and higher off-shoring from Europe. For the top-4 IT players, we have built in 3.0-7.2% growth. TCS is likely to grow 7.2% QoQ (4.5% organic plus 2.7% from consolidation of IT Frontier Corporation), driven by broad-based growth across verticals (unlike Q1FY15 where growth was driven by smaller verticals). HCLT is likely to maintain its growth momentum and grow 3.6% QoQ with IMS and BPO being the growth drivers. Infosys and Wipro are likely to post 3.0% growth each owing to seasonally strong quarter and ramp up of the deals won earlier. Tech Mahindra (TECHM) is expected to grow 3.6% QoQ.

Wage hikes to singe margins

EBITDA margins of the top-4 IT companies (except Infosys) are likely to decline by 30-80bps impacted by wage hikes (HCLT and Wipro), while consolidation of IT Frontier Corporation will impact TCS’ margin (60bps). Wage hikes are likely to mar Wipro’s and HCLT’s EBITDA margin by 80bps and 30bps, respectively. Infosys’s margins are likely to improve by 150bps as it ramps up deals won earlier thereby improving operational metrics.  Commentary by players on margin trajectory and levers available, particularly in wake of the stable currency scenario, will be keenly monitored by investors.

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INFORMATION TECHNOLOGY earnings Preview: Kotak securities PDF link

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INFORMATION TECHNOLOGY
We expect companies under our coverage to report a strong performance on
the revenue front. The industry is seeing strong demand trends as
developed economies, especially USA, recover further. Cross currency
benefits should have a negative impact to the extent of 50-80bps. Margins
are expected to be maintained QoQ as the benefits from rupee depreciation
and SG&A leverage are offset by salary hikes by select companies and
seasonal variations.
We understand that, over the quarter, the overall demand scenario has
remained stable / improved across sectors. The US economy has continued
to show signs of improvement. While European economic growth in EU
remains challenged, deeper penetration into clients and challenges on
revenues / costs of clients are leading to higher outsourcing from that
region, we understand. TCS has already indicated that, growth should be in
line with its expectations. The new strategic vision to be laid down by
Infosys as well as any revision to Infosys' FY15 guidance will be closely
watched.
We maintain our constructive view on the medium-to-long term prospects
of the sector on expectations of improving demand over this period. The
Rupee has depreciated over the past few weeks and has provided tailwinds
to the sector. However, we believe that, the probability of a significant
depreciation from the current levels is low.



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J.P. Morgan - India IT Services

India IT Services Impact of INR-USD on demand/growth: The demand curve is not inelastic and responds inversely to secular INR movements

· We see undue investor focus on Indian IT companies’ FY15/16 margins and EPS due to the strengthening INR. To us, a greater worry from structural INR appreciation is the impact that this has on secular (or medium-to-long term) growth of the Indian IT industry (and thus, the impact on P/E of stocks). This possibility is hardly discussed at all as it is commonly believed that INR-USD dynamics do not affect secular demand and revenue growth (which is not the case, in our view).Demand is not an inelastic/inflexible curve ‑ investment capacity and pricing philosophies also shape the secular demand curve for the industry and for individual companies. These factors are susceptible to secular shifts in INR/USD trends. For example, the advantages of a weak INR regime are clear. Besides the short-term boost to EPS, the weak INR will likely release excess margins that (a) are invested in accelerating market-share penetration in newer markets/service-lines and in lower-margin contracts/geographies, (b) allow greater pricing flexibility and (c) afford leeway to take more bets - vendors will likely shy from exercising these levers at stronger INR-USD levels (they would probably do much less of these if for example, the INR-USD was at 55 than they would if INR-USD was at 60). A weak INR regime, thus, hastens the process of expanding the addressable market and results in potentially higher revenue growth over the medium-to-longer term (though with differing results among vendors).

· The reverse is true in a structurally stronger INR environment. In a stronger INR environment (more specifically, when the strength of the INR takes it to a higher stable level), firms have less investment capacity, have less room for pricing flexibility, cannot afford to take as many major bets, may be warier of entering emerging/newer markets if economics don’t make sense – all of these constraints limit the pace of addressable market expansion and thus, revenue growth; most of these constraints would not hold as much in a weaker INR environment. Thus, unless the industry takes a margin reset, we see somewhat of an inverse relationship between INR-USD levels and secular growth rate of the industry contrary to the belief of some (though we can’t quantify this or draw the precise nature of this relationship; see figure below for a representation).

· Thus, the industry’s secular growth in an exchange rate regime reverting tightly around INR-USD of 60 will be different from that with exchange rate mean-reverting tightly around INR-USD of 55. Correspondingly, this should impact the P/E of the industry and companies therein. Investor expectations of a structurally strengthening INR-USD also impact P/E of the industry/companies but such an impact on P/E is likely to be only temporary if these expectations do not become reality. (Note: A structurally stronger INR is NOT our base-case; we still work with average exchange rate of Rs 59-60 for FY15/16 - hence, we stay OW on Tech Mahindra, Infosys, HCLT on moderate valuations and improving demand trends in the coming quarters.)

Figure 1: The industry’s secular (medium-to-long term) growth varies inversely with the INR’s secular strength with consequences for industry & company P/E – demand is not inelastic, a weaker INR regime releases ‘excess’ margins that gives firms substantial leeway on investments, pricing, and ability to take multiple bets - all of which help quicken the pace of addressable market expansion resulting in better secular top-line growth – room for pulling such growth levers gets squeezed by a structurally stronger INR unless the industry (or the influential players) take a margin reset – this is a bigger worry than near-term EPS/margin impact; but we are not building the case for a structurally stronger INR

IT: A wrap-up of recent discussions with the industry and consultants : Credit Suisse

● FY14 is poised to be a good year: Recent discussions with
industry sources, consultants and companies reaffirm a strong
demand environment and pick-up in discretionary spending.
● Immigration bill is a non-issue for customers: Buyers are not
quizzing consultants about this. Senior leaders in the US
Congress have assured the industry on the absence of
discriminatory clauses. An industry survey of CIOs suggested that
most will be forced to offshore more in case of an adverse fallout.
● Some other key issues: Cloud revenues will be like a "reverse
hockey" stick – lots of work initially before any drop in revenue. Buyers
are not renegotiating rates down due to the INR depreciation. In
Europe, there is strong growth in the Netherlands, Germany and
Sweden. There is some insourcing of data centres but not a trend.
● Company-specific feedback from consultants continue to favour
TCS: TCS remains the best service provider and a "strategic
thinker", Infosys is more aggressive by bundling IPs but not
reducing like-to-like pricing, Wipro needs to be more consistent,
HCLT's infra business remains very strong with recent wins

It’s the tech money, honey :: Business Line

"Damned if you do, damned if you don't" - this largely seems the story of big-ticket M&A in the Indian IT/BPO industry ::JPMorgan

 “Big-ticket” M&A in Indian IT ordinarily have several objectives, but
three are most often articulated: (1) introducing or raising growth profile in a
distinct, altogether new function (vertical/horizontal/geography), normally the
more immediate payoff; (2) cross-synergizing, which is selling the acquired
capability into the broader base of the acquirer’s existing clients and the
acquiring firm’s existing capabilities into new clients from the acquisition to
boost the acquirer’s organic growth prospects; and (3) achieving sufficient,
scalable offshore flow-through (or downstream) over time to scale and break
even on margins (this applies to acquisitions made onsite). Items 2 and 3 are
typically longer-term aims, much harder to realize, as well, as they entail
integration of the target into the acquirer’s mainstream. This has proved a
torturous agenda, as integration can easily undermine the culture,
processes and identity of a target, which defeats the logic of the acquisition.
 We find that most, if not all, large M&A fails at Items 2 and/or 3. Highprofile acquisitions that have delivered significantly below expectations, in our
view, include Info-crossing (acquired by Wipro in Aug-07 for US$600mn),
Oracle’s acquisition of i-Flex (stock price of Oracle Financial Services
motivated more by technical factors such as delisting) and, to a lesser extent,
Axon (acquired by HCLT for US$658mn in Dec-08). Info-crossing has not
consolidated Wipro’s then-leadership in infra-management (if anything,
TCS/HCLT has taken over leadership in infra-management in the last two
years). The financial products business at OFSS has been languishing for a
while now, growing at just single digits in percentage terms. AXON has not
helped HCLT grow enterprise solutions (SAP/Oracle solutions) ahead of peers,
though AXON has helped HCLT sell its core infra-management services to its
(AXON’s) clients.
 In an attempt to preserve the distinctiveness of the target and also as part of
learning from the shortcomings of previous M&A integration efforts, many
acquirers are delaying the integration of targets into the mainstream, which we
see as prudent. This might postpone the synergy gains, but if doing so minimizes
risk of the M&A going wrong, it might be well worth it.
 Historically, the market has been initially skeptical of larger mergers of
listed entities, especially mergers involving a company merging into a
smaller/comparably sized one (e.g., Patni-iGate or Tech MahindraSatyam). We find that it can be 12-18 months after a merger announcement
that tangible value emerges (if it happens) for the investor, as the acquirer
sets about tackling the initial burden-of-proof (we have seen this with the
TechMahindra-Satyam merger, for instance). Investor interest in stocks of
companies involved in a merger emerges only at very reasonable valuations,
when merger/acquisitions risks are more than adequately priced in. Such a point
may be reached after a period of significant stock underperformance following
the merger announcement.
 We would temper buoyant expectations of significant acquisition(s) or
merger(s). The feel-good factor that the prospect of a large acquisition
sometimes induces may be more psychological and may not square with the
subsequent track record, as our analysis suggests

Are we entering an era of lower technology spending intensity? ... Not quite so for IT services :: JPMorgan

IT intensity or IT spending as a % of GDP/corporate profits is a key indicator of
the technology spending intensity of an economy. Plotting IT intensity for the US
since 1995, we see several outcomes at play that have implications for IT services
(IT services is one sub-segment besides hardware, software and telecom services).
 IT spending as a % of corporate profits for the US has been moderating
since CY08 and has reached a 6-year low. This raises questions as to whether
the US economy is entering an era of lower technology spending intensity.
We think that there are both cyclical (temporary) & structural factors at
play here. Corporate profits/balance sheets are robust in the US; thus capacity to
spend on IT is not in question. It is a matter of confidence & timing (hence,
cyclical). Today, we think corporations are getting over this cyclical hump.
 In addition to cyclical effects, some segments of IT spending are seeing some
adverse structural impact, particularly on the pure hardware side thanks to
technologies such as cloud and supporting virtualization which compresses
hardware/data-centre growth. Gartner points out infra-as-a-service business
models are forcing disruption on the infrastructure/hardware players (e.g.
Dell/HP). Revenue cannibalization resulting from industrialized, cloud-based
services risks muting growth for the IT outsourcing providers that are heavily
focused on asset-heavy traditional infrastructure outsourcing (e.g. CSC).
 Also, the ongoing tide towards smartphones/tablets is structurally impacting the
PC industry (hardware). Though this results in smart secular growth for spending
on devices (as per Gartner, devices are among the fastest-growing sub-segments
within IT spending – it is the entrenched PC-dependent players who do not seem
to be able to cope adequately with this trend). Likewise, on the software side, what
we see happening is different players emerging that commercialize newer business
models (e.g. Salesforce) – a phenomenon needing established, players (e.g.
Oracle) to keep up. This does not necessarily dim the outlook on top-down
software spending; it’s the incremental shift that needs watching. In fact, Gartner
sees software as the fastest growing sub-segment.
 On the other hand, the picture on asset-light IT services is better, in our
view, despite oft-expressed reservations about the lowered intensity of IT
services spending in the US. One common view of pessimists is that
investments that had to be made in spreading diffusion of technology in the
economy have substantially been done and IT services is already ingrained in
business activities within the US. What tends to get missed is the capacity and
room for business innovation, change and productivity brought about by
technologies which demands increasing IT services consumption.
 The consumption of technology is still rapidly rising thanks to new waves
such as SMAC (social mobility, mobility, analytics and cloud) – much faster
than corporate IT budgets can accommodate them. Therefore, as the units of
consumption go up pushing the technology mainstream, price per unit may show
a downward trend. Alternatively, keeping the unit pricing competitive for newer
business models promotes usage and helps cast the net wider attracting newer &
different client segments. It’s the pricing trend that needs watching in the pricevolume
equation – will newer business models impact pricing is the key issue.
 The SMAC wave buffeting IT services has the potential to change the
assimilation & growth landscape for IT services. We estimate that SMAC-led
opportunities alone should raise the 3-5 year revenue CAGR profile of offshore
IT services industry by at least 1% (net of cannibalization). Thus, we think a
reversion to mean of IT services to profits ratio in the US is possible.

Indian IT on watch....It will take much more intensive and effective lobbying to combat the immigration bill :: JPMorgan

 This time it’s different. The immigration bill issue is a battle that Indian IT
will have to fight largely by itself – something that it did not have to do in the
past when the stakes were high. Whenever interventions pertaining to highskilled visa restrictions (H1B) were attempted in the past, the US tech industry,
led by companies such as Microsoft, would oppose any such moves. Now that
the H1B visa limit has been increased to 180,000, and much more liberal views
are proposed towards green-card holders (or in-process green-card applicants),
US tech companies’ issues seem to be largely taken care of. When it
specifically comes to the US Tech IT Services group (e.g. IBM, Accenture,
Deloitte) who have lobbying clout, higher cost provisions (visa/wages) apply to
them as well, but outplacement does not. They are thus unlikely to lead in
opposing the bill, in our view, leaving Indian IT to fight it largely on its own.
 Strong, explicit support from influential clients (e.g. large BFS clients) cannot be taken as a given. They might have larger issues (from their perspective)
to battle/mediate with the administration/law-makers. For example, regulatory
and risk issues are likely far more important for banks than lobbying against visa
provisions in the immigration bill, especially when their incremental outsourcing
requirement could be met (to some extent) through the likes of Accenture, IBM.
 Shouldn’t the government of India (GOI) intervene more forcefully? We
think so, given the importance of IT exports to India’s GDP (~5% of the total, or
7-8% on an incremental basis) and, equally importantly, the multiplier effect
that this sector exerts via consumption and growth of ancillary industries (e.g.
real estate, travel/transportation, hospitability). With the Indian economy
projected to grow by 5.8% in FY14 (GDP), even a 0.3-0.4% downward impact
due to this bill is likely to be a significant issue for the GOI.
 The bill seems to have some inconsistencies, and may have unintended
consequences. If clients are forced to adopt more offshoring in a bid to offset
higher costs, this would probably defeat the purpose of creating more local jobs
(at least in IT Services). Also, we believe large third-party Indian IT firms
(including Cognizant) are not the main H1B visa-guzzlers (contrary to common
perception); they consumed less than 25% of total H1B visas in 2012.
 Why are we not turning more negative on the sector? Why are we just
putting it “on watch” despite our view that Indian IT will have to lobby
much more intensively and effectively than it has had to in the past or is
doing now? The bill is not a done deal – there is a fair distance to go before this
can be written into law. The process could take the rest of this year, which gives
Indian IT firms, with strong intervention from the GOI, some time to lobby for
the retraction of key clauses.
 But this has an attendant cost – client behavior could change with respect to
long-term engagements (more so, if the “outplacement” clause is not
removed early enough). So far, client behavior is unchanged, but it’s too early
to conclude that it will remain so throughout 2013. This remains the primary risk
to our thesis that the overall demand environment will remain healthy and that
2013 will be a better year for growth than 2012. However, we still see our thesis
as a low-risk one – what may happen is redistribution of market share away
from offshore IT Services vendors towards MNCs (e.g. Accenture) and captives