Information and Techonology Sector:
Time to put cash to good use
In our view, the current weak global macroeconomic scenario provides an excellent
opportunity for Indian IT companies to augment their business model by shifting to the
value creation model, which involves deploying huge cash balances for making
suitable acquisitions. Besides, we continue to remain positive on the long-term growth
outlook, considering the off-shoring abilities, the global delivery capabilities, and the
strong functional expertise of the Indian IT players. However, we believe that the sector
will witness a slowdown in volume growth and pressure on margins in the medium term
despite assistance from the depreciating rupee vis--vis the dollar.
Business model shift: from cost arbitrage to value creation
We believe that the current scenario provides an excellent opportunity for the
Indian IT companies to move away from the cost arbitrage model to the value
creation model. Large players such as Infosys, Wipro, and TCS have huge cash
balances, ranging from USD 400 mn to USD 1.75 bn. We believe that these
companies can utilise this cash to push their inorganic growth plans as many
small/mid-size IT companies across the world are available at attractive valuations.
In this way, the Indian IT companies can improve their product offerings, increase
their spread into newer services/technology verticals, as well as diversify
geographically. Such a strategy should equip the Indian IT companies to target
end-to-end transformational deals and command better pricing power in the future.
Long-term growth intact
In our view, the Indian IT players delivery capability and the focus on high-end
services will ensure their long term growth. We believe that off-shoring will continue
to increase as it provides a win-win situation for both the clients and the IT players.
This is because off-shoring costs less than on-site services and enjoys higher
profitability. Currently, IT players are setting up off-shore development centres
(ODCs) at locations other than India to service non-English speaking clients in
Japan, China, and Eastern Europe. Besides, with a foray into high-end consulting
services, IT companies will be able to command a larger share of their clients IT
budgets.
Global turmoil: volume growth to slow, margins to dip by 24% in the next 2
Years
Given the current weak global economic scenario, we expect the volume growth for
the Indian IT companies to slow down to around 515% p.a. in the next 2 years,
compared with around 2035% p.a. for the last two years. Additionally, we expect
the operating margins to decline by 24% in the next 2 years. As many clients are
delaying their planned projects and are slowing down the ramp-ups of new projects,
we expect the overall volume growth to decelerate. On the other hand, large BFSI
clients may force the IT companies to cut prices in the near-to-medium term.
Moreover, reduced activity could force existing players to resort to price
undercutting in order to win large deals. Furthermore, the IT companies efforts to
improve geographical and vertical diversification will push their SG&A spending
higher. As a result, the operating margins are expected to come under severe
pressure in the near term.
Rupee deprecation: a short-term relief
The rupee has deprecated by more than 20% in the last few months, easing the
pressure on the margins and providing much-needed relief to the sector in the near
term. However, we expect this advantage to disappear in the medium term. In our
view, the rupee will climb up to nearly Rs. 44 in FY10 on the back of a relatively
better performance of the Indian economy (vis--vis the US economy) and the
resumption of the Foreign Institutional Investors (FII) inflow into the Indian markets
post the stabilisation of the global financial markets and the return of investor
confidence.
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