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There's no stopping the Indian IT juggernaut
Leslie D'Monte
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January 30, 2007

IT software and services sector firms continue to be on a roll. Just when the market was expecting the December 2006 quarterly results to be a tame affair - primarily due to an appreciating rupee, rising attrition and wages and fewer billing days - IT majors, mid- and small-caps beat market expectations in many cases to post more-than-satisfactory results.

IT bellwether Infosys Technologies set the ball rolling, weathering a rupee appreciation of 3.8 per cent to register a net profit of Rs 983 crore (Rs 9.83) - a sequential growth of 5.8 per cent in net profit and a 5.9 per cent sequential increase in its top line.

The sequential growth prompted the company to once again revise its guidance for the full year. It now expects to cross the $3 billion level (it has provided guidance of Rs 13,910-13,919 crore) for 2006-07.

Given the projected growth rate, its net profit alone will be around Rs 3,700 crore (Rs 37 billion) in FY07 (in FY03, its consolidated revenue was Rs 3,640 crore). A feather in its cap, Infosys was added to the Nasdaq-100 Index on December 18.

The largest Indian IT firm Tata Consultancy Services, on the other hand, beat market expectations to become the first Indian IT company to clock $1 billion in revenues in a single quarter as it posted a net profit of Rs 1,105 crore (Rs 11.05 billion) for the quarter.

The IT behemoth thus crossed the $3 billion revenue mark in the first three quarters, registering an 8.4 per cent sequential increase in its total revenues and 11.4 per cent q-o-q increase in net profit for Q3 FY07.

TCS executives attributed the company's performance to a good business mix and continued better pricing. The company is on its way to become a $4 billion entity this financial year.

Wipro's global IT business, which includes IT and BPO services, grew 6.2 per cent q-o-q in Q3 FY07 with a net profit increase of nearly 7 per cent. HCL Technologies too reported a sequential top line growth of 6.2 per cent growth and a net profit growth of 18.7 per cent.

Satyam, on the other hand, was more disappointing with revenues rising 3.7 per cent q-o-q and a 5.45 per cent net profit growth. The rupee appreciation impacted all software companies, but that is not a matter of concern. Software companies are on a strong wicket and should keep clocking improvements going forward.

Success ingredients

Most of the recommendations of analysts, so far, remain in the "hold" or "buy" category.

What's working for all IT services firms (small or big) is their global delivery models and global delivery centres which helps them de-risk their businesses by expanding geographically, acquiring companies in their domain areas (be it major companies like Wipro or mid-caps like 3i Infotech, Subex Azure, i-flex, Four Soft or Tech Mahindra), winning larger deals (for instance, HCL Technologies, Tech Mahindra, TCS and Infosys have all struck multi-million dollar deals this quarter) and negotiating new contracts at billing rates that have increased 3-5 per cent and more.

For TCS, there was a 90 basis points expansion in EBITDA (earnings before tax, interest and depreciation) margins to 28.3 per cent in the third quarter. Over the last six months, the IT major has been able to expand margins by over 400 basis points.

According to ICICI Securities, the reasons include higher pricing, productivity improvements and an offshore shift (41.6 per cent of revenues in Q3 FY07, as against 41 per cent last quarter).

On the volume front, the management has ten deals ranging in size from $50-100 million. It is looking at strong growth in the Chinese and Latin American markets.

The number of clients contributing revenues of over $1 million in the case of Infosys has increased from 206 a year ago to 256, while the number of clients contributing revenues over $5 million has risen from 78 to 108 over the past 12 months. The company has 11 clients contributing over $50 million, against seven clients a year ago.

It also has two clients contributing greater than $100 million. Its billing rate for the quarter continued its upward trend with onsite rates increasing by 1.9 per cent q-o-q and offshore rates up by 1.7 per cent.

Infosys' billing rates have now seen upward movement for four consecutive quarters, which is particularly impressive, says Edelweiss Securities.

Satyam too has seen an offshore shift and lower employee costs powered margins despite the weakness in top line growth. It reported a strong 205 basis point expansion last quarter.

Employee costs reduced to 58.2 per cent of revenues from 61.3 per cent in Q2, as the impact of the Restricted Stock Units was largely factored in. The contribution of offshore business improved by 130o basis points, which helped in better margins, according to Angel Broking.Moreover, the Indian economy is booming. No doubt, there is pressure from the Democrats in the US on outsourcing, but it is not likely to make much of a dent on the top lines or bottom lines of Indian IT services companies, infer experts.

Further, the IT software exports business is well on course to achieve the ambitious target of $60 billion by 2010 is an oft-repeated statement by Nasscom.

The latest figures add more credence to this figure. The Indian domestic IT market is expected to exceed $15.9 billion in 2006-07 recording a 21 per cent growth.

Software and services (IT-BPO) exports are expected to exceed $31 billion in fiscal 2006-07 - a 32.6 per cent growth over last year's figure of $23.6 billion. So, to reach $60 billion in 2009-10, the Indian tech sector has to grow at slightly less than 25 per cent a year, which does not seem difficult.

Innovation holds the key

On the human resources front, TCS saw an attrition rate of 10.8 per cent, which is the lowest among IT firms. Other IT firms have seen attrition rates anywhere between 13-20 per cent. This remains a matter of concern.

On the flip side, though, the dearth of IT engineers is forcing the Indian and technology companies to recruit around 40,000-50,000 non-IT professionals and science graduates in this financial year, which is the highest by any industry in the country.

This is notwithstanding the fact the over 10 lakh (1 million) IT professionals are being churned out annually by IT and management institutes.

IT majors like Infosys, TCS, Tech Mahindra and Wipro are some companies recruiting non-IT personnel for IT jobs, while other IT companies and the unorganised sector is also close behind.

Healthy competition

Global consulting firm neoIT predicts that companies based in the West will take a keen interest in onsite set-ups to stay competitive as well as explore eastern markets, which are not only cost-effective delivery locations, but also rapidly emerging markets by themselves.

India will continue to lead the supplier market and Europe will continue to show a strong growth. Internationally, neoIT's report predicts that 2007 will see Russia emerge as a strong contender in the IT outsourcing market with an expected growth of 40-45 per cent in 2007.

It is currently the third largest IT outsourcing supply market, behind India and China. Russian IT companies specialise in high-end software and embedded software product development, which acts as a differentiator from lower-priced offerings from Indian companies, it says.

On the India front, the billing rates amongst the tier-1 India IT services providers too will go up by 3-4 per cent both for existing as well as new contracts in 2007, according to neoIT.

The study has attributed the growth in the billing rates to a growing demand for skilled resources, rise in wages, and increased overheads incurred in maintaining quality.

However, despite the hike, the offshore services providers will remain competitive against the global players, says Sabyasachi Satpathy, senior director, neoIT.

The positive sign is that India will remain the fastest-growing country in the Asia-Pacific region in terms of domestic IT spending and is expected to grow at 21.5 per cent to touch Rs 75,891 crore (Rs 758.91 billion), according to IDC.

In 2007, IDC predicts System Integration partners will aim to minimise costs by breaking down activities into smaller modules. Vendors like IBM have already come to market with such offerings. TCS, Wipro and HP are expected to follow suit in 2007 and this trend is expected to gain further momentum through the year.

It's a no-brainer that the operating profit and revenue margins of IT firms will decrease as they get increasingly bigger. However, what's heartening is that with every quarter, they have found better ways of dealing with margin pressure and have become more efficient.

Further, mid- and small-cap IT firms are unfurling their potential and should soon cover up for the excellent margins that the bigwigs will gradually give up with time.

A recent Forrester report concluded that global outsourcing will become the dominant form of IT delivery by 2012. The next quarter's figures would only add muscle to this prediction.

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