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Software: Vitalstatistixs - Views on News from Equitymaster
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  • Jan 16, 2001

    Software: Vitalstatistixs

    Software companies have caught investor fancy like no other sector in history. In 2000, the sector witnessed unparalleled highs. But when concerns surfaced the same sector ended the year with huge losses in market capitalisation. This left hordes of disgruntled investors who didn’t know what hit them. Does it mean that investments in software companies are a mistake, never to be repeated? Not quite.

    Though one does not deny the reverses suffered by these companies in the recent past, but the truth is that the Indian software companies are on a roll. Year after year, quarter after quarter they have put in very high growth rates. The real issue is how to separate the wheat from the chaff. By this we mean how does one segregate the real winners (the dark horses) from a maze of high growth companies? To help you in identifying these winners, we present some parameters that would help you read a bit more between the lines.

    Software value chain

    Value Chain
    Universal/Mass Products
    Strategic Consulting
    IT Consulting
    Technology Development
    Networking & System Integration
    Internet & E-commerce
    Education & Training
    Application Packages/ Custom Products
    Software/Application Development & Reengineering
    Customer Services & Maintenance
    IT-enabled Services
    IT Staffing/Body Shopping
    A company’s position in the software value chain determines its future prospects. Those higher up have a better chance of survival against the odds. The chain shown in the table is arranged in ascending order. As we go up, the skill set requirement and hence the entry barrier into that segment increases. At the lowest end is employee augmentation (more commonly know as body shopping) and at the top end is IT consulting. The other areas at the higher end would be technology and products.

    According to the model, Infosys is high up the software value chain due to the fact that it is into products, consulting and technology.

    Wipro again is heavily into technology and is in cutting edge areas like business intelligence and systems integration. Another positive for Wipro is its experience in facilities management, which it can offer as a value added service.

    Hughes is a company that has been developing software for the telecommunications industry. The company has been developing technology for the future. The kind of knowledge and skill sets required is very hard to find globally. Therefore, Hughes and others in the technology arena seem to have some good times ahead.

    Companies that are headed for troubled waters are those that just take up specifications and code. These are mainly project-based companies. Another set are the implementers' who implement products for others. Once the product loses its prominence so do the implementers. This is due to the fact that the skill sets required are general in nature.


    The revenues for software companies come mainly from projects, products and services. Projects mean that companies develop software for particular requirements of a client. The products are general in nature and the same solution is sold to different clients. This means that one effort is turned over and over again.. Further, marketing expenses for products are higher than in the case of services but again the variable costs for products is lower. Visualsoft is one of the companies that have been extremely successful with products. It has operating margins of around 50% due to its product business. This is amongst the highest in the industry.

    Revenue break-up by project, products and services
    (% of revenues) Projects
    Infosys 48 + 6* 3 22 5
    Visualsoft 49 51 - -
    Hughes - 29 71 -
    * Package implementation, 2QFY01 figures

    There is a higher amount of risk associated with products, as they may not be accepted. Mastek one of the first to bring products had to suffer, as these products did not do well.

    Client Concentration

    Many software companies have a huge amount of business coming for one or two major clients. The prospects could be severely affected on losing these clients. For example initially Hughes Software's major client was its parent Hughes Network systems. Presently, the contribution from HNS has come down to about 37%.

    Client Concentration
    Contribution to
    revenues (%)
    Top 5
    clients (%)
    Top 10
    clients (%)
    Infosys 30 45
    Wipro 39 53
    Hughes 51 n.a.
    Satyam 37 54
    FY00 figures

    Another example is Digital that has more than 80% of its revenues coming from Compaq. Obviously there should be an element of caution with these companies.

    The number of clients added in the last quarter indicates how successful the marketing efforts of the organisation have been. Another important parameter to look at is the % of repeat business. There are two ways to look at this parameter. Higher percentage of repeat business would mean that the company has been doing a very good job with its assignments and the repeat business is on account of satisfied customers. But in a longer-term relationship the billing rates may suffer.

    New clients and repeat business
      Clients added in a
    quarter (number)
    business (%)
    Infosys 27 84
    Wipro 33 85
    Visualsoft 9 n.a.
    Hughes 12 84
    Satyam 35 82
    Figures in bold indicate estimates, Figures for 2QFY01


    Of the total software exports revenues for India an estimated 56% come from the United States. With the US economy slowing down there are concerns about future growth prospects. All the majors are diversifying their portfolios and looking towards Europe, Japan, and Australia for sustained growth.

    Geographic mix
    (% of revenues) US
    Rest of
    world (%)
    Infosys 75 18 1 6  
    Wipro 65 27 - - 7
    Visualsoft 65 31 - - 4
    Hughes 79 19 - - 2
    Satyam 78 7 - 2 13
    1QFY01- figures

    Onsite - Offshore Ratios

    The Indian software companies have a competitive edge against their American and European counterparts due to lower billing rates. If the development work is done in India rather than the US the costs are even lower. This is known as offshore development. Companies that offer offshore development will be able to work on low billing rates.

    Onsite – Offshore mix
    (% of revenues) Onsite (%) Offshore (%)
    Infosys 36 55
    Wipro 51 49
    Visualsoft 24 56
    Hughes 10 15
    Satyam 48 25
    Figures in bold are estimates, Figures for 2QFY01

    Attrition rate

    One of the major concerns of the software industry is employee attrition. What separates the successful from the not so successful ones is the ability to retain talent, which is a tough job. The industry average is around 25%.

    Employee turnover
      Attrition rate (%)
    Infosys 9
    Wirpo 17
    Visualsoft 3
    Hughes 24
    Satyam 20
    Figures for 2QFY01

    Growth in Revenues per employee and profit per employee

    The cost per employee and other data like improvement in the revenues per employee gives an idea about improvement in the productivity. Again profit per employee must show an upward trend. The employee cost which is in the range of 30% to 40% of revenues is likely to increase and if the profit per employee has not grown then it may take a hit.

    Infosys (Rs m) FY 98 FY99 FY00 FY01
    Revenue per employee 1 1.4 1.6 2.2
    Profits per employee 0.2 0.4 0.5 0.8
    Wipro (Rs m) FY 98 FY99 FY00 FY01
    Revenue per employee 5.2 3.3 2.7 2.4
    Profits per employee 0.3 0.2 0.3 0.4
    Hughes (Rs m) FY 98 FY99 FY00 FY01
    Revenue per employee 0.9 1.4 1.2 1.3
    Profits per employee 0.2 0.3 0.4 0.4
    Satyam (Rs m) FY 98 FY99 FY00 FY01
    Revenue per employee 0.7 1.1 1.3 2
    Profits per employee 0.1 0.2 0.3 0.3

    Employee cost as a % of total revenues

    The percentage gives an idea how the company is spending the money on the employees. If this figure is very high then the company will have to maintain its growth rates to pay higher wages otherwise employee attrition rates in the company may increase.

    Wage cost
      % of revenues
    in FY00
    Infosys 35
    Wipro 11
    Visualsoft 50
    Hughes 30
    Satyam 37
    *Figures for Wipro are low due to the fact that software
    is only a part of its business portfolio, which
    includes consumer good, lighting, pneumatic and others.

    Receivable Days

    Infosys 60
    Wipro 71
    Visualsoft 150
    Hughes 100
    Satyam 116
    FY00 figures
    This indicates the time period within which the company receives its dues. The industry best is around 60 days and average around 90 days. A figure greater than 120 is a cause for concern.

    These measures are just add ons to be used with the conventional methods of analysing the performance of companies like revenue growth rates, ROA, ROIC, RONW and others. Every industry is unique in nature and to read between the lines parameters may differ. The ones presented are just a few that could help in making things a little more clearer, so when the rough times come, the companies you invest in stand you in good stead.



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