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Wipro: Global IT services show the way
Jan 18, 2006

Introduction to results
Wipro has announced strong consolidated results for the third quarter and nine-month period ended December 2005. The company has reported a strong double-digit sequential growth in topline, driven by the global IT services business, which saw double-digit volume growth in both onsite as well as offshore services. Wipro witnessed operational improvements, with SG&A leverage and an offshore shift, which offset lower utilisation rates, lower billing rates and compensation increases for its offshore staff. This led to a strong 150 basis points margin expansion, which, in turn, led to a double-digit sequential bottomline growth, in spite of considerably lower other income due to forex losses. The nine-month performance has also been encouraging.

Financial performance (Consolidated): A snapshot
(Rs m) 2QFY06 3QFY06 Change 9mFY05 9mFY06 Change
Sales 24,941 27,652 10.9% 58,594 75,310 28.5%
Expenditure 19,074 20,747 8.8% 43,506 57,073 31.2%
Operating profit (EBDIT) 5,867 6,905 17.7% 15,088 18,237 20.9%
Operating profit margin (%) 23.5% 25.0%   25.8% 24.2%  
Other income 415 176 -57.5% 631 714 13.0%
Interest 2 19 664.8% 50 28 -44.3%
Depreciation 751 773 2.9% 1,741 2,252 29.3%
Profit before tax 5,528 6,289 13.8% 13,929 16,671 19.7%
Tax 831 948 14.1% 2,035 2,408 18.3%
Minority interest - -   72 1  
Equity in earnings of affiliates 83 94   133 233  
Profit after tax/(loss) 4,780 5,435 13.7% 11,955 14,495 21.2%
Net profit margin (%) 19.2% 19.7%   20.4% 19.2%  
No. of shares 1,423.1 1,430.3   1,399.7 1,424.2  
Diluted earnings per share* (Rs)         13.2  
P/E ratio (x)*         35.0  
* On a trailing 12-months basis

About the company
Wipro is India’s third largest software services exporter and also has interests in the hardware and consumer care and lighting (CC&L) businesses. However, the largest contribution to its revenues comes from the global IT services and products division (77% of consolidated revenues). Within the global IT services and products business, the company derives revenues from R&D services (34%), enterprise business (57%) and BPO services (9%). The company provides BPO services through its subsidiary, Wipro BPO Services.

What has driven performance in 3QFY06?
Global IT services drive the topline: During 3QFY06, the global IT services business of Wipro (Wipro Technologies) grew at an impressive 12.0% sequentially, ahead of the consolidated revenue growth. This was mainly due to strong volume-led growth. This was the case, even as billing rates fell sequentially. Offshore rates were lower by 0.1%, while onsite rates fell by as much as 3.6%. This was totally offset by the impressive sequential volume growth of 16.0% offshore and 12.8% onsite. The fall in billing rates is a continuation from 2QFY06, where onsite rates declined by 0.8% and offshore rates by 2.1% and is a clear indication that Wipro is facing some amount of pricing pressure. It should be noted that the revenue growth includes US$ 1.3 m (Rs 59 m) of acquisitions that Wipro made during the quarter. Even excluding for this impact, global IT service revenues grew at 11.7% sequentially and overall revenues at 10.6%.

Key service lines for Wipro, such as technology infrastructure services, testing and package implementation all witnessed an impressive double-digit sequential growth. These new service lines, or ‘differentiated services’, as Wipro calls them, have been the main growth drivers for the company, even as the share of application development and maintenance (ADM) has declined. In terms of geographies, the US, Europe and Japan all saw double-digit sequential growth rates.

BPO revenues (9% of the Global IT services revenues) also managed a growth during the quarter, albeit at a slightly subdued pace of 4.3% sequentially. The management has clearly indicated that this business is undergoing a transition phase and this is expected to continue for the next few quarters. The non-voice component is being built up and Wipro’s focus will be on increasing this to around 35%+ over the medium term. BPO PBIT margins saw an over 300 basis points improvement, to 16.1% from 13% in 2QFY06.

Wipro added as many as 61 new clients during the quarter, including 1 in BPO. This has been the highest-ever customer addition in a quarter. The total number of active clients now stands at 485 in IT services and 30 in BPO. The company added 3,770 people in IT services, even as recruitment has resumed in the BPO segment, with a net of 1,419 people being added this quarter. This has been the first quarter of a net increase in hiring in this business after 2 successive quarters of employee reduction. The total headcount in IT services now stands at 36,626 people and in BPO at 14,398 people.

The other segments of Wipro were relatively flat on a sequential basis, except for Consumer Care & Lighting (CC&L). However, on a year-on-year basis, these segments have shown good traction, growing between 17% and 35%.

Productivity improvements drive margins: In 3QFY06, Wipro had given a salary hike to its offshore staff. The company hired a fairly large number of people and net utilisation rates fell to 68% from 70% in 2QFY06. The company, however, leveraged on SG&A expenses, which reduced as a percentage of revenues from 11.3% in 2QFY06 to 10.7% this quarter. Employee costs also reduced as a percentage of revenues from 42.3% to 41.3%. There was also an offshore shift, with offshore revenues increasing as a percentage of global IT services revenues from 45.3% to 46.9% in 3QFY06. All these factors led to Wipro’s operating margins expanding by 150 basis points.

Higher margins drive net profits, despite forex loss: The impact of the higher margins was felt in the bottomline for 3QFY06, which grew at an impressive rate of 13.7% sequentially. This was despite a forex loss of Rs 232.2 m, which led to a significant fall in other income. This has been the case with all the other software majors that have announced results so far.

Performance in the recent past…
  4QFY05 1QFY06 2QFY06 3QFY06
Sales growth (%, QoQ) 9.4 (1.3) 9.8 10.9
Profits growth (%, QoQ) 1.5 (1.2) 11.7 13.7

What to expect?
At the current price of Rs 463, the stock is trading at a price to earnings multiple of 21.8 times our estimated FY08 earnings. During the quarter under review, the company exceeded its guidance for the global IT services business, growing to US$ 473 m (including BPO) as compared to the guidance of US$ 463 m. Wipro’s management expects consolidated revenues from the global IT services and BPO divisions to grow sequentially by 7.7% in 4QFY06 to US$ 510 m. This implies total FY06 revenues at US$ 1.81 bn, a year-on-year growth of 33.9% for this business, which, as a matter of fact, is slightly above our revenue estimates for the business.

The fact that recruitment has picked up in the BPO segment is an encouraging sign. Wipro’s management has repeatedly mentioned over the past few months that it intends to increase the share of non-voice revenues in the total revenue mix. While in the short term, some heartache is likely to be there due to the sluggishness seen in recent quarters, we believe that, over the longer term, the company is on the right track. Billing rates are generally higher for non-voice services like technical support, equity research and finance and accounting, and attrition rates are also generally lower.

Prospects for the global IT services business appear strong, with increasing acceptance of offshoring and traction in Europe. R&D services, a major service line for Wipro, is seeing an up tick, as telecom players and semiconductor companies make more investments in developing new products, such as mobile convergence, multimedia and gaming. The offshoring component is also high in these services, providing a possible margin upside.

We expect Wipro to continue to benefit from the offshoring trend, based on its size, scalability management quality and execution strengths.

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