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IT services: Shift in focus - Views on News from Equitymaster
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  • May 22, 2002

    IT services: Shift in focus

    After a number of revisions, the software sector closed the year with a 29% growth (according to Nasscom) and a change of name. The software sector is being increasingly referred to as the IT services sector. This is due to the fact that contribution from IT enabled services (ITES) to the revenues has jumped in FY02. Thus, revenues of the IT services sector means revenues from software and IT enabled services combined.

    The IT services industry grew by 29% in FY02 to clock revenues of Rs 365 bn (US$ 7 bn). A very subdued performance compared to the previous year’s (FY01) steep growth 65%. The reason for the deceleration was the recession in the US, the largest market for the industry. While software exports grew by only 22% (64% in FY01), the ITES segment grew by a strong 73% (70% in FY01). This resulted into a combined growth of 29%. As a result of outpacing the software services, the contribution of ITES to the total revenues increased to 20% in FY02.

    The primary reason for steep growth in the ITES segment is the relatively smaller size. Due to low manpower costs, services like call centres can be operated out of India at one-fourth the cost of operating them in the US or Europe. The low cost of operations has caught the attention of many and increasingly corporates, abroad, are choosing to outsource work to call centres in India. The next phase of growth is expected from clients going a step forward, and outsourcing non-core business processes to Indian IT companies. The emerging opportunity of business process outsourcing (BPO) has attracted almost all the software majors like Wipro, Infosys, Satyam and HCL Technologies.

    The advantage these companies have is two fold. Firstly, they are known names in the western markets. The BPO contracts typically run into a number of years and therefore, business continuity of the vendor is a must. Thus, corporates in the west are likely to be more comfortable with known names. Secondly, these companies have a significant client base to which they offer software related services and have established their credibility. The Indian software majors can easily tap these clients for business. The revenues from the ITES segment are expected to grow by 65% in FY03.

    Software exports
    As far as the software exports are concerned, Nasscom expects a growth of 22% for FY03. The forecast is based on the assumptions the business environment will continue to be similar to that seen in FY02. Billing rates will be under pressure and the growth will mainly stem from growth in volumes. In FY02, while the onsite billing rates declined by 8% to 10% on an average, the fall was much steeper for offshore billing rates. The offshore realisations declined by 30% to 35%. Added to this was the fact that offshore projects grew by 70% and onsite projects grew by a small 10%. Thus, a bulk of the revenues came at a much lower price point. In FY03, Nasscom expects a 23% growth in offshore volumes. The billing rates are likely slide further due to the stiff competition among Indian IT services companies.

    The growth is likely to continue from services that showed strong growth in FY02. This includes areas like package implementation, systems integration and package implementation. The macro environment in the US has shown initial signs of recovery. This could translate into increased IT spending with a lag of about two to three quarters.

    Traditionally, the recovery in the technology sector in the US has been led by an improvement in the semiconductor industry and therefore, the string of positive numbers that have come from the chip industry, in the past few months, could be taken as initial signs of a recovery. In April, Intel had reported of sales improving going forward. Novellus another chip equipment manufacturer had also reported of capital spending in the semi conductor industry picking up going forward. May is the fifth consecutive month of rising semiconductor equipment orders.

    The combined growth for the Industry is expected to be a 30% in FY03. The faster growth in revenues from ITES is expected to increase the contribution from 20% in FY02 to 25% in FY03. The focus, therefore, is likely to shift from the growth in software exports to the growth in ITES. Companies like Mphasis have seen very swift growth in revenues from the call centre business. MsourceE, Mpahsis’s call centre subsidiary, clocked 359% growth in revenues in FY02. MsourceE’s revenues are expected to grow by 200% in FY03. Though the contribution of the revenues from ITES was only 8% to the total revenues in FY02, the three-digit growth figure caught the markets fancy and the stock price skyrocketed.

    Infosys, HCL Technologies and Satyam have just announced their ventures in the BPO business. Strong growth in revenues from new business areas is likely to excite the markets and this might cause the valuations for the stocks to head north. However, retail investors on their part should be cautious and keep and eye on the valuations. The moment the markets factor in irrational growth expectations in the stock prices it would be prudent to exit.

    Also, the Nasscom report mentions that growth was getting increasingly polarized and top ten companies accounted for 73% the growth. The mid sized players were the hardest hit. Please keep this information in perspective, while making your investment decision. While it is the top rung stocks that gain rapidly when the prospects of a sector improve, it is the smaller stocks that witness rapid erosion in stock price when times turn bad.



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