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Software: The Big 3 - Views on News from Equitymaster
 
 
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  • Jul 25, 2003

    Software: The Big 3

    The June quarter financial results for the top three Indian IT majors Infosys, Satyam and Wipro (ISW) have been declared. Here in this article, we consider the combined results of the Big three, as they more or less reflect the Indian software sector. The combined sequential topline growth for the companies has been 6%, while profits grew by 14%. Operating margins continue to face pressure and have fallen by 100 basis points sequentially.

    The three combined...
    Rs m 4QFY03 1QFY04 Change
    Sales 26,625 28,283 6.2%
    Other Income 529 705 33.3%
    Expenditure 19,267 20,771 7.8%
    Operating Profit (EBDIT) 7,358 7,511 2.1%
    Operating Profit Margin (%) 27.6% 26.6%
    Interest 2 8
    Depreciation 1,261 1,060 -16.0%
    Profit before Tax 6,624 7,149 7.9%
    Extraordinary items 0 0
    Tax 1,213 971 -19.9%
    Profit after Tax/(Loss) 5,411 6,178 14.2%
    Net profit margin (%) 20.3% 21.8%
    No. of Shares 613.2 613.2
    Diluted Earnings per share* (Rs) 35.3 40.3 14.2%
    (* annualised)

    While the pressure on billing rates continue, the topline growth for ISW has been driven by growth in volumes and higher utilizations. Also, as these companies are moving up the value chain, they are increasing their revenues from onsite services. Onsite services have higher billing rates as compared to offshore services. Sequential growth in volumes for Infosys, Wipro and Satyam was 9.6%, 6.4% and 6.2%, respectively. Though billing rates were under pressure in 1QFY04 also, the decline was less severe than that was witnessed in the previous quarters. All three companies are expecting stability in billing rates going forward. It remains to be seen how billing rates move over the next few quarters (we have factored in a 3%-5% fall in blended billing rate for the aforesaid companies in our estimates).

    While billing rates may still take a while to stabilize, ISW continue to be optimistic on volume-based growth. This is reflected from their additions in manpower in the recent past. However, Satyam seems to be less aggressive than Infosys and Wipro. In 1QFY04, while Infosys and Wipro added 1,700 and 2,251 employees respectively, Satyam added just 833 people.

    Apart form billing rate pressure, increase in expenses have also impacted 1QFY04 operating margins for ISW. Personnel expenses, for example, have risen mainly on account of increase in employees and staff-related costs. Also, as these companies are putting up systems and infrastructure in place by setting up new development centres and improving on their marketing and distribution channels, selling and general expenses have also seen a sequential growth. These increases have resulted in total expenditure for ISW increase by around 8%, relatively higher than their topline growth. Infosys continues to maintain superior margins compared to its peers.

    Despite the downturn, Infosys and Satyam have revised their revenue and/or earnings guidance for FY04. These upward projections come at a time when uncertainty regarding the global economic slowdown still prevails.

    A look at valuations...
    Infosys* Satyam* Wipro**
    Current market price (Rs) 3477 190 923
    P/E (x) 20.7 11.9 23.1
    Market cap/sales (x) 5.2 2.5 4.1
    * based on companies' FY04 projections
    ** based on our FY04 projections

    As global majors recognize the benefits of the Indian offshore software service model, companies that are able to scale up their operations are likely to benefit. However, investors need to look beyond the financials. Sound management policies and excellent work ethics will differentiate the great from the good. Compared to the frenzy during early 2000, in the last three years, retail investors have learned a lesson or two when it comes to selecting software stocks .

    Consider this question: Where have the likes of DSQ Software, Global Tele and Silverline gone?

     

     

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