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Wipro: On course…

Oct 5, 2004

Within the host of Indian IT stocks that have rallied ‘incessantly’ since the beginning of this financial year, there is one stock that has generated a substantial amount of investors’ attention. We are talking about Wipro, the third largest exporter of software services from India. Let us try and understand the reasons for investors’ increased recognition of the growth story that is Wipro.

Wipro over the years has transformed itself into a world-class provider of software services, despite starting off as a manufacturer of hydrogenated oils and soaps. This is vindicated by the fact that, in FY04, revenues from global IT services contributed to around 74% of the company’s consolidated revenues, from 57% in FY01 (see chart above). This has been made possible by Wipro’s evolved global delivery model that has brought the company global recognition through its ability of providing integrated services to clients.

In recent times (since 1QFY04), Wipro has managed to shake off its under performer tag. And the company has been helped in this regard by initiatives of restructuring its business portfolio. Post this restructuring, Wipro has been able to affect improvements in billing rates and has exhibited continued strength in volumes. Consequently, the company has managed to improve its operating margins that had been excessively hit due to incidence of acquisition related charges in FY03.

The ‘pearls of strings’ strategy of acquiring niche companies across key domains has also helped Wipro grow and strengthen its revenue streams. While the company made no acquisitions in FY04, after the ‘bold moves’ of FY03 (when it made five key acquisitions), the strategy continues to be to grow business both the organic and inorganic way. If one were to go by a recent announcement by the company, its BPO arm, Spectramind, is looking at acquiring companies in niche areas. We believe that the consolidation taking place in the Indian BPO sector is likely to leave a few good companies like Spectramind in the fray to cater to niche and high-end customers. As seen from the past experience, future acquisitions, while impacting Wipro’s profitability in the short-term, might ensure that the company is able to cross-sell more from its bouquet of software services to clients that such consolidation brings with them.

Apart from BPO, going forward, Wipro is likely to gain from the huge potential that exists in high-end services like systems integration, package implementation and Information Systems outsourcing. Also, since global technology spending has been showing signs of improvement, the fact that Wipro has an edge over its peers when it comes to technology R&D, is likely to help the company grow faster. Ironically, the very R&D services that had severely impacted the company’s revenues in times of weakness in global technology spending (as R&D budgets were cut), are likely to provide Wipro an edge over its competitors as spending in new technology picks up. While we had mentioned in the past that a high dependence on R&D services for growth is a risky proposition, the fact that Wipro has brought this segment’s contribution at ‘safe’ levels, is likely to stand in good stead for the company.

Valuations

A low floating stock (which means many investors are chasing few shares of the company) and, consequently, consistently high valuations are the major risks for investors (both current and probable) in Wipro’s stock. At the current price of Rs 628, the stock is trading at a P/E multiple of 42.5x FY04 earnings, which is expensive by any standards. In relative terms, Wipro’s current P/E multiple is quoting at a 15% premium to Infosys’ P/E multiple based on its FY04 earnings.

While we maintain our stand that the company has the capability to be an outperformer against all its peers on the back of its management’s capabilities, wide range of service offerings and technology advantage, what price should investors be ready to pay for its growth is highly questionable. However, since we believe that Wipro will be among the frontrunners in the move towards high-end outsourcing, a long-term holding in the company would help investors gain adequate share in its growth.


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