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Indian IT: Striving for a better future?

Nov 10, 2008

Indian IT companies announced their September quarter results amidst the worst crisis the industry is facing since the start of this millennium. This time around, the financial crisis has badly hit the BFSI (banking, financial services and insurance) segment, which has been the major revenue source for Indian IT firms. However, despite the turmoil IT majors like Infosys, TCS, Wipro and Satyam managed to register decent topline and bottomline growth during the said quarter. However, managements of all these companies have indicated caution for the coming few quarters as dust settles on the crisis that has led to tightening of technology budgets.

Indian IT: Consolidated performance*
Consolidated financial snapshot Consolidated Consolidated Change
(Rs m) 1QFY09 2QFY09  
Sales 199,220 217,103 9.0%
Expenditure 150,919 161,733 7.2%
Operating profit (EBDITA) 48,301 55,369 14.6%
Operating profit margin (%) 24.2% 25.5%  
Other income 3,204 1,218 -62.0%
Interest 1,954 5,475 180.1%
Depreciation 3,804 1,341 -64.8%
Profit before tax 45,746 49,771 8.8%
Tax 5,273 7,092 34.5%
Minority interest 100 114 14.2%
Equity in earning of affiliates 106 113 6.4%
Profit after tax/(loss) 40,479 42,905 6.0%
Net profit margin (%) 20.3% 19.8%  
* Consolidation of results of Infosys, TCS, Satyam and Wipro

If we consolidate the July to September 2008 numbers of the four key players, sales have grown by 9% QoQ. Operating profits are up 15% QoQ on the back of a slight improvement in operating margins. The improvement in operating margins was largely on account of better utilisation of resources and depreciation of rupee against dollar. Lower base effect due to the impact of salary hikes in 1QFY09 also led to sequential margin improvement during 2QFY09.

As for the combined bottomline, the same registered a growth of 6% QoQ during 2QFY09. The pace, however, was slower than topline growth as companies were impacted by sharp rise in interest expense. For instance, Satyam recorded a 130% QoQ rise in interest expense, while Wipro recorded a jump of 48% QoQ. The impact on bottomline was also on the back of a 62% QoQ decline in other income.

What to expect?
While the September quarter’s performance was muted for these companies, it did not reflect the real impact of collapse of some major investment banks and financial institutions. In the US, who are among the key clients for some of these Indian firms. Considering that industry research firms like Gartner have indicated that technology spending is going to slow down significantly going forward as businesses cut back on budgets following the spreading of economic crisis, the next few quarters are expected to be tough for Indian It companies.

Gartner has in fact lowered its projection for global IT spending (on hardware, software and technology services) in 2009. It now estimates that technology spending could rise by only 2.3% in 2009 (as against the earlier estimates of 5.8%). Gartner expects the US and Western European countries to be the worst affected from the slowdown in technology spending. Considering that these two regions contribute around 75% to the total global technology spend, a slowdown there can severely impact the fortunes of the technology industry in India.

Although the overall situation looks pretty grim from a short to medium term perspective, we can take respite from the fact that Indian IT firms are trying to increase exposure to other markets like Eastern Europe, Middle East and Asia-Pacific, which is likely to stand them in good stead going forward.

The recent report from Nasscom has indicated that Indian IT companies can target the Japanese market, which is the world’s second largest economy and is highly dependent on technology. The Japanese IT services market stands at US$ 108 bn. Currently, India’s share of the same is mere US$ 1 bn to US$ 1.5 bn. The ageing Japanese economy is facing acute manpower shortage and strong global competition in terms of cost as well as innovation can open a new window for Indian IT firms.

We also believe that valuations of some of the leading companies are already factoring a deep slump in demand. The risk-return balance for investors in these stocks is currently favouring the latter. While we cannot say for sure how these stocks will behave in the short term, they present a compelling investment proposition for long term investors.

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