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Software 2005: Higher, faster, stronger!

Dec 30, 2005

The year 2005 was a highly eventful year for the Indian software industry. There was certainly no shortage of action. Mergers and acquisitions were made, top-tier companies continued to grow at a robust pace, big deals were signed and the laggards continued to under-perform. The market picture
As regards market performance, the CNX IT index has, in fact, been a laggard compared to the benchmark index, the S&P CNX Nifty. This has been despite the strong performance of top-tier software companies. It should be noted that numerous mid-sized companies under-performed relative to the large caps, thus, pulling down the overall index's performance relative to the benchmark, the CNX Nifty.

The large companies
The top-tier software companies performed a lot better compared to the mid-sized companies. We have always maintained that we believe it will be these companies that will gain the most from the offshore outsourcing wave that is currently sweeping the globe. Business fundamentals remain strong, a greater share of the client's wallet is going towards a meaningful offshoring strategy, scalability is increasing all the time and a definitive movement up the value chain is being noticed. All these factors point to better times ahead for these players. This is what is being reflected in these companies' stock prices. Satyam, for example, soared by nearly 75% in 2005. Of course, as regards valuations, some stocks appear to have run ahead of themselves. But the moot point to note here is that we continue to believe in the longer-term growth story of the large software companies.

The mid-sized companies
The mid-sized companies have been clear underperformers in 2005, with the notable exception of i-flex, which was boosted by enterprise software giant, Oracle's acquisition of Citigroup's stake in the company. But overall, it is clear that these companies are, by and large, struggling to keep pace with the larger companies. In fact, the gap between the top-tier companies and the mid-sized firms is increasing with each passing year. This has been clearly reflected in their stock performances, with the markets giving a 'thumbs-down' to some of these companies. In fact, companies like Polaris saw their stock prices tank by as much as 26% during 2005.

Certain trends that played out also point to an element of consolidation taking place in the industry. Numerous mergers took place and the biggest of them all was, undoubtedly, Oracle acquiring Citigroup's stake in i-flex. Global majors like Cap Gemini have also expressed interest in buying out companies in India, firstly, to get a credible offshore base and secondly, to gain access to strong skills. This points to an increasing trend, whereby mid-sized companies will either have to merge with each other, or get taken over by other firms.

Conclusion
While we continue to remain positive on the industry growth prospects as a whole, we believe that this growth will continue to remain concentrated among the top-tier companies. Only those mid-sized companies that have niche areas of operations and that are not 'me-too' companies will hold their own and grow. Consolidation could be a major theme come 2006, as acquisitions in the industry start to build up in a more meaningful manner. Global majors are also expected to ramp up offshore in a big way and majors that as yet do not have a presence offshore will scout for acquisitions to skip the learning curve. All in all, we appear set for exciting times in 2006 as well.


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