1. Technology: Downtick in growth likely for IT companies in FY17

Technology: Downtick in growth likely for IT companies in FY17

Players with strength in consulting practice and investments in digital are going to do well.

By: | Published: January 18, 2016 12:21 AM

FY2017: modest slowdown in a patchy year. FY2017 could witness a modest slowdown in growth rates for Indian IT due to a combination of (i) patchy spends across verticals, (ii) pricing pressure and diminishing returns in the core run-the-business services and (iii) lack of full participation in consulting-led shaping of business opportunities and engagements in digital. We would not be surprised with 2-3% lower growth rates for the industry. The good thing is that stock prices are already building in some slowdown. Companies that have track records of delivering in unstructured opportunities will lead the growth; we back Infosys on this count.

Challenges in 2016: a few specific to budgets and a few amplifications of previous year’s theme

FY2017 is not shaping well for Indian IT. Though a bit early to quantify, we would not be surprised if the industry growth rate is lower by 2-3%. This implies industry growth rate of 10-11% in FY2017e, down from Nasscom FY2016e industry growth guidance of 12-14%. We detail our thoughts:


A few budget specific challenges in 2016: Patchy spends across verticals could weigh on FY2017 performance. Our industry interactions suggest sluggish IT spends from banking clients in 2016. Note that the Banking vertical was a key driver of growth for Indian IT in FY2016e and contained the negative impact of energy and telecom verticals to some extent. Additionally, in the banking vertical, a few specific situations of captive ramp up, change in leadership at a few large global banks and associated change in strategies could also play a part in impacting growth for vendors. For example, Deutsche Bank management has set targets for reduction of IT Infrastructure costs and headcount as a part of its 2020 strategy. Macro environment, as evidenced from mixed economic data, is also worrying.

w Diminishing returns in traditional services: Constrained IT budgets and business imperative to spend in digital imply self-funding mechanism i.e. through cost take outs in traditional services to fund digital. Vendors are achieving the desired cost savings for clients through managed services, fixed priced contracts and pricing concessions. Vendors’ disproportionate focus on these services has only accelerated the pricing decline. This trend is unlikely to reverse in 2016.

w Shaping business opportunities: Nearly the entire discretionary spending is digital-led. However, Indian IT’s share in discretionary services is lower than what it used to be due to (i) fragmentation with many new players targeting the growing discretionary pie through new and disruptive business models and (ii) consulting-led growth in any technology and business changes in the early phase of evolution. Indian IT’s underinvestment in consulting means it could miss out on consulting-led transformational engagements. Participation can improve, but at a later phase, when large systems integration opportunity comes up.

w Delay in closure of deals: Finally, we believe there are a few cases of delays in closure of deals due to greater diligence and scrutiny of sourcing decisions by clients on agility and nimbleness to deal with further shifts and changes in the technology.

A part of the impact elaborated above is transient in nature, especially in select cases of delay in deal closures. Additionally, participation and share in discretionary demand will increase as digital technologies mature and in the process, create large systems integration opportunities.

Bottom line—growth opportunities are immense: FY2017 could be a soft year with possibilities of acceleration in growth in subsequent years.

Industry growth likely to decelerate; we back Infosys

IT industry’s growth could moderate in FY2017 and we would not be surprised with a downtick in c/c growth. Markets are already pricing in some moderation in growth. The extent of weakness is difficult to quantify at this point though. What is clear is that players with strength in consulting practice and investments in digital would do well. Indian IT lags in this area. Stock picking is critical even though the sector is relatively inexpensive. We back Infosys—sustainable measures for a turnaround, healthy revenue momentum in traditional services and likely benefits of automation in the medium term, underpin our positive view.

We like Tech Mahindra (TM) for its continued strengthening of leadership in telecom and progress in the enterprise segment. However, we caution that the near-term outlook is weak, given the lull in a couple of key accounts and delays in decision, pending regulatory approvals in M&As.

—Kotak Institutional Equities

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