A hesitant smile

Updated: Apr 27 2008, 05:30am hrs
As the quarter results come in, Indian IT companies look ahead with cautious optimism Rajesh Menon analyses whatcould be in store

Days after the four Indian IT majors TCS, Infosys, Wipro and Satyam detailed their earnings and gave a muted outlook with back-ended growth for fiscal 2009, it was the turn of global IT behemoth Accenture chairman and chief executive officer William (Bill) Green to put things in perspective and give credence to the management commentaries of the Indian software firms that outsourcing has come to stay. In a dialogue in the Silicon hub of India, Green gave a historical ring to the outsourcing theme. If you look at the history, in the last economic downturn, outsourcing accelerated in a dramatic way. There is no question that an economic challenge brings people to focus on bringing in more business efficiency. The market is more mature now and outsourcing is a proven method in many cases to improve business outcomes, he said.

So, as Indian companies put their foot forward with cautious optimism, there is some consolation in the form of global majors also betting on what has so far been Indias success story outsourcing. Having already taken a hit due to the appreciating rupee against the US greenback 11% in fiscal 2008 Indian IT companies had to face another headwind in the form of a slowdown in the worlds largest economy and its biggest market, the US, from where it derives around 60% of its revenues. Grappling with rising costs, wage inflation and the threat of tax breaks going off by March 2009, there was trepidation among the software folks that Indias IT story may lose its charm.

But as Indias IT bellwether Infosys Technologies came out with its details in line with the street expectations but with a better-than-expected earnings per share (EPS) guidance for fiscal 2009 there was something to cheer about. A flat growth in the first quarter of fiscal 2009 was not the best way to kick off a new financial year, but then Infosys chief executive officer and managing director S (Kris) Gopalakrishnan admitted there were short-term challenges, (but) we as a company see significant growth opportunities in the medium to long term.

In other words, it meant that with the first quarter revenue flat and the EPS down 3%, Infosys will have to show 7% revenue growth and 8% on the EPS front in the second, third and fourth quarters to maintain its guidance of 19-21% growth in revenue year-on-year and 16-18% year-on-year growth in EPS. In fact, Infosys said 76% of its 100 large clients have flat or have slightly cut their technology budgets for calendar 2008 as against 2007 due to the slowdown in the US. Nearly 19% of them are seeing major decrease in the technology budgets of up to 10%, while others are seeing less than 10% or flat. Discretionary spending will be under pressure and decision-makings are getting delayed. There have also been sporadic project cancellations one or two projects, chief operating officer S D Shibulal said, adding, the remaining 24% customers were seeing an up-tick in their tech budgets.

Infosys results indicate decent IT services demand. Further, Infosys normal conservative stance should mean that guidance builds in most of the possible negatives. However, concerns remain on demand, given muted first quarter guidance and weakness in the financial sector. While we are confident of Infosys ability to meet guidance, out-performance would depend on demand in our view, global investment bank JP Morgan said in its post-earnings report.

However, Infosys is confident of garnering more work offshore despite economic turbulence in the worlds largest economy and its biggest market the US that contributed 62% of the total revenue. We believe that offshoring as a pie within the budget will increase in spite of softness in the budget, chief financial officer V Balakrishnan said.

A couple of days later when its competitor and neighbour Wipro detailed its earnings, it once again brought the market situation is changing rapidly, which has a bearing on our immediate business dynamics. However, we remain resilient, we remain agile and confident of another good year. Considering this, we have drawn up an aggressive plan to capitalise on the likely back-ended positive momentum for a profitable volume growth, Wipro chairman Azim Premji said.

But then, the back-ended growth is also the big catch. There have been sporadic project cancellations and large discretionary projects are on hold till they (the customers) get some stability, executive director and chief financial officer Suresh Senapaty said. Which again means that Wipro, too, is betting on the third and fourth quarters to make up for its muted first half.

We expect Wipro to report earnings growth of 16.9% in FY09. An uncertain business environment and volatility on the forex front will pose challenges going forward, brokerage house Prabhudas Lilladher said in its report. Incidentally, Wipro has increased its forward cover from $2.45 billion on a gross basis at the end of December quarter to $3.5 billion, including long-term contracts, at the end of March quarter even as Infosys brought down the forward cover. Our objective is to make sure that we are well protected. Given the kind of volatility, we thought the better way to deal with it is not to play with the forex, Senapaty said.

That brings us to Indias largest software export house Tata Consultancy Services which tried to put up a brave front, but came out with a foggy outlook indicating weakness for a while. Though its chief executive officer and managing director S Ramadorai said they were satisfied with the annual performance, it was not a view shared by the investor and analyst community. Our full year results reflect a validation of our strategy and robust business model that has helped us deliver strong growth rates again on an ever increasing base in a difficult and challenging environment. We will deliver sustained, profitable growth in the next financial year, Ramadorai said.

However, TCS has the largest exposure to the banking, financial services and insurance (popularly called BFSI) segment among the IT majors with 43.6% of revenues and it was in this segment that it witnessed turbulence from two of the top 10 clients who have deferred some projects. The company indicated that volume growth would remain sublime during first half of FY09, with one of the clients having deferred ramp up until second quarter, while another Tier 1 starting engagements on a case by case basis. Besides, we wish to highlight that the companys tone has changed over the past three months on the pricing front, with the company talking of stable pricing from stable pricing with an upward bias earlier, Emkay Share said in its report.

As for Hyderabad-based Satyam, it was a year where it led its peers in volume growth that was over 42% and that with a stable pricing environment and optimistic hedging on the rupee front, has made the company give a guidance of 24-26% topline growth and 17-19% growth in EPS. This signifies a reasonably strong growth outlook for FY 2009. However, it should be noted that a key risk here is that the company has assumed a rupee-dollar rate of Rs 40 in its guidance. This we believe is fairly optimistic and if the rupee does appreciate, the company could have a difficult time meeting its guidance, Angel Broking said in its report.

So, what does these commentaries mean for the IT industry To begin with the days of heady growth of 35-40% are over and it is time to look beyond the US market and diversify its geographic reach to sustain the momentum. As Accentures Green says: Historically, an economic downturn in the US or the UK would have all competitors slow down together and decide not to invest. This year, the competition is about companies in the emerging markets, which continue to see growth all around them. Fifty companies in the list of Fortune 500 are from emerging markets. This says it all.

The moot point here is that everything depends on the demand environment. While some have argued that the slowdown will lead to more demand and accelerate outsourcing, it also depends on how the worlds largest economy copes with it and wriggles out of it. For the time being, it is the story of a muted first half and a strong second half. How the script plays out, only time will tell.