Software stocks faced a relentless sell-off on the bourses after they unveiled their first quarter earnings, with a few companies failing to meet estimates. It was a turbulent quarter for IT majors as they struggled to maintain margins amidst a 7 per cent surge in the rupee value and wage hikes of 12-18 per cent. However, an analysis of the quarterly financial and operational metrics reported by the frontline IT companies (Infosys, TCS, Wipro and Satyam) reveals that thoug h the rupee factor has played spoilsport, there are several positive business trends that could have a bearing on the medium-term outlook for these companies.
The financials
Revenue growth was on the lower side for all the four companies, with rupee appreciation leading to lower realisations for the companies. While TCS and Satyam recorded a 0.79 per cent and 2.87 per cent sequential increase respectively in revenues, Infosys's revenues remained unchanged. Wipro registered a decline of 3.44 per cent in revenues from the previous quarter.
On a sequential basis, earnings before interest, taxes and depreciation (EBIDTA) fell for TCS (8.54 per cent lower), Infosys (9.44 per cent) and Wipro (4.95 per cent), but remained almost flat for Satyam (0.02 per cent) on a sequential basis. But the profit after tax has declined significantly for three of the four companies, except TCS, which showed a marginal increase in earnings over the preceding quarter.
Damage Control
The pressure on realisations because of rupee appreciation was mitigated partly by hedging of forex exposures and partly through volume growth. TCS has taken forward contracts for about $2.5 billion, Infosys for $925 million, Wipro for around $400 million and Satyam has hedged around $750 million worth of contracts for the year, ranging between 20 per cent and 50 per cent of estimated revenues.
This partly helped companies lock into a fixed exchange rate of (Rs 40.5-42 to a dollar), reducing the downside risk in revenue realisation from further rupee appreciation. The other mitigating factor was the volume-led (person months billed) growth, witnessed by all four companies. TCS had a volume growth of 7.6 per cent, Infosys 6.9 per cent, and Wipro 6.5 per cent; while Satyam topped the list with a 9.5 per cent volume growth on a sequential basis.
Volume-led growth is important earnings driver when realisations are under pressure as a higher volume of billable work can make up for lower rupee rates. TCS, Infosys and Satyam were more successful at protecting or growing the topline. However, Wipro could not increase its volumes enough nor did it hedge enough to compensate for the topline erosion caused by rupee appreciation.
Business Metrics
Services mix: Application development and maintenance continues to be the key revenue generator for these companies. For TCS and Infosys they contribute half the revenues and for Satyam the contribution is around 43.7 per cent. But a h ealthy trend is that some of the high-value and margin services, such as consulting, package implementation and product engineering are all seeing an increasing trend for the four companies.
Another interesting development is that infrastructure management services (IMS), with high revenue generating potential, has begun to contribute significantly to the revenues. So, the big four do appear to be making headway in improving the profile of their offerings to ensure growth.
Verticals: Not surprisingly, the banking financial services and insurance (BFSI) vertical continues to be the top contributor to revenues, considering that this segment sees the highest IT spend by clientele overseas. For TCS, this seg ment contributed 43.1 per cent (41.3 per cent the previous quarter), for Infosys 36.1 per cent (37) and for Satyam 23.7 per cent (24.7). In addition, the manufacturing and telecom segments are also increasing their contributions, accounting for 30-45 per cent of the revenues. Globally, there is an increased spend in technology in the latter two segments, and the big four appear well-placed to tap this potential.
Geographic Spread: North American clients continue to be the biggest revenue sources. For TCS this stood at 51.3 per cent (51.1 per cent the previous quarter), Infosys 62.6 per cent (62.6), and for Satyam 61.7 per cent (62.5). Geograph ic diversification in client base is evident from the fact that Europe has started to contribute between 20-30 per cent of the revenues of all these companies, and has shown an increasing trend sequentially; so is the case with Asia-Pacific and West Asia. This may help companies diversify their currency exposures so that exposure to the dollar could eventually be reduced.
Billing Patterns: Large companies have reported increases of 1-2 per cent in billing rates, indicating improved pricing power. Billing patterns, in terms of a higher proportion of fixed price billing have also shown positive trends wit h TCS (42.7 per cent) and Satyam (32 per cent) leading the way. TCS and Infosys (27.5 per cent) have shown a sequential increase and this is a healthy trend.
Of the two key methods of billing, fixed price contracts are done on the basis of proportion of work completed, while time and material billing is based on resources deployed in the project, often on a per-hour basis.
The ability to price a contract on fixed billing requires a clear ability to forecast the timelines, resources and expertise required to complete a project. This can help predict cash flows to formulate a suitable hedging strategy.
Utilisation: Except TCS, which saw a 0.5 percentage point decrease in employee utilisation levels to a still healthy 79.1 per cent , the other three companies had higher employee utilisation levels this quarter. While in Infosys the le vel was 73.9 per cent (73 per cent the previous quarter), Wipro had 74.5 per cent (68.2) and Satyam 79.9 per cent (78.4). The maximum level considered practicable is around 80 per cent. The fact that all four companies are moving towards that level indicates improved efficiency, especially given the volume growth.
Attrition Rates: Satyam managed marginally lower attrition rate (14.9 per cent) sequentially; while Infosys's attrition rate(13.7 per cent) was the same as the last quarter; TCS's attrition rate increased by a marginal 0.2 percentage points to 11.5 per cent. Wipro's attrition rate of 20.1 per cent is among the highest in the industry. Attrition is a key execution risk. While TCS, Infosys and Satyam seem to have it in control, the figures indicate that Wipro may have a greater challenge on its hands. Rupee appreciation and wage increases may also pose risks in terms of erosion of competitive advantage for these companies.
Looking ahead
Putting a turbulent quarter behind, each of these companies made certain strategic moves that are expected to deliver value and revenue growth in the long run. TCS has hived off its banking product software division into a strategic business unit, to provide a separate and focussed thrust to banking sector clientele.
Infosys has struck a deal with Philips BPO, which is expected to widen expertise in the financial accounting space for its BPO division and make its offerings more integrated.
Satyam has a won a deal from FIFA for software development which is expected to deepen its expertise in newer areas and generate revenues.
Wipro has taken the inorganic route and has acquired US-based Infocrossing, an IMS specialist. Though this acquisition may reduce margins in the near term, given Wipro's presence in computers and peripherals, together with software expertise, this move may help Wipro widen its client base.
There is increasing evidence from recent numbers that the top four IT companies are being sought by clients for quality and value arbitrage rather than mere cost arbitrage (though cost is still a primary driver), which signifies a move up the value chain.
Multi-million dollar client additions continue to be healthy for all the four companies and have increased sequentially. The repeat business percentage for Infosys and TCS is over 99 per cent and for Satyam is at 89.5 per cent. The number has improved significantly on a sequential basis in all three cases — further evidence of improving quality of service delivery. A high repeat business percentage may also help reduce sales expenditure to mine new clients.
On the rupee front, recently, the RBI curbed external commercial borrowing (ECB) levels for Indian companies. This move, if it curbs a further sharp appreciation in the rupee, could prevent a further squeeze on realisations for these companies. However, the prognosis for the rupee would also hinge on other capital flows through the FII and FDI routes.
The key take-away from the quarterly numbers for frontline IT companies is that these companies have made reasonable progress on the operational and business aspects that are within their control — a move up the value chain on service offerings, headway in geographic diversification and more efficient use of resources.
On the people front, TCS, Infosys and Satyam seem to have made reasonable progress in dealing with attrition, while Wipro, which has done reasonably with regard to other metrics, may have to critically address issues on the HR front to stay competitive. The medium-term outlook still appears positive for the 'big four'.
From an investment perspective, a possible US slowdown or a slowdown in IT spend by overseas clientele, has replaced the rupee factor as a key risk to the major technology companies. With several companies having a significant exposure to the banking and financial services vertical, the recent turmoil in this space could have significant implications on the business and pricing environment. A close watch on developments on this front is warranted at this juncture.
No comments:
Post a Comment