DSIJ Mindshare

The IT Outliers

The IT sector is not being looked upon with too much of optimism, thanks to the gloomy set of news surrounding it. Despite this, there do exist some companies which are capable of swimming against the tide, thanks to their forward thinking and better strategising, says Sagar Lele

The BSE IT index has dropped by 5.67 per cent in December 2012 so far (till December 11, 2012). Recent events surrounding Cognizant, Syntel, Infosys and Hexaware have densely fogged the outlook for the Indian IT industry. While investors are turning increasingly pessimistic about the outlook for the industry, we have picked up a select few that have the ability to adapt themselves and find avenues for growth regardless of a dampened business environment.

Over a period of 1 year, the BSE IT index has yielded a negative return of 3.86 per cent versus a rise of 12.76 per cent in the Sensex.

Various factors across the globe, concerning different companies have dented the outlook for the Indian IT industry. For long, the IT industry has been facing issues like reduced customer spending and delayed decision making. Pricing pressures have been witnessed by many companies resulting in margins getting thinner by the quarter. This has been further aggravated by changes in technological trends, requiring companies to readjust their offerings and services.

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There are always certain characteristics that separate the wheat from the chaff. Accordingly, as far as IT companies are concerned, those with the following characteristics will always be in a position to outperform their peers:

1. Those who can adapt their service offerings and focus areas to changing trends
2. Consider and adopt an inorganic growth model
3. Specialise their offerings in certain verticals thus provide industry-specific expertise and
4. Fuel growth through models that are different from plain vanilla application development and maintenance

There are four such companies, Cognizant Technologies, Polaris Financial Technology, Tech Mahindra and Persistent Systems, which we have done either or all of the above and hence managed to keep their financials rolling. These companies clocked an average growth in revenues and profit of 5.62 per cent and 8.35 per cent respectively in the last four quarters. This is higher as compared to the overall average revenue and profit growth of 2.71 per cent and 3.90 per cent respectively. Stock returns for these companies have averaged 34.73 per cent against a negative return of 3.86 per cent registered by the BSE IT Index.

Dynamism In The IT-scape

Recent trends have been indicative of quick changes in the landscape of the IT industry. These changes revolve around the emergence of new disruptive SMAC (social, mobile, analytics and cloud) technologies, demand from geographies like East Europe and Latin America and increased demand from governments for large-scale projects. These changes have definitely resulted in a pressure on IT firms with regards to implementation. However, these challenges have also provided companies with a remarkable opportunity for growth.[PAGE BREAK]

Moreover, client needs have changed drastically over time. “Clients have a dual mandate of simultaneously reducing costs while innovating for growth and competitiveness. Clients no longer want to choose between a strategic partner and a cost-effective outsourcing provider; they want strategy and efficiency combined”, says R. Chandrasekaran, Group Chief Executive – Technology and Operations, Cognizant.

A good example of grabbing this prospect has been that of Cognizant. Cognizant has implemented a strategy to distribute investments across three horizons to focus and scale on various fronts of demand. The 3 horizons being:

1. Application development and maintenance, data warehousing and business intelligence
2. Management consulting, BPO and IT infrastructure services
3. Newer geographies (Latin America), newer industries (government/public sector), newer technology architectures (SMAC)

With the first two horizons, Cognizant continues to remain robust on established models and continues to implement strategies that are flexible with the current environment. With the third horizon, it drives growth by capturing the changing environment.

This strategy seems to have worked well for Cognizant which has been a consistent outperformer with average annual revenue growth of 30.41 per cent in the last 5 years.

Infosys too seems to be getting on this path with the implementation of Infosys 3.0. Through this strategy, Infosys focuses on being relevant to the whole range of its clients’ spending – covering business transformation, business IT services and business innovation with a goal to have an improved portfolio of businesses that will ensure high-quality, industry-leading growth, enhanced revenue productivity and relatively higher margins.[PAGE BREAK]

Stimulating Growth The Inorganic Way

In line with the implementation of Infosys 3.0, the company recently acquired a Swiss-based leading global management consultancy firm, Lodestone Holding AG. It advices companies on devising innovative business operating models, optimising processes and implementing new technologies leveraging SAP. The company has expertise in various industries. As of August 2012, it had 858 employees and revenues of CHF 207 million (USD 222 million) at the end of 2011.

The acquisition will help Infosys expand its Consulting & Systems Integration business, allow cross-selling of services with Lodestone’s clientele, improve the position of Infosys giving it exposure in geographies like continental Europe and emerging markets like Latin America and Asia Pacific. Also, considering higher revenue per employee for Lodestone, it will help boost margins for Infosys. The benefits of this acquisition are expected to start showing in Infosys’ performance starting December.

Similarly, Tech Mahindra has lately been aggressive on the acquisition front. It recently acquired Hutchison Whampoa’s call centre business. It also acquired a 51 per cent stake in Comviva Technologies, a Bharti Group company that addresses mobile service providers by providing them solutions in the areas of value-added services (VAS), mobile applications, platforms, mobile financial solutions, etc.

Tech Mahindra derives revenue primarily from technology services provided to clients in the telecommunication industry (In FY12, 80.7 per cent of revenues came from Telecom Service Providers and 6.6 per cent from Telecom Equipment Manufacturers). Considering the industry-specific operational model of Tech Mahindra, this acquisition would definitely help the company leverage its position.[PAGE BREAK]

The Benefits Of Industry-Specific Expertise

With focus shifting from pricing to partnering, clients have been looking for industry-specific expertise to help provide tailored services to drive innovation. Considering Tech Mahindra’s strong presence in the telecom industry, clients would prefer services from it rather than having to deal with generic service providers. Even after British Telecom’s (BT) exit from Tech Mahindra via stake sales, both parties have maintained that this wouldn’t affect Tech Mahindra’s business proposition with BT. Moreover, although the revenue component of BT has been reducing over the years, there has been an increase in amount of IT work that Tech Mahindra has been doing for BT.

Similarly, Polaris Financial Technology has a stronghold in the Banking, Financial Services and Insurance (BFSI) sectors. Although IT companies faced pressures from the BFSI vertical in FY12, Polaris managed a growth of 27.08 per cent on the revenues front. Polaris, with a range of products and services catering to the BFSI vertical has been able to provide clients with solutions to handle complex deals. It has also kept itself on track with changing trends by launching cloud platforms for the baking and insurance sectors. It launched the world’s largest FT Grid, a cloud offering that enables offering financial technology infrastructure and banking products on a pay-per-use model.[PAGE BREAK]

New Business Models

A notable example of a company that has shifted to growth using non-linear models is that of Persistent Systems. Its business model and solutions are concentrated on OPD (Offshore Product Development), Sell-With Business, Technology Consulting and IP-based business models. The IP-led business has worked so well for Persistent that in Q2FY13, 18.9 per cent of its revenues came from the IP-led business that grew by 48.5 per cent sequentially.

Persistent has been an active in inorganic IP led deals, having made 3 deals so far in FY13. The latest addition to Persistent’s kitty was Doyenz’s rCloud that provides backup and disaster recovery for physical and virtual servers under the cloud for SMBs. Vivek Sadhale, Company Secretary and Head – Legal and Investor Relations, Persistent Systems said that the Persistent Systems continues to look out for deals to augment its IP-led business.

Jargon Buster

  • IP-led Business: Generation and development of Intellectual Property and garnering revenues out of the sale of these products and solutions
  • Sell-With Business: Providing solutions by partnering with companies like IBM, Salesforce.com and Oracle[PAGE BREAK]

The Outlook

Considering the fact that about 80 per cent of IT services revenues come from the U.S. and Europe, the outlook is bound to be dampened due to global issues like slower than expected growth in the US, delayed recovery of Europe and regulatory issues arising in various other countries. Slower growth for IT companies is going to be a natural effect of the above factors. That said and done, what we are focusing on is the resilience and the adaptability displayed by certain companies in a bid to beat these blues. And based on the above factors, we are relatively bullish on Tech Mahindra, Polaris Financial Technology and Persistent Systems. Why have we left out Infosys? Because the company is likely to face some blips on its guidance and achievement in the short term but we continue to remain bullish on it over the longer term.

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