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Indian IT - Long term growth outlook intact
The global economy is set to improve going ahead with global GDP predicted to grow by 3.5% in CY2013 and 4.1% in CY2014. Global IT - business process management (BPM) spend is expected to grow in the range of 5-6% over the next two years and global sourcing is set to grow faster at ~8% during 2013 and 2014. India continues to be the global sourcing leader, but it accounts for only ~10% of the total global IT-BPM spend of US$124-130bn, which implies that the market is huge and presents immense untapped opportunity. Indian IT-BPM firms are well positioned to take advantage of these trends by working towards developing new capabilities, servicing the entire IT services value chain and expanding their focus to new geographies, technologies and industry verticals. Indian companies grabbing market share vs global peers: We expect worldwide IT spending (excluding hardware) to post a three-year CAGR of 4.4% while the total sourcing market is expected to grow by ~7-8% (~2x of worldwide spend). Top IT service players globally have been increasing their market share every year in the overall IT-BPM spending and have gained ~110bp per annum share annually since the last five years. While the worldwide IT services market has posted a five year CAGR of just ~3.5% and global sourcing market having posted a CAGR of ~9% commensurately, Indian software services revenue has posted a 16% CAGR (almost 2x of growth in global sourcing); primary reason for the same being the labor arbitrage or cost savings to clients. The top-5 Indian IT companies have been increasingly gaining market share since last five years in the overall revenues from biggies of IT services sector globally. Indian IT - Large cap companies leading the growth: The top-5 Indian IT services vendors have increased their share of Indian IT exports by ~135bp per annum. This supplements the fact that Indian large-cap players have been surpassing mid-cap companies in terms of grabbing market share. Taking into notice the average market share gains over the past six years (FY2007-12) and 7-8% CAGR in global sourcing spend for the next three years, the top-5 Indian IT companies are likely to grow at ~14% CAGR over the next three years. Valuation: We continue to remain positive on TCS and HCL Tech from a longer term perspective, though current valuations preclude us from taking any considerable upsides from current levels for the next couple of quarters. We expect TCS and HCL Tech to lead the growth in tier-I IT pack by growing higher than the industry average in FY2014. We recommend Accumulate rating on TCS and HCL Tech with target price of `1,624 and `875, respectively. The PE premium commanded by TCS over Infosys has reduced now, given Infosys outperformance during 3QFY2013 after six quarters of disappointing results. We maintain Accumulate rating on Infosys as well as Wipro with target price of `3,132 and `473, respectively. Tech Mahindra remains one of our preferred picks in the entire IT space as the company has recently acquired two companies which will give it inorganic boost. Also, post its merger with Mahindra Satyam, the risks which the company is facing right now such as client concentration and industry concentration will be curtailed and the company will be able to reap benefits from Mahindra Satyams capability in enterprise services. Along with Tech Mahindra, we like KPIT Cummins among mid-caps at the current level with a target price of `130, owing to recent correction in the stock price despite industry leading revenue growth.
Please refer to important disclosures at the end of this report
The worldwide IT spending grew by 4.8% yoy in CY2012 to US$1.9tn. In line with growth in global IT spend, the global sourcing market also grew to US$124-130bn, ie a growth of 9% over 2011, which is nearly twice the growth in global IT spend.
Worldwide IT spending
On the face of a volatile economic environment, 2012 recorded a steady growth for technology and related services sector, with worldwide spending of US$1.9tn, a growth rate of 4.8% yoy. Of the worldwide technology spend of ~US$1.9tn in CY2012, software products, IT, and BPM services contributed ~US$1.1tn (58%) while hardware accounted for the balance ~US$797bn (42%). Worldwide, hardware spending grew by 7%, IT services spend increased by 3.3%, BPM grew by 4.9% and spend on software products increased by 3.3%. In line with growth in global IT spend, the global sourcing market also grew to US$124-130bn, ie a growth of 9% over 2011, which is nearly twice the growth in global IT spend. As per Nasscom, lingering concerns about global economy also impacted contracts in 2012 as volumes fell by ~13%. However, average contract value remained fairly steady at US$21bn largely on the back of number of mega deals signed in the BPM space. As per Nasscom, accelerated IT spending is likely to be witnessed in 2013 with areas like mobility, cloud, and social media expected to grow much faster, thereby shifting the overall spend in technology.
(USD bn)
1,100
% growth (yoy)
We expect worldwide IT spending (excluding hardware) to post a three-year CAGR of 4.4% while the total sourcing market is expected to grow by ~7-8%.
We expect worldwide IT spending (excluding hardware) to post a three-year CAGR of 4.4% with growth being led by emerging industry verticals such as retail, energy & utilities and lifesciences & healthcare. Worldwide IT services spends have grown at a CAGR of 3.4% over the past 8 years. New requirements in legal and regulatory work, process improvement and demand for new applications are expected to aid growth in legacy industry verticals BFSI and manufacturing. The telecom industry vertical is expected to remain sluggish in the near term. The year witnessed a pronounced shift to smaller contracts while mature verticals and segments were the growth drivers for global sourcing deals.
(%)
India has emerged as the preferred outsourcing destination; Indian IT exports revenues (excluding hardware) are estimated to be at US$75.8bn in FY2013, up 10.2% yoy, and contribute ~80% to the total IT-BPM revenues (excluding hardware).
Indian IT industry
The Indian IT services and BPM industry is an integral part of the global sourcing strategy and has been increasingly contributing to the domestic economy over the years. During FY2013, IT industry in India is estimated to aggregate revenues of US$108bn in FY2013, with the IT software and services sector (excluding hardware) accounting for US$95bn of revenues. Exports revenues (excluding hardware) are estimated to be at US$75.8bn in FY2013, up 10.2% yoy, and contributed ~80% to the total IT-BPM revenues (excluding hardware). Domestic IT-BPM revenue (excluding hardware) is expected to grow at 2% to US$19.3bn in FY2013. As a proportion of national GDP, the sector revenues have grown from 1.2% in FY1998 to ~8% in FY2013. For CY2013, growth for the Indian IT industry exports has been predicted to be in the range of 12-14%.
US$3.2bn PE/VC investments; accounts for ~37% of the total investments in India
direct employement to ~3mn people; one of the largest private sector employers
~7% share in total FDI; sector ranked 4th in contribution to total FDI
21,985 47,494
21,854 50,085
Aggregate revenues
Source: Nasscom, Angel Research
62,903
69,348
74,165
88,452
100,868
108,448
The growth rate for the Indian IT sector has moderated in the last couple of years from 40% CAGR (FY2003-07) to ~15.9% CAGR (FY2007-13E). The key reasons for the decline are: 1) increasing revenue base, 2) comparable offshore employee base of MNCs such as IBM, Accenture, Capgemini, 3) weak macro-environment over the past few years and 4) increasing commoditization of services like ADM.
25.2%
27.1%
26.8%
28.3%
29.7%
30.7%
While in the past two decades Indian IT had been a story of market share shift from MNCs like IBM, HP, Capgemini, Accenture, CSC to India based outsourcers Infosys, TCS, Wipro, Cognizant and HCL Tech, driven by labor arbitrage. Although the labor cost advantage has been on a declining trend, there still is a comfortable 20-25% cost saving for clients along with availability of a young workforce. The market share of top 5 Indian IT players TCS, Infosys, Cognizant, Wipro and HCL Tech has been increasing since last six years in the overall IT spend from top IT companies globally and we expect this trend to continue going forward. Top-5 Indian IT companies have been increasingly gaining market share since last five years in the overall revenues from biggies of IT services sector globally.
FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 29.8 19.5 13.3 9.6 9.2 4.8 3.3 2.8 92.3 2.6 1.9 1.5 0.9 0.9 7.7 29.7 18.0 13.9 8.4 9.1 4.8 3.2 3.4 90.4 3.1 2.3 2.0 1.2 1.0 9.6 30.5 16.3 12.0 11.3 8.7 4.5 2.9 3.4 89.6 3.1 2.4 2.2 1.5 1.1 10.4 27.1 16.5 11.4 17.1 7.8 4.1 2.5 2.9 89.4 3.1 2.4 2.2 1.6 1.3 10.6 26.0 16.2 12.6 16.2 7.4 4.0 2.3 2.6 87.3 3.8 2.8 2.4 2.1 1.6 12.7 26.0 15.0 12.8 15.3 6.8 4.2 2.9 2.7 85.7 4.4 3.0 2.5 2.6 1.8 14.3
While the worldwide IT services market has posted a five year CAGR of just ~3.5% and global sourcing market of ~9%, Indian software services revenue has grown at a CAGR of 16%. The primary reason for the same is the benefit accruing out of labor arbitrage, leading to cost savings for clients. Along with large players in the global IT industry, the top-5 Indian IT companies have been increasingly gaining market share since the last five years in overall revenue terms, in some cases cannibalizing into the market share of global IT biggies. Indian IT is becoming competitive in terms of services being offered to the clients globally in addition to cost advantage. During FY2007-12, Indian IT services revenue market share has grown at an average of 85bp per annum. The top-5 Indian IT services vendors have increased their share in Indias IT exports by ~135bp per annum over the same period; supplementing the fact that Indian large-cap players have been surpassing mid-cap companies in terms of grabbing market share.
Indian IT-BPM: Large-cap companies to continue to surpass midcaps in revenue market share.
Worldwide, IT services spends have grown at a CAGR of 3.4% over the past six years. During this period, Indian IT services revenue market share has grown at an average of 85bp per annum. The top-5 Indian IT services vendors have increased their share in Indias IT exports by ~135bp per annum over the same period. This supplements the fact that Indian large-cap players have been surpassing mid-cap companies in terms of grabbing market share. Also, with midcaps facing issues such as demand pressures, limited pricing power, high client concentration, limited bench, limited margin levers and high revenue base, we expect large-caps to lead in terms of revenue growth and grab incremental market share.
Assuming the average market share gains over the past six years and 3.4% CAGR in worldwide IT services spend, the top-5 Indian IT companies are likely to grow at ~14% CAGR over the next three years.
FY2007-13E
805 312
support across key verticals of BFSI, manufacturing and telecom to Fortune 500 clients. From a value perspective, the industry is now increasingly aligned to its customer business, providing scale and maximum leverage, as against just offering cost arbitrage and a solution for skill shortage.
Exhibit 9: India the only country to offer full spectrum of IT-BPM services
Full gamut of services
IT Services, eCommerce BPM, Animation and Gaming ER&D Knowledge Services Software Products OSPD
Ownership Profile
MNCs
GICs
Integrated
Pure-plays
Players Portfolio
Tier I firms
Medium
Emerging
Start-ups/Small
Verticals Portfolio
Hi-Tech, Manufacturing
World Presence
Americas
Europe
Asia
Africa
Australia
Customers
Fortune 500
SMBs
Governments
NGOs
As per industry reports, even after years of outsourcing and rising competition, India continues to maintain its dominant position as a leading outsourcing market as compared to other emerging economies such as China, Philippines and Indonesia. India is the all-round standout with its first mover advantage and deep skill base, and still maintains its lions share of the IT-BPM market. India continues to maintain its advantage of cost-efficiency as compared to other key locations worldwide. As per Nasscom, under current macro-economic conditions, global customers continue to value Indian IT companies owing to their strong cost management and highly mature client delivery capabilities across verticals. One of the most critical factors that is enabling India to keep its position as a leading service player in the global outsourcing market is its output of highly qualified talent pool of technical graduates and postgraduates every year. In FY2013, it is expected that India will churn out 4.74mn graduates and postgraduates (Source: Nasscom).
(USD '000)
70 50 30 10
38-40
31-33
30-32 25-27
21-23
19-21
Buenos Aires
Monterrey
Prague
Beijing
Kuala Lumpur
Operating cost per FTE per annum for IT services: ADM 2012
Source: Everest Research, Nasscom, Angel Research
Going ahead, we expect growth to be driven by emerging industry verticals such as retail, healthcare and utilities, even as the traditional industry verticals BFSI and manufacturing record industry average growth rates.
Industry vertical wise growth: New verticals to surpass growth in matured verticals aided by lower base
In line with the past trend, BFSI and manufacturing industry verticals have remained two of the largest verticals in terms of total share in IT spending, with more than ~42% share. Emerging verticals such as retail, healthcare, lifesciences and utilities have contributed ~30% to the total spend in 2012. As per Nasscom, growth during CY2012 was driven by emerging industry verticals such as retail, healthcare and utilities, growing at a consolidated 12%, even as the traditional industry verticals BFSI and manufacturing recorded just an industry average growth rate. We expect this trend to continue going ahead as well.
Metro Manila
Bengaluru
Singapore
Bangkok
Pune
The BFSI industry is the most mature in terms of offshoring and IT has permeated across most of the BFSI value chain. This industry accounts for the largest share of more than 41% of Indian IT-BPO exports.
Going forward, technology services spending in the BFSI segment will be driven by the key imperatives of integration, optimization and regulation. Worldwide spend in BFSI vertical is expected to post a three-year CAGR of 3.1%.
Worldwide IT spend in the manufacturing vertical is expected to post a three year CAGR of 4.4%.
Telecom industry has been struggling since recession in FY2009-10, reason being that most of the telecom infrastructure in developed markets has already been built which has resulted in a shift from capex to opex model and hence most work outsourced is in the maintenance space.
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In healthcare, data analytics has started playing a key role with significant increase in clinical trials and processing of patient responses. Worldwide IT spend in this industry segment is expected to post a three year CAGR of 7.0%.
Exhibit 11: Worldwide industry vertical wise spend emerging verticals to lead the growth
(USD bn) BFSI Manufacturing Retail Healthcare Transportation Communications and media Utilities and Construction Services Government Others Total
Source: IDC, Angel Research
2015 3 year CAGR (%) 271 310 145 69 50 230 78 131 229 327 1,840 3.1% 4.4% 5.6% 7.0% 5.7% 4.0% 6.7% 5.0% 5.3% 0.7% 3.9%
11
FY2011 FY2012 28.6 32.6 30.4 23.0 20.9 13.3 12.6 13.4
25.0 23.4
53.4 40.9
12
SAMC Social, Analytics, Mobility and Cloud emerging technologies which could reshape the future of IT-BPM industry
As per IDC, Indian IT vendors are expected to generate more than US$225bn from SMAC related revenue by 2020. As per industry sources and commentary from Managements of various IT companies, consumerism and the ubiquity of connected smart devices have led to convergence of four forces: social, mobile, cloud and analytics. Social analytics brings together elements of segmentation, targeting, predictive marketing and effective customer relationships to translate into a revenue mechanism that affects profitability of business. Enterprise mobility helps enterprises meet strategic imperatives, improve operational efficiencies, real-time connectivity across functions and create engaging customer experiences. Cloud envisages virtualization, elastics selling, service automation and immense cost improvement through dynamic abstraction of IT services. Big data offers a unique suite of advanced analytics for better intelligence and derive meaningful insights from customer data to increase sales, better target customers, improve reach and gain competitive advantage. As per IDC, Indian IT vendors are expected to generate more than US$225bn from SMAC related revenue by 2020. SMAC has reoriented the business model of traditional IT firms by shifting focus from cutting costs and managing IT infrastructure to a move towards creative solutions that help clients businesses grow. As per Gartner, enterprise mobility market is expected to reach ~US$140bn by 2020, a CAGR of ~15%. Global market of big data is expected to grow by 45% annually to reach ~US$25bn in 2015 while global market of cloud is expected to reach US$650-700bn by 2020. (Source: Nasscom). International Data Corporation (IDC) predicts that 2013 will be a year of big jumps in SME businesses cloud use.
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Outlook
Global IT-BPM spend is expected to grow in the range of 5-6% over the next two years and global sourcing is set to grow faster at ~7-8% during 2013 and 2014. India has retained its position as a leading global shoring destination with a 50-55% share in global sourcing market and has been able to maintain and inch up its share despite challenges. With customers increasingly engaging with Indian service providers as a strategic partner rather than just a technology service provider, key players of the Indian software industry have capitalized on areas such as continued focus on cost-efficiency, scalable environment, availability of human capital and customer centric approach. We continue to remain positive on the overall Indian IT sector, especially on large- cap companies. The global economy is set to improve going ahead with global GDP predicted to grow by 3.5% in CY2013 and 4.1% in CY2014. Emerging geographies are coming up in a big way as important trade destinations. Nasscom suggests that five major technology changes are expected to open new opportunities for service providers smart computing, software-as-aservice, social technologies, mobility and analytics. These factors are expected to drive growth in overall technology spend by ~6% in 2013. Global sourcing is set to grow faster at ~7-8% during 2013 and 2014. India continues to be the global sourcing leader, but it accounts for only ~10% of the total global IT-BPM spend of US$124-130bn, which implies that the market is huge and presents immense untapped opportunity India continues to be the global sourcing leader, but the total global IT-BPM sourcing market of US$124-130bn accounts for only ~10% of the global IT-BPM spend, which implies that the market is huge and presents immense untapped opportunities. Indian IT-BPM firms are well set to take advantage from these trends by working towards developing new capabilities, servicing the entire IT services value chain and expanding their focus to new geographies, technologies and industry verticals. Indian IT companies are investing into building platforms to drive further growth opportunities. These domain solutions and technology platforms will offer improved revenue leverage vs talent employed in the industry. Nasscom indicated that FY2014 total revenues from India (domestic + exports, excluding hardware) are expected to grow by ~13-15% to reach US$106-111bn and out of this, exports are likely to be in the range of US$84-87bn, ie a growth of 12-14% yoy. Gartner has recently indicated an optimistic outlook and has increased IT spending growth forecast for CY2013 to 4.2%, up from the prior forecast of 3.8%, mentioning that uncertainty around the globe is coming to end and the same is likely to lead to an increase in IT spending. In addition, IDC also predicts worldwide IT spending to exceed US$2.1tr, up 5.7% yoy in CY2013. We expect tier-I companies to lead growth during FY2014 with volume growth to be 10%+. In terms of mid-cap IT companies, we expect challenges to persist due to factors such as high client concentration, demand pressures, restricted pricing power, limited margin levers, and limited bench sizes.
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Valuation
We expect TCS and HCL Tech to lead the growth in tier-I IT pack by growing higher than the industry average in FY2014. We continue to remain positive on TCS and HCL Tech from a longer term perspective, though current valuations preclude us from taking any considerable upsides from current levels for the next couple of quarters. TCS stock price has run up significantly and is currently trading at 19.8x FY2014E and 17.6x FY2015E EPS, which leaves little room for upside in the stock price in the near term. HCL Tech is currently trading at 14.7x FY2014E and 13.4x FY2015E EPS. We recommend Accumulate rating on TCS and HCL Tech with target price of `1,625 and `875, respectively. The PE premium between TCS and Infosys has reduced now, given Infosys outperformance during 3QFY2013 after six quarters of disappointing results. Infosys is currently trading at 16.9x FY2014E and 15.6x FY2015E EPS which is at a premium to the Sensex. Infosys is expected to perform better than its larger peers during 4QFY2013 aided by recent acquisition of Lodestone, which we believe would lead to re-rating of the stock further. We maintain Accumulate rating on Infosys as well as Wipro with target price of `3,132 and `473, respectively. Tech Mahindra remains one of our preferred picks in the entire IT space as the company has recently acquired two companies which will give it inorganic boost. Also, post its merger with Mahindra Satyam, the risks which the company is facing right now such as client concentration and industry concentration will be curtailed and the company will be able to reap benefits from Mahindra Satyams capability in enterprise services. Along with Tech Mahindra, we like KPIT Cummins among mid-caps at the current level with a target price of `130, owing to recent correction in the stock price despite industry leading revenue growth.
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DISCLAIMER
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Analyst ownership of the stock HCL Tech Hexaware Infosys No No No No No No No No No No No No Angel and its Group companies ownership of the stock No No No No No No No No No No No No Angel and its Group companies' Directors ownership of the stock No No No No No No No No No No No No Broking relationship with company covered No No No No No No No No No No No No
Infotech Enterprises
KPIT Cummins Mahindra Satyam MindTree MphasiS Persistent TCS Tech Mahindra Wipro
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Ratings (Returns):
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