Bangalore: Financials on the mend and signs the world economy is not falling off the cliff are good news for India's high profile IT outsourcing industry but that's still not enough for the sector to regain its past glory.
Many customers of India's software services exporters, who had so far chalked up impressive rates of growth, are struggling to stay afloat, have gone bankrupt, or are tackling severe cost cuts, leaving them little room to boost technology spending.
Add the risk to earnings from the rupee trading at five-month highs, the end of a decade-old tax holiday next year on major technology facilities and pressure on bailed-out clients not to outsource jobs and the outlook becomes more messy. "The economic downturn is so severe that people are not making decision on investments and they are cancelling new project works.
It's very tough time for these guys," said John McCarthy, principal analyst for Forrester Research. "The golden age of massive profits for offshore companies is over."
Powered by an army of low-cost, English-speaking workers, India's $60 billion IT outsourcing sector provide services ranging from managing complex computer networks and call centres to software coding to maintaining technology operations.
Indian software services firms came out of the 2000-2002 technology spending bust with sales growing up to 50 per cent a year as they won over companies to contract out inefficient operations instead of managing them in-house.
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But as global companies scramble to chalk out new business strategies in the post-Lehman world, cautious is the buzz word, especially for longer-term contracts worth millions of dollars.
STILL-CAUTIOUS CLIENTS
"At the macro level there is some confidence back, people are slightly more comfortable, but on the ground things are still the same," Infosys' Chief Financial Officer V Balakrishnan told the Reuters Global Technology Summit this week.
"Customers are still focused on cutting their spending, so the IT budgets are under pressure," he said. "If the second half recovery happens, like what the market predicts, possibly it will be in the beginning of the next calendar year." Infosys, India's second-largest IT outsourcer, last month forecast its first decline in annual revenue in dollar terms, marking a watershed for a sector that is a magnet for thousands of young job-seekers in the country.
Infosys, rivals Tata Consultancy Services and Wipro also face competition from big players, IBM, Accenture Hewlett-Packard who have raided their home-turf and are winning contracts. "From our financial services point of view while the full recovery has not happened, there is stability," said Tata Consultancy's Chief Operating Officer N Chandrasekaran.
India's IT outsourcing sector employs more than two million people, mostly young workers who helped boost demand for luxury apartments to electronics gadgets to cars in tech hubs such as Bangalore, Hyderabad and Gurgaon.
STRETCHED VALUATIONS
Top IT firms were unlikely to move back into peak valuation range of 20-30 times forward earnings as the days of heady growth rate are over, Religare Hichens, Harrison said. India's IT sector index is up 26 percent this year, underperforming a 42 per cent rise in the 30-share market index.
Infosys and Tata Consultancy have both gained about 35 per cent and Wipro is up 60 percent, but analysts remain cautious as customers still struggle.
British telecoms carrier BT Group, one of Infosys' top clients, cut its dividend and announced 15,000 further job losses last week.
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General Motors, a client of Tata Consultancy, may need to enter bankruptcy to restructure. Nortel Networks, a client of Tata Consultancy, Infosys and Wipro, filed for bankruptcy in January. Valued at more than $18 billion, Infosys trades at 15 times forward earnings, while Tata Consultancy is at about 13 times and smaller rival Wipro is at about 16 times.
"Valuations are stretched given our forecast 2-yr flattish earnings growth. Moreover, we see downside risk to earnings from recent Rupee appreciation," Bank of America-Merrill Lynch analysts said in a report titled "Treading on thin ice: Downgrade Infosys, Tata Consultancy." "While market shows signs of bottoming, demand is yet to look up, with risks to pricing as well.
Lurking protectionism worries," the analysts said in its report issued on Thursday. The rupee fell 19 per cent in 2008 helping cushion margins of Indian exporters.
A tax holiday scheme for software firms located in technology centres expires in March 2010, and this would hit earnings of top firms from April 2010 onwards by raising their tax rates to 18-22 per cent from about 10-15 per cent currently, analysts said.
Any protectionist measures, mainly in the US, to stem the flow of jobs to emerging markets is a concern after President Barack Obama unveiled plans to tighten rules allowing firms to defer paying taxes on profits made overseas.
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