In midst of the fundamental shifts in technology landscape, changing client demands, and increasing protectionist policies in the US, Indian IT firms have found it difficult to maintain the high growth rates that have been prevalent in the industry for a long time. NASSCOM estimates IT export revenue from India to increase by 7-8% in 2017 – compared to 12-15% from 2012 to 2016. There is a systemic shift in spending towards digital areas of analytics, cloud, IoT, AI and ML. However, unlike traditional IT services, contracts of digital transformation projects are relatively smaller in terms of size and time period.
Digital projects are typically being implemented at a business unit level and large scale enterprise wide implementations are few and far between. For example, a typical analytics project is anywhere between $250-500k in size with an implementation period of 4-6 months. Contract sizes of cloud implementations such as Salesforce, AWS or Azure are also smaller in size compared to traditional ERP or IMS implementations, primarily because these hardware and software packages themselves are cheaper to purchase – hence the System integrator revenues are also less.
Overall, the top 28 Indian companies in our coverage have reported an average revenue growth rate of 2.6% q-o-q and 9.2% y-o-y. The best performer being Polaris with growth rate of 21.4% q-o-q and 38.1% y-o-y. India’s largest IT services firm, TCS reported Q2 FY18 revenues at $4.74bn – a growth of 1.7% q-o-q and 7.1% y-o-y (in constant currency terms). This was the 12th straight quarter where the company underperformed or at best matched analysts’ estimates. Infosys, which is undergoing structural changes at management and board levels, reported sequential growth of 2.2% and a y-o-y growth of 4.6% (in constant currency) to reach $2.7bn in Q2 revenues. Wipro, while crossing a landmark of $2bn in quarterly revenue, reported muted growth numbers of 0.3% q-o-q and 2.8% y-o-y (in constant currency) – in line with the management guidance. It reported a constant currency. The 1 year return of the BSE IT index is 16.4% compared to 28.9% of the Sensex.
In spite of muted growth numbers, we believe that the larger IT firms, with over $1bn in annual revenues, are better positioned to re-model their business over the next 12 to 18 months towards digital services. All three firms – TCS, Infosys and Wipro – reported high growth in revenue from their digital practices. For TCS, revenue from digital exhibited a constant currency growth of 5.9% q-o-q and 31% growth y-o-y. The share of revenue from digital also increased to 19.7% from 18.9% in the previous quarter. Wipro reported a sequential growth of c.6% from its digital services, with an increase of 160 bps in the share of digital revenue which now forms 24.1% of the total revenue. While Infosys does not report digital as per the industry classification, it reports revenue from its new software and services which showed a growth of more than 14% sequentially.
However, it would be interesting to see how the smaller players – below $1bn in annual revenues – cope with these changes in the industry. These firms are also under significant pressure to reduce their H1B presence in the US. Mid-cap companies also face significant competition from certain key players in the digital space such as Liquid Hub, ProKarma and Globant. Successful M&A transactions is probably a key factor here in turning around these businesses towards digital. However, valuations are an obvious challenge because there are only a handful of good acquisition targets in the market.