IT companies still leveraging balance sheets

The slowdown appears to have left software companies — programmed to adopt a risky means of garnering revenues — leveraging the balance sheet in order to win deals.

Under this approach, the service provider bears upfront costs in purchasing software, hardware and other equipment and books the investment as expenditure in its balance sheet.

It’s a risk IT vendors took to keep their toplines intact during the slowdown. But experts feel the quarterly ritual is here to stay.
“We see the IT services market gravitating towards such deals,” CLSA analysts Bhavtosh Vajpayee and Nimish Joshi wrote in a note to clients on Tuesday.

Most top IT firms, including Infosys, HCL Technologies and Wipro, have been following this approach, mostly in the domestic market, to ensure deals keep coming their way.

Infosys Technologies, India’s largest IT firm by market capitalisation, which earns a small percentage of its revenue from this model, has roped in partners to ensure efficient delivery of services to clients.

“There are two aspects in this approach, namely ownership and control. Our partners own it in terms of costs, while we control it. So, nothing comes directly onto our balance sheet.

For example, our HRO offering is on a similar partnership model,” said S Gopalakrishnan, CEO of Infosys Technologies.

The company considers the model a win-win for both its clients and itself.

“Customers get flexibility in payment with the pay-as-you-go model. On the other hand, service providers are moving towards a non-linear model as payments are not directly linked to the workforce employed but to efforts and results,” said Subhash Dhar, senior vice-president and head - communication, media and entertainment business, Infosys Technologies.

That is not to discount the inherent risk, though.

“If you see the deferred revenue or other expenditure of some of the top Indian IT firms, you will find they are increasing, especially for those firms which have big infrastructure management business. This can be drag for the companies,” said a Delhi-based independent analyst who requested not to be named.

The company concedes as much. “It is a highly risky model but we have worked out a financial model, which computes the company’s risk appetite and suggests proportionate investment that can be made. We do not take undue risk. We invest in creating a business platform every quarter and are able to
recoup it by adding 3-4 customers,” said Infosys’ Dhar.

Creating a business platform involves investment in software licence, hardware, application development and other such expenditures.

“Each of our business platforms takes six months to break even. Our risk levels, at any given point of time, are usually low. Even as we make new investments, the older ones (investments) fall out of the risk bracket by then and are giving us profit,” said Dhar.

Though small now, revenues from the use of balance sheet are growing fast for Infosys. “It is in an early stage and volumes are in single digit,” said Dhar.

The model is not new to the industry.

“This approach was adopted by erstwhile EDS (now HP Global Services) and IBM. In fact, IBM still follows the balance sheet leverage model in some of its client engagements.

 Although this ensures more business wins, it actually depends on the structure of the deal to gauge when the service provider will make money from the contract,” said the independent analyst.