Wall St sees China’s Vanceinfo, Neusoft toppling TCS, Infosys

Little known Vanceinfo Technologies or Neusoft Corp of People’s Republic of China may not be big enough yet, but they likely represent a threat for India’s $50 billion information technology outsourcing industry.

Along with Accenture and Cognizant, New York Stock Exchange (NYSE) listed Vanceinfo is one of the 2011 top stock picks of JP Morgan, the US financial services firm.

Tellingly, American depositary shares of Infosys Technologies or Wipro Technologies are missing from the list.

JP Morgan isn’t the only firm punting on the Chinese IT story.
Investment advisory CLSA predicts that the rise of China in the IT space has started, and that they will be a force to reckon with by 2014.

From about $10 billion worth of IT exports in 2009, CLSA predicts that China will see its outsourcing sector grow at about 25% annually to touch $30 billion in 2014.

Wall Street’s faith in the China IT story saw Vanceinfo gain over 150% over the past year, from its 52-week low of about $14.79 on February 5, 2010 to $37.44 on Wednesday on the NYSE.

Likely, sensing the investor interest, the Chinese outsourcer has just filed with the SEC for issuing more shares to raise up to $90 million from the market.

“They (Chinese outsourcing firms) are already a significant competitive factor for Indian outsourcers,” said Sid Pai, managing director at the Indian arm of TPI, one of the largest global outsourcing consultancies. They’ve grown well and are getting more and more North American clients.”

Pai, however, stops short of calling the Chinese IT firms a threat, at least for now. To be sure, Vanceinfo is small compared with India’s outsourcing juggernauts such as Tata Consultancy Services or Infosys Technologies, but the pace of growth, albeit on a smaller base, may be indicative of the times to come.

Vanceinfo clocked a compounded annual growth rate of about 54% between 2007 and 2009, growing revenues from $62.7 million in 2007 to $148.1 million in 2009.

For the first nine months in 2010, its revenue touched $152 million and the employee base has more than doubled from 3,675 in December 2007 to cross 10,000 at the end of 2010.

“China appears to be following a path remarkably close to its more developed IT-services outsourcing peer (India), indicating a tipping point is near at hand,” Nimish Joshi and Bhavtosh Vajpayee, analysts at CLSA wrote in a June report.

“Basic foundations are in place —- an increasingly skilled employee pool, the global push for low-cost delivery and local R&D centres of multinational firms.”

Along with the fast rising wages in India, which is undermining the country’s cost advantage, the fact that large clients in the US are looking to de-risk their offshore supplier bases by sending work to alternate offshore locations such as China gives further credence to the Chinese story.

“Geographic diversification in offshore delivery should grow in importance, particularly to China and Latin America and away from India,” JP Morgan analysts Tien-tsin Huang and Puneet Jain noted in a January 13 report on investment themes for 2011.

“Nowadays, it is typical for CIOs at large corporates in the US to adopt an i2+1, where they want two delivery locations in India and one other offshore location, which is increasingly either China or a Latin American location,” TPI’s Pai said.

Unlike in India, wages are more controlled in China.

“It is only a matter of time,” said Hansa Iyengar, senior analyst, market intelligence, at the UK-based technology researcher Ovum.

“The cost advantages are slowly eroding and may be over the next 4-5 year period you could expect China and Brazil to have the same prominence on the global offshoring map.”

Indian IT firms have been proactive and not reactive in recognising the growing significance of China and investing there. But, their presence in China is yet to reach a significant scale.

Infosys chief executive Kris Gopalakrishnan had announced in October that his company plans to increase its headcount in China to about 4,000 “immediately,” from 2,850 currently.

When contacted, executives at the firm were not available for comment as they were busy meeting analysts following the announcement of the company’s third quarter financial results.

TCS, which started Chinese operations in 2002 —- among the first Indian IT firms to do so —- is also unhappy with its performance in China.

Its chief executive said as much during the quarterly financial results announcement last October. The company has only about 1,100 people in China.

At about 800 engineers in China, JP Morgan’s other top pick —- Cognizant —- still has a long way to go in China.

There are challenges to hiring and operating at the same scale in China and that has to do with availability of talent, some analysts say.

“In China, trained talent is not as abundant as it is in India,” said Samiron Ghoshal, partner and India IT advisory leader at Ernst & Young. “While language is being addressed, it may still take at least another five years before China will have the skilled talent and processes maturity as India.”

However, according to CLSA, China produces more engineering graduates than India —- about six lakh compared with a little over 5 lakh in India.

The issue of language is being addressed, too.

“It is true that Chinese engineers in general are not as proficient in English as Indian engineers. But compared to Chinese university graduates of a previous decade, the English level has improved considerably,” Melissa Ning, a Beijing-based spokesperson for Vanceinfo said.

English language is not so much of a barrier when it comes to offshore work, according to Ning. It is only the client facing staff in the US who would require such language skills and for that companies like Vanceinfo can hire from the US market.

“It is the project managers who would be required to have English communication skills to understand customer requirements,” Ning said. “For those doing programming in China, however, speaking English is not such a high priority or barrier.”

Fresh out of the slowdown, Indian IT is waiting for business to normalise before scaling up investments in alternate delivery locations such as China.

Ovum’s Iyengar says such investments will follow, sooner than later. “Indian IT firms have been on a lean mode following the economic slowdown in the West,” said Iyengar.

“We expect things to be back to normal by second half of this year and by then we expect to hear more about investment plans in alternate global delivery locations such as China and Brazil.”