Analysts rush to write IT’s epitaph

Tech counters are not long-term attractions any more, they say

Praveena Sharma & C Chitti Pantulu

BANGALORE/HYDERABAD: Indian IT is no longer sexy as it used to be. In fact, the lissome lass seems to have lost most of her charm and the warts have begun to show.

At least that’s what one is led to believe by industry analysts. Tech counters are no more long-term attractions. Though the industry is bound to survive as a business, IT is set to go the same way as those of the pharma and auto ancilliaries and components counters, said full-service securities house First Global.

“It seems awfully hard to come to terms with this, but the Indian IT is perhaps past its ‘best before’ date. It is yesterday’s story,” First Global associate director, research, Hitesh Kuvelkar said, downgrading the sector to underperform.

Some of the more informed investors are already getting out of the sector, which will not be able to maintain the 30%-plus growth rates for very long, Kuvelkar told DNA Money.

The reasons for this line of thinking are not difficult to seek. Thanks to increasing costs, both fixed and variable, the IT sector faces the prospect of lower margins this year, despite billings rates outpacing predictions 2-5%. On top of that comes the twin blow of a fast disappearing and uncertain “currency subsidy” and the impending aftermath of the US sub-prime mortgage defaults on IT spends, which are usually decided between October and December.

The importance of currency subsidy is illustrated by the fact that if the rupee-dollar exchange rate had remained at the 1996 levels, then FY07 profits attributable to exchange rate movements since 1996 would range from a low of 40% for Infosys and TCS to a high of nearly 67% for Satyam, said a First Global research note.

To put it another way, but for the currency subsidy, Infosys' earnings would have grown at a compounded annual growth rate (CAGR) of 52.7% in this period against 60.1% with currency subsidy. For Wipro, the same would have been at 35.8% against 45.1% and for Satyam at 38% against 52.5%.   

With the rupee appreciation, the currency subsidy is on the wane. And rising employee costs, inflating 20% plus every year, cannot be sustained without decimating margins for long, it added.  Going forward into the second half of the current fiscal, the industry faces a crucial phase between October and December when most US IT budgets are decided.

Street estimates were building in significant revenue momentum for offshore vendors in FY08-09 with a growth consensus of 37-39% year-on-year. The growth in FY09 was expected in the range of 28-30%. But with the latest crises, the thinking seems to have changed.

"We expect a repeat of this uncertainty in early 2008 as well, given the mounting pressures on the mortgage segment, in general, and the risk of contagion to the banking sector, in particular," brokerage firm CLSA stated in a report last week.

Software companies echo the concern. "We have to be cautious and watch the next 3-4 months to see if the mortgage industry meltdown trickles down to other sectors in terms of credit squeeze," said Wipro chief strategy officer Sudip Nandy. 

CLSA analysts Bahvtosh Vajpayee and Nimish Joshi said the sub-prime phenomenon could play out in markets like the UK, too.

Back in 2003, when tech firms were hit by the slowdown in IT spending, pricing was affected more than volumes. It had lasted for three quarters, during which, even in the worst of times, revenues grew by 15-20%, while pricing waned by 5-7%.

This time round, the situation is different. While First Global feels the sub-prime issue will have some impact, though not dramatic, its combination with the currency subsidy issue could be another of the proverbial straw on the camel's back.