Changing Times for IT Services
The last twelve months have been ugly for IT Services stocks. As an industry it was probably the worst performing industry in the Indian stock market. The chart below of Infosys vs. Sensex makes the point better than I can ever describe it.
Source: Bloomberg.com
Going by last year’s results for the bigger players, this deep dive was not quite deserved. If you look at revenue growth, sure there was some slowing down in growth from Infosys and Cognizant, but some of it was expected as the companies grow larger.
Source: Gridstone Research
There doesn’t seem to be anything particularly wrong with margins either. A few basis points here and there don’t make a trend.
Source: Gridstone Research
So what does the market see ahead and why is it punishing the shares of these companies so severely? I think they see three fundamental problems with the industry:
Slower growth in a maturing industry. It’s harder to grow on a large revenue base. Also, the industry is much more competitive with the global majors ramping up their offshore capability.
The coming recession. It’s still not a foregone conclusion, but if there is a recession in the US economy and perhaps globally as well, that’s bad news for the industry. I wrote about this a few weeks back. (link)
Pressure on margins due to a hardening rupee and rising wage costs. The majors should be able to get price increases to offset these effects, but competition in a low growth market can create a buyers’ market which could drag everyone’s pricing down.
Do the current prices in the market reflect the above correctly? I think it may have overdone it a bit. But the fundamental shifts are real.
If adversity is ahead for the industry, it should be interesting to see how different companies handle it. Momentum, which is what the entire industry has enjoyed so far, is a funny thing. It creates inertia. When you don’t have to change anything to grow, you sometimes forget how to effect change. That’s what worries me. IBM and Accenture are already undergoing the pain of change. They will emerge strong with a comparable offshore capability and their quiver full of market-side arrows. When it comes time for the Indian players to change, will they have the imagination and the gumption to do it?
[Since I write often about the IT Services industry and other public companies, I have added a disclosure to my “About me” page.]