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The current global economic and market downturn has taken its toll on the IT Services group as a whole. The Business Process Outsourcing (BPO) companies were all under significant pressure even before the economic malaise, with a slowdown in its growth trajectory.
In other words, the BPO companies were all trading with an early 2009 growth/recovery story in mind. However, this thesis is now undergoing some re-evaluation, given that overall recovery prospects are being pushed towards the latter half of 2009 or early-2010.
The current financial market fallout adds further uncertainty to their growth picture, with roughly 50% of market cap already shaved off for the BPO companies since the fallout -- relative to its 52-week high, Cognizant Tech (CTSH - Analyst Report), Hold) is down approx. 38%, Infosys (INFY - Analyst Report), Hold) down 41.1% and Wipro (WIT - Snapshot Report), Hold) is down 38.8%.
There's no mistaking that the global financial crisis has found its way to India's shores at a time when the country is in no shape to weather it. With banks in the USA and Europe struggling to survive, outsourcing is less likely to be a dominant theme going forward. It is expected that the BPOs may cut their dollar revenue forecasts due to a downturn in the U.S. market, which contributes nearly half their revenue. These companies have already said that customers were delaying decisions on new projects in the tough global environment.
The Impact of a Weak Financial Services Sector
Among the major players in the IT Services sector, the percentage of total revenues derived from the financial services vertical is split between Cognizant and Genpact (G) at roughly 45%, 43% for Tata Consultancy Services (TCS), 35% for Infosys and approx. 25% for Wipro.
Given that a major portion of this exposure (more for the application outsourcing firms and less for the BPO firms) can potentially come from discretionary software development and other projects, the concerns raised about the negative impact of further tightening of bank IT budgets in 2009 is justifiable. The attempts by the Indian IT outsourcers to mitigate these concerns by disclosing the revenue mix from the investment banking sector compared to the more secure insurance or commercial banking sectors have been met with tepid responses so far. The differentiation has not gained much ground as the contagion seems to have spread to every corner of the financial services vertical.
While Infosys, Cognizant, TCS, Wipro and most other Indian vendors have alluded to the negative impact of a weak financial services sector, most of these companies after having posted somewhat strong sequential growth rates in their financial services verticals in Q2/Q3:FY2008, have began to falter. The current growth rate expectations have come down considerably since late-2008.
It is, however, in line with expectations as a large portion of growth recorded in H2:2008 comes from the ramp of deals signed in 2007/2008. Needless to say, most investors are now looking beyond H1:2009 and are weighing how the calamity in the financial services vertical will affect overall 2009 results. Investors are well aware that the March 2008 shock from the collapse of Bear Stearns caused several pending Indian application and business process outsourcing deal awards to get delayed, and there is no reason to believe that the September 2008 shock won't have had the same effect.
The current feedback from the Indian outsourcing companies are still somewhat tempered. There are indications that Q1:FY2009 have fared better sequentially, but data points also indicate that enterprise IT spending is still depressed, and new offshore IT bookings remain muted with a persistent 15%-25% pricing pressure. While existing projects are not necessarily being canceled, new deal activity has slowed dramatically.
Infosys indicated recently that many clients are still pushing the company to reduce its delivery costs so as to lower clients total offshore IT spend. The fact that most Indian vendors have very large (30%-50%) exposure to the financial services sector doesn't help and some vendors have high exposure to clients that are reducing headcount materially.
Many of the outsourcing advisory firms (which advise large enterprises on their deals with the offshore and domestic outsourcing vendors) are also reducing headcount and looking for strategic combinations. Add to this the negativity associated with the current anti-outsourcing sentiments and the fallout from the Satyam (), Sell) debacle, and the picture is not so bright going forward.
There is, however, a silver lining in the dark clouds. Some of the companies have indicated that the level of client discussions is still healthy, even though these discussions are converting to signed deals at a much slower clip. It also appears that deal activity in continental Europe and in the local Indian market is healthy, although neither region represents a material portion of the revenue mix for most of the Indian outsourcers.
The consensus view is that the current slowdown will last at least a few more quarters and that Q3/Q4:FY2009 will be the recovery quarter with the industry in full gear in 2010. The fact remains that visibility is so low that no one really knows when companies will feel comfortable enough to move forward with strategic offshore outsourcing decisions.
The new bookings recovery was initially pegged by the Indian vendors for Q4:2008 and then it was pushed to Q2:2009. The CEO of TCS indicated recently that a Q3:2009 recovery is more likely. Also, the management of Infosys indicated that this year it is looking for growth for the IT industry at somewhere in the region of 15 percent, compared to 30% last year. However, Infosys also reiterated that it would hire the 25,000 people it has targeted for this year and that there are no plans to cut headcount.
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