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Business News/ Home-page / Inside IT’s growth story
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Inside IT’s growth story

Inside IT’s growth story

Ahmed Raza Khan/MintPremium

Ahmed Raza Khan/Mint

Mumbai: The September quarter results of India’s top four information technology (IT) outsourcing companies underscores the fact that demand for IT services is extremely strong. Cumulative revenues of Tata Consultancy Services Ltd (TCS), Infosys Technologies Ltd, Wipro Ltd’s IT services division and HCL Technologies Ltd rose by 10.3% quarter-on-quarter (q-o-q) to 25,688.6 crore.

But in the current demand environment, achieving high growth isn’t particularly difficult. It’s more important to assess how well India’s top IT firms have managed this growth spurt—in terms of employee resources and margins, and cash flow management.

Ahmed Raza Khan/Mint

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From an industry perspective, the important thing is that all top companies have grown volumes at a healthy rate. As one analyst from a foreign brokerage points out: “The nature of demand is extremely healthy, and growth isn’t merely being driven by pent up demand in the system. Clients are handing out work related to compliance, risk management, consolidation of ERP (enterprise resource planning) systems and supply chain integration." Wipro, which is fairly accurate with its quarterly guidance estimates, has said that it expects revenue to grow by 3.5-5.5% in the December quarter. Assuming its peers are able to continue growing at a faster pace, industry growth is likely to be high even in Q3.

How well have India’s top firms managed this growth phase? While each of the top four firms have grown volumes at a decent pace, their ability to manage employee resources, margins and cash flows have differed substantially. Analysts at CLSA Asia-Pacific Markets point out in a note to clients, “Credit is due to TCS in manpower management, which has been the best in the industry. TCS has also faced industrywide headwinds of wage inflation. However, unlike Wipro, which cut manpower extremely aggressively in the slowdown, and Infosys, which reorganized its manpower through iRACE, TCS has been much more considerate to its employees. This is reflected in the much lower attrition, which has helped TCS service the demand upswing much better. This has also limited sub-contractor usage driving margin upsides."

Attrition levels at Wipro and Infosys have been relatively high and the latter had to resort to high use of sub-contractors to meet the surge in demand last quarter. Besides, the latter has had to resort to out-of-turn promotions, while Wipro and HCL Tech have issued much higher number of options to employees below market price. The resultant increase in employee costs for these firms has impacted margins. As the chart shows, TCS and Infosys reported a strong growth in earnings before interest and tax, while earnings of Wipro and HCL Tech fell considerably. But note here that Infosys’ margins had fallen sharply in the June quarter and margins were expected to bounce back in the September quarter. Of the four firms, only TCS’ earnings have been meaningfully higher than Street expectations. TCS, however, benefitted from a one-off gain, thanks to which its rent costs fell by 46% q-o-q. But for this gain, margins would have been flat. Still, this doesn’t take away from the fact that the firm has managed its employee resources and margins relatively well.

Incidentally, TCS shares have risen by over 5% since the beginning of the results season last week, making it the only company among the top-tier firms to witness a rise in share price. Infosys and HCL Tech’s shares have fallen between 4% and 5%.

Despite the iRACE fiasco, Infosys’ performance on the margin front has been relatively good too. But Wipro and HCL have clearly disappointed as far as margins go, with the latter’s profit margins at their lowest levels in the last 12 years.

A similar difference is reflected in the cash flow generated by these firms. Here, Infosys leads the pack, with a free cash flow (FCF) of 1,273 crore in the September quarter, which works out to an impressive 18% of its revenue. TCS isn’t far behind with an FCF/revenue ratio of around 15% last quarter. But Wipro’s FCF amounted to just 5.5% of revenue last quarter and HCL Tech reported a negative FCF. CLSA’s analysts note, “Such low margins and an inferior cash flow profile are a reflection of HCL’s strategy to trade growth for margins/earnings quality and recovering these will remain a challenge for HCL."

In sum, growth in the current environment is almost a given for top IT firms. But not all Indian firms are managing this growth phase well.

mobis.p@livemint.com

Sridhar Chari in Bangalore and Surabhi Agarwal in New Delhi contributed to this story.

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Published: 22 Oct 2010, 11:37 PM IST
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