5 min read.Updated: 17 Jul 2013, 11:21 PM ISTAnirban Sen
Second-quarter profit driven by fresh orders, forex gains, allaying concerns that followed sacking of CEO Murthy
Bangalore: Nasdaq-listed software services firm iGate Corp. surprised investors by posting strong growth in second-quarter profit, driven by fresh orders and forex gains, allaying concerns that followed the recent sacking of chief executive officer (CEO) Phaneesh Murthy.
IGate, however, is struggling to find a replacement for Murthy and risks losing its biggest customer Royal Bank of Canada (RBC), which contributes more than 10% of its annual revenue.
Experts highlighted several challenges facing the company that two years ago acquired Patni Computer Systems and harboured ambitions of being ranked in the same league as top Indian software companies Tata Consultancy Services Ltd (TCS) and Infosys Ltd.
Two months after the Fremont, California-based company sacked Murthy for failing to disclose a relationship with a subordinate, iGate is scrambling to find a replacement CEO because of its huge $700 million debt, unsettled tax claims and lawsuits filed against it, according to three candidates who had been approached by executive search firm Russell Reynolds.
Despite reports about top executives from Infosys and former Patni CEO Jeya Kumar being in the race for the top post at iGate, the reality is that potential candidates are wary of taking up the assignment, the candidates said, requesting anonymity as these discussions were private.
“There are some unanswered questions and concerns about the role that makes you think again and again," one of them said.
Russell Reynolds, appointed by iGate to scout for a CEO, did not immediately respond to an email query seeking comment.
IGate said on Wednesday it expects to appoint a CEO by the autumn season in the US that begins in September.
Murthy’s exit “was a major setback. He was more or less a one-man show", said Rajat Juneja, practice director at outsourcing advisory firm Everest Group. “The lack of the company’s ability to find a new CEO within the organization goes to show how dependent they were on him."
Murthy was widely seen as the face of iGate and credited with turning it into a formidable rival to bigger Indian information technology (IT) firms.
“Murthy was instrumental in iGate’s growth strategy, the Patni integration, and we suspect key customer relationships. He will not easily be replaced, and accordingly we anticipate uncertainty will cloud the shares over the intermediate term until a new CEO is hired and his strategic vision is communicated," US brokerage firm Oppenheimer said in a note in May after Murthy’s departure from iGate.
IGate could also lose its biggest client RBC, which contributes about $100 million in annual revenue, as the bank has started to shift work to other service providers, two people familiar with the matter said.
Losing a client such as RBC at a time when all top banks in Canada have stopped outsourcing fresh business to Indian IT firms could prove to be a severe blow for iGate, which earns 30-40% of its overall sales from banking and financial services companies.
“If RBC decides to choose another vendor and scale down work that it does with iGate, then obviously their business will be hit because that is their largest client," said Juneja of Everest.
Earlier this year, iGate came under the scrutiny of the Canadian government, which is probing allegations of job losses at the RBC, its largest bank, because of temporary foreign workers hired by iGate to replace existing staff.
Indian IT firms such as iGate, TCS and Infosys that count Canada’s biggest banks and financial services firms among top customers are facing a backlash in that country amid high unemployment. Canada’s top five banks have stopped handing out fresh outsourcing projects temporarily, according to two people familiar with the development.
On Wednesday, during a post-earnings conference call, iGate said it did not anticipate any impact on its business due to the immigration laws in Canada and it had not seen any pull-back from any of its Canadian clients after the government probe.
“It’s pretty much been business as usual since we got a clean bill after the audit," said interim CEO Gerhard Watzinger, an iGate veteran.
An RBC spokeswoman declined to comment on whether the bank had started shifting work away from iGate and said it would continue to work with iGate if it complied with RBC’s policies on outsourcing.
“IGate is a long-standing supplier and we will continue to work with them provided that they comply, like all our suppliers have to, with our supplier code of conduct," the spokeswoman said in an emailed reply. “As previously mentioned, we will only use external suppliers when their investment in scale, technology or operational knowledge provides superior skill sets and capabilities we cannot duplicate inside our own business or in Canada."
IGate’s debt has also accumulated, and its acquisition of Patni continues to be an area of concern for investors.
Former CEO Murthy, whose goal was to transform iGate into a tier-1 IT giant, pushed for the acquisition of Patni to create a $1 billion firm that would rival TCS, Infosys and Wipro Ltd.
The idea was to create a firm that would have the scale to go after larger outsourcing deals from top American corporations such as Citigroup and General Electric Co. IGate, however, is still lagging on that front and the acquisition of Patni will continue to be a drag on its growth, say experts.
“With Patni, iGate bit off more than it could chew," said Pratik Gandhi, an analyst at IDBI Capital.
Since the acquisition of Patni, iGate has missed its guidance, posted a drop in its margins and lost market share to rivals.
To be sure, some of iGate’s efforts have paid off, with the company signing a seven-year $200 million contract with Swiss financial services firm UBS AG in the June quarter. According to people familiar with the development, the contract was signed when Murthy was still heading iGate. UBS didn’t immediately reply to an email query seeking confirmation on the deal.
IGate also said it was optimistic about near-term spending by top clients and it had booked orders worth more than $600 million, including three multi-year contracts worth $100 million.
For the June quarter, iGate posted a 60% rise in core net income to $34.5 million, with revenue growth of 6% to $283.3 million. Analysts were expecting a net profit of $28.7 million on revenue of $279.1 million, according to Bloomberg estimates.
Gross margin for the company, which added 11 new clients during the quarter, stood at 37.9%, compared with 37.4% in the year-ago period.
Experts say the longer-term challenges cannot be ignored. “IGate will have a tough time making a mark when the outsourcing industry growth has slowed down and larger peers such as Infosys and Wipro have been struggling to post double-digit growth," said Gandhi of IDBI. “Whoever comes in as CEO for them has an acid test ahead of him and will have a tough time achieving strong growth."