While the investment community ventures out in helmets with the stock market falling back to earth from the sky, information technology (IT) services stocks are one of the few bright spots. While some IT stocks have also faced a slight setback due to the overall tenor of Dalal Street, they have been less impacted than their compatriots in other industries.
And now, the earnings season is once again upon us, with IT services majors beginning the cycle of announcements on results for the quarter ended September 2018. Most onlookers expect that there is broad-based strength in the IT outsourcing market and that this will continue for at least the next couple of quarters. There are several key factors that form the backdrop for this view and are worth understanding in some detail for those of us who are lay people, gripped by the frenzy of the recent sell-off in Indian equities.
First, while we bemoan the fall of the rupee vis-à-vis the US dollar, the fall is good news for IT firms overall. Some naysayers feel that this is not really an advantage since the treasurers at these companies would have taken hedging calls to contain the impact of currency fluctuations. This is no doubt true, but the truth is that Indian IT services treasurers hedge mostly against appreciation in the rupee (which would leave them with lower revenue and lower margins) and not so much against the rupee depreciating.
This is simply because the bulk of the India-based providers experience their cost base in rupees, and as such are much less worried about the rupee depreciating since it creates a windfall for their firms.
All things considered, the rupee’s recent fall is a welcome tailwind for these companies. Many analysts expect that most firms will be positively impacted by the rupee’s fall this past quarter, and estimates a range between 40 basis points to 200 basis points (one basis point is one-hundredth of a percentage point) in terms of foreign exchange lift delivered directly to these firms’ bottom lines. This lift will continue into the October to December quarter. The rupee has fallen by another 5% in early October alone.
The other factor is something that I have spoken of in this column a couple of times over the last several months—there is an undeniable rebound in overall market activity in the IT deal space.
First, IT contract durations have shrunk and had arrived at a record low of 3.2 years last year. Deal activity in the market for old contracts coming up for renewal will be quite high through the rest of this calendar year and, possibly, into next year.
Second, the US economy is in extraordinarily high gear and unemployment there is at record lows. This means that the appetite for outsourcing will go up as long as the US’ economic boom continues.
Third, the hype around “digital disruption" has largely settled down and client firms have realized that their spend on “digitization" of their firms has moved into the more mundane space of application development and maintenance for process automation: the application developer and his or her maintenance retinue, who clean up the mistakes made by developers during the time an automated application is in service.
While the positive impacts of these overall factors are clear, they will impact IT services firms differently, since each has had firm-specific factors affecting their current performance. That said, I expect that most firms will have bullish predictions on growth for the rest of the year.
The effects of the fall in the rupee will linger for a while and the deal space will remain healthy, but a lot of the new “digital" work comprises the automation of IT services—and automation simply means that the developers and maintainers who write programming code for automation methods are the head of a snake eating its own tail.
Indian IT services firms will have a couple of more quarters of excellent numbers, but increased automation means they are not quite out of the woods yet.
Stay invested in Indian IT for the short-term while the markets roil. Once they settle, begin to pare down.
Siddharth Pai is founder of Siana Capital, a venture fund management company focused on deep science and tech in India.