For IT firms, deal wins paint a grim picture

Subdued deal activity is likely to impact short-term revenue growth across the IT sector. (Image: Pixabay)
Subdued deal activity is likely to impact short-term revenue growth across the IT sector. (Image: Pixabay)

Summary

  • Despite the absence of any notable improvement in discretionary IT spending by clients, market speculation about revenue recovery in FY25 is already underway

The revival hopes for the information technology (IT) sector hinge significantly on the rate of deal acquisitions, yet the December quarter (Q3FY24) witnessed a lukewarm performance in this arena. Following an exceptional second quarter, top-tier IT firms experienced a slowdown in deal wins during Q3.

While moderation was expected due to the quarter's typical seasonal downturn, the absence of mega deal announcements and the trend of lengthier deal durations have raised concerns. Among the large-caps in the sector, only Infosys Ltd reported a mega deal in the last quarter. Industry-wide management commentary has highlighted a continued slowdown in decision-making processes, leading to deal delays and subdued bookings. “Ex-Infosys, last twelve month deal flow growth was 5-18% year-on-year with Tech Mahindra down 41% year-on-year," said a report from Ambit Capital.

Subdued deal activity is likely to impact short-term revenue growth across the sector. Consequently, Infosys has adjusted its FY24 growth guidance to 1.5-2% from the previously projected 1-2.5% in constant currency (CC) terms. HCL Technologies narrowed its FY24 CC revenue growth guidance to 5-5.5%, and Wipro has guided for a -1.5% to 0.5% sequential CC revenue growth in IT Services for Q4, which is lower than some analysts’ estimates.

The problem, however, is that although IT companies are yet to report any notable improvement in discretionary IT spending by clients, the Street is already talking about revenue recovery during FY25. In fact, cost-reduction/optimization deals continue to be the focus area of clients.

“Our analysis indicates that many enterprises have outlined cost savings targets that stretch into 2024. The reprioritization of spends toward the focus areas of investment is not yet complete," said analysts at Kotak Institutional Equities. “These do not inspire confidence of a significant recovery in discretionary spending at least in H1CY24," they added.

Nevertheless, the Nifty IT index has gained 22% in the past one year. There are expectations that the US Federal Reserve will cut interest rates this year, thus benefiting the banking, financial services and insurance (BFSI) sector – a key IT demand driver. The easing interest rates scenario is expected to push clients to loosen their purse strings and give their IT budgets a push, translating to higher deals for IT companies.

For now, amid client caution and subdued macros, Ambit’s analysts maintain that positivity on headline deal-flow numbers could be misleading as revenue conversion is slower and leakages higher. Plus, there are delays in deal ramp-ups. Thus, it expects Infosys’ revenue to drop in Q4 at the mid-point of its guidance, despite the company seeing the strongest deal flow growth.

Note that global IT giant Capgemini SE, which released its Q4CY23 results last week, pointed to a slow growth scenario in 2024. Commentaries on demand by Cognizant and Accenture, too, are not encouraging. According to Nirmal Bang Institutional Equities, the weak start to 2024 indicated by these three big players (Capgemini, Cognizant and Accenture) could lead to soft revenue growth guidance by Infosys and HCL for FY25 – possibly in the mid-single digit territory at best– despite strong order inflow in FY24.

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