IT sector’s earnings outlook: how bad will it get?4 min read . Updated: 27 Apr 2020, 12:23 PM IST
- Managed Services will drop by 17% in the coming quarter and about 7% overall for 2020
IT service majors have begun their announcements on results for the quarter ended March 2020. Until the pandemic hit, most onlookers expected that there was broad-based strength in the IT outsourcing market and that it would continue for the foreseeable future.
Last year, the National Association of Software and Services Companies (Nasscom) stopped publishing its yearly estimate for Indian Information Technology (IT) exports and refrained from providing guidance for Financial Year 2020. Nasscom’s numbers had long been the homegrown benchmark used by captains of India’s IT industry. Today, we have no industry touted benchmark and there is rank uncertainty about the future. Also, IT services firms are abandoning forward revenue and earnings guidance. Investors are flying blind.
Investors should look elsewhere for industry benchmarks. The gold standard among research reports on IT services belongs to the ISG Index, published by ISG (Information Services Group, Inc.). Now in its 70th consecutive quarter, it has become very robust and relies on over 200 discrete data sources. Its focus is on IT outsourcing ‘big deals’ awarded during the quarter in the commercial (non-governmental) sector. These deals are made much of by IT CEOs.
With 70 serial quarter-by-quarter views of activity in the deal space, ISG produces a startlingly accurate view of the deal cycles in the industry. This is especially true since the renewal or renegotiation of old deals form about 80% of the overall market.
I recently spoke with Michael Connors, chairman and CEO of ISG, and Steven Hall, President of its European business, to get some insight into what they had seen in this immediate past quarter. More important, I wanted a steer on what they expect for the remainder of the year.
This column will necessarily focus on numbers. The numbers are germane to the current earnings announcement season, and to what may be expected in future.
The Index tracks both the Managed Services market, in which Indian IT outsourcing firms are active, as well as the broader combined market in As-a-Service offerings in cloud and software, where Indian firms are largely absent. The As-a-Service market includes work that is outsourced to Big Tech giants such as Amazon Web Services, Google Cloud Services, IBM and Microsoft Azure.
The first two months of the quarter showed strong growth in the overall combined market and in managed services. However, 85% of the market was booked in January and February, with a noticeable trail-off in March across the globe as the reality of the pandemic hit. Despite the March downturn, the global combined market ACV still grew 7% year-on-year.
At the beginning of the quarter, Managed Services (where Indian firms are prevalent) was on track to grow at 9 to 10% year-on-year but weakened at the end of the quarter to register only a 2% increase. This suggests that new deal ACV was depressed by about 700 basis points (7%) by the impact of covid-19. That it stayed at 2% is only because the Americas, the largest single region for IT service demand, was impacted later in the quarter by covid-19.
The combined market’s real growth engine was in the As-a-Service market, with an 11% year-on-year increase, primarily led by “hyper-scaler" Infrastructure-as-a-Service providers such as Amazon, IBM and Google. This boost, which will continue, was from firms moving additional workloads to the public cloud as more employees work from home. They will regularly see peak loads from video collaboration tools being employed on their cloud-based environments.
Conversely, the research expects a slowing in the Software-as-a-Service market. Software-as-a-Service providers will be hit by companies shedding costs and user licenses as businesses around the world continue to furlough corporate employees. Clients will also seek extended payment terms and price reductions in addition to the reduced number of licenses and users.
The researchers also looked at contracts accounting for approximately $9 billion in ACV which were stressful for providers who needed to buy hundreds of thousands of laptops, secure them, make sure they were connected and train employees on how to work remotely. Hall estimates that these contracts are only being fulfilled at 80% of their pre-pandemic productivity levels and that revenue will consequently be impacted in future.
There are about 1,400 captives in India, 700 in the Philippines and 450 in China, and another 1,000 or so spread out across other parts of Asia-Pacific. Approximately 40% of these centres have less than 500 people. These have struggled with the global work-from-home orders. Many clients will reconsider their global delivery strategies. Hall expects to see a switch from labour arbitrage strategies to micro-services, artificial intelligence and robotic process automation solutions to address business resilience challenges. He predicts half of all global captives with fewer than 500 people will be repatriated or acquired.
Due to the sudden rise in hyper-scalers, ISG forecasts a 5% rise in As-a-Service ACV in the second quarter, and a 12% increase by the end of the year. Indian IT providers are non-performers in this area and are unlikely to benefit.
But managed services, where Indian IT firms are prevalent, will be down 17% in the coming quarter and down 7% for the full year, impelled by weakness in key industries such as Travel, Transportation and Hospitality; CPG and Retail; and Financial Services. For deal timing, ISG reviewed each industry and its overall IT sourcing prevalence. It expects 60% of clients to delay technology spend for 90-plus days. So, there we have it. Compare the numbers to what you are hearing from your investment targets and make your own conclusions.
Siddharth Pai is founder of Siana Capital, a venture fund management company focused on deep tech and science in India.