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Business News/ Opinion / Views/  Recent correction in IT Services: Cracking the Code

Recent correction in IT Services: Cracking the Code

What is often overlooked is the inherent resilience of the Indian IT sector

What is often overlooked is the inherent resilience of the Indian IT sector (Photo: Mint)Premium
What is often overlooked is the inherent resilience of the Indian IT sector (Photo: Mint)

It is a rapidly evolving landscape, and the IT services sector gets disrupted by a “tech refresh" cycle at least once every five years. In the late 90s, it was finding a solution to the Y2K problem, while in the early 2000s, web development was the pre-requisite skill set, and post-2009, data center and SaaS skills began to dominate. A radical change beckoned around 2015 when businesses started moving to the cloud. There was demand for a more front-end skillset that could weave in AI, machine learning, and advanced analytics along with an understanding of sectoral dynamics. In 2020, Covid accelerated a multi-year technology cycle led by cloud, and digital transformation – the nature of IT spending also changed, evolving from discretionary to a strategic priority.

Today, IT contracts do not focus on cost alone. They also have wide ramifications on competitive advantage and innovation. Jamie Dimon sounded a warning recently on “an economic hurricane on the horizon" but was equally vociferous in defending the IT budgets “Technology always drives change, but now the waves of technological innovation come in faster and faster. “

The India advantage

Indian IT services sector has been at the forefront of these “tech refresh" cycles. Within the global outsourced spending basket, the Indian IT Services industry has consistently gained market share owing to the ability of the companies to upskill the workforce at scale at each turn in the cycle. In 2022, India’s IT exports are likely to be upwards of $170 billion, representing over 12% of total global IT spend, and since the turn of the century, has grown by 19% CAGR. Indian IT companies are not mere outsourcing vendors but are emerging as strategic partners driving transformational changes in the client’s business. I have often noted a dismissive tone about Indian firms being mere cost arbitrageurs. Nothing could be further from the truth. India’s ecosystem and strong and technically qualified workforce provide the edge.

Correction from long-term perspective

In a long-term context, an investor should evaluate the recent sharp correction in the IT sector, down 30% year-to-date with some individual names correcting even more. Strangely, it seems that the markets have bracketed India’s IT services companies alongside the consumer tech names in Nasdaq. In my recent conversations, clients have cited top-down concerns like rising rates and fears of the US recession as reasons for this correction.

It seems that anything connected to “growth," “tech," and “consumer" have taken a beating. Also, larger institutional ownership has led to a sharp correction in IT services companies, given the record FII outflows. However, fears regarding a US recession impacting Indian IT services may be misplaced. For one, technology deals are a source of competitive advantage and are less likely to be affected by near-term growth uncertainties. Secondly, as we have seen during past recessions, a US slowdown often triggers large enterprises to look for more optimized solutions from both cost and customer perspectives. Thirdly, recent results from industry leaders like Accenture reinforce the positive demand environment. At worst, there is a delay in decision-making in some geographies and verticals. Still, the changing nature of deals over the last few years (long-term, enterprise-wide) provides near-term visibility of revenues.

This is not to suggest that the sector is immune to an economic slowdown. It is just that Indian IT companies seem to have more levers to navigate the challenges. The IT services companies in general generate superior returns in capital, have strong professional teams with great execution capabilities and the business is underpinned by a highly capital efficient business model. While we do not build our portfolios based on top-down sector allocation, given the above factors, we do tend to find more companies within the IT services sector from a bottom-up perspective. The sector has had its share of skeptics over the last two decades. At each inflection point, commentators have feared that Indian IT companies were not well-prepared to make the transition and hence would lose market share to global competitors. However, what is often overlooked is the inherent resilience of the sector and the under-appreciated fact that Indian IT companies have always done an admirable job of re-skilling the workforce at scale and have emerged stronger after each slowdown.

Prateek Pant is chief business officer, WhiteOak Capital Asset Management Company.

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Published: 13 Jul 2022, 10:56 PM IST
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