When the senior management of Infosys Technologies, the software services bellwether, stands up to deliver the management guidance for 2007-08 on April 13, it is likely to strike a far more conservative note than usual. Till late 2006, the broad market consensus was that Infosys will be able to comfortably deliver 30 per cent earnings growth for 2007-08. But with the subtle change in the global macro-economic environment, that expectation is slowly fading and the markets are now veering towards a low to mid 20s earnings forecast from the software major.
Even as late as February, there were positive signals from several directions. In early February, Nasdaq-listed Cognizant Technology Solutions announced 43.3 per cent earnings guidance for 2007, broadly in line with its guidance at the start of 2006.
Accenture, the multinational consulting-cum-services major, not only delivered a strong second quarter performance, it also dwelt on its robust outsourcing pipeline led by its management consulting practice. The company, which has 13,000 management consultants, is expected to nearly double its size over the next three years, of which some growth will come from low-cost, highly skilled locations such as India.
Large-deal momentum
Informal checks conducted across frontline software services companies also corroborated the widely-held view that the offshoring pipeline continues to be strong and large-deal momentum is also swinging in favour of the Indian players. For instance, Tata Consultancy Services indicated in its Analyst Day presentation in February that it was pursuing 10 deals of $50 million and above and some in the $100-million range. And in the third quarter, it added five $50-million deals, with two above $100 million.
Satyam Computers has also indicated that it is pursuing 12-13 deals above $50 million, of which five may be in the $100-million range. Its large-deal initiative is being spearheaded by Mr Hetzel Folden, a former CSC executive, who heads the Strategic Deals group at Satyam. The company recently announced that it has signed a five-year $200-million contract with Applied Materials Inc.
In its analyst interaction in February, Wipro also talked about a large-deal team headed by Mr Sanjay Joshi that is focussing on seven large contracts.
Anecdotal evidence is that nothing has changed materially on the large-deal front; in fact, the pace has only quickened over the past year. What has materially changed over the past month, however, is the macro-economic environment, and specifically three key variables. These are:
US slowdown and its impact
The former Federal Reserve Chairman, Mr Alan Greenspan's allusion to the possibility of a recession in the US by year-end has rattled the markets at the global level. Though the Fed Chairman, Mr Ben Bernanke, has stepped in to allay those fears, the markets still remain on tenterhooks.
If the slowdown fears are for real, the entire IT industry may be entering a tricky phase, something the sector has not encountered since the dotcom/telecom meltdown in 2001. If recession fears play out only in the latter part of 2007, it may be too early to assess the shift in the spending priorities among enterprise clients, the extent of weaker sales of packaged application products such as SAP or Oracle and slowdown in discretionary spends on software development projects in the US and Europe. Now that this fear has surfaced, Infosys is likely to remain conservative in its full-year guidance, irrespective of the robust momentum on the ground.
Rupee appreciation
The appreciation of the rupee against the dollar has traditionally played spoilsport for software companies. The sharp appreciation of the rupee, especially in late March, has not only taken the sector by surprise, but will also contribute to the conservative guidance stance of Infosys.
For the sector, which is already miffed by the Minimum Alternate Tax and Fringe Benefit Tax on ESOPs introduced in the recent Budget, this will be an unexpected double whammy for margins and earnings growth.
Sectoral impact
Considering that three key players — TCS, Infosys and Cognizant — derive a chunk of their revenues from the BFSI (banking, financial services and insurance) space, any slowdown on this front can have negative implications for the sector. Except for the merger talks in ABN Amro, the IT spending patterns appear to show no visible signs of slack at present.
However, recent reports in Financial Times suggest that Barclays is expected to unveil its takeover of ABN Amro in the next 10 days. If this largest financial services deal goes through, it has the potential of shaking up the entire BFSI space. The competitive fall-out of this deal will have to be watched carefully. ABN Amro has an ongoing five-year $400-million application support contract with TCS and Infosys, struck in September 2005.
Even assuming that the impact of this development is minimal, if slowdown fears persist, Indian vendors may find it difficult to put through billing rate hikes in their renegotiations with clients.
This, again, is likely to reinforce a conservative streak in Infosys. In this backdrop, investors may be better off waiting for Infosys to unveil its 2007-08 guidance before taking fresh exposures across the IT sector.