Time for IT to move

The appreciating rupee, sub-prime concerns and the makings of a recession in the US notwithstanding, IT counters are once again catching attention. And clearly, the bigger they are, the more beautiful they appear.

While their rock-bottom valuations may be the immediate cause for this attention, the long-term story of the sector, particularly of the big four counters, is the logical reason why analysts have been recommending them to investors over the last week.

First Global Securities India Ltd, which downgraded IT late August to underperform, revised its call to market perform on Monday.

JP Morgan analysts Bhavin Shah, Mythili Balakrishnan and Nishit Jasani, on the other hand, said long-term fundamental investors should begin accumulating top-tier names with a 12-24 month view in mind, even though IT stocks may not outperform in the near term.

Ajay Mathrani and Aniruddha Bhosale of Deutsche Bank, too, put a buy call on the top four as it believed the structural growth for Indian IT services was completely on track, though a US slowdown could have a cyclical impact on the sector, an aspect that is already factored in.

While the jury is still out on the impact of a potential US slowdown and a cut in tech spends in its wake, the appreciating rupee was certainly the dampener in the first half of FY07.

Two months since, there is evidence the biggies seem to be learning to live with a stronger rupee.

They are finding ways to mitigate its impact. For instance, Satyam Computers has started servicing US customers out of Malaysia and China, with incremental work being shipped out to new development centres in these countries.

“Billing in local currencies and cheaper resources in alternative outsourcing destinations definitely ensure margins in a scenario of a strengthening rupee,” said Virender Aggarwal, director and senior vice-president, Asia-Pacific, Africa and Middle East territories, Satyam Computers.

Clients, too, now prefer getting work done out of sites other than India for various reasons.

So, to that extent, while the overall offshoring story remains intact, there seems to be a new twist to the tale with nearshoring and alternative offshoring destinations gaining preference, thanks to the strong rupee vis-à-vis the dollar.

Cognizant Technology Solutions is also reportedly planning to reduce onsite operations by 10-15% to move them to near-shore locations like Canada and Argentina.

It would thus appear that India would incrementally lose out to other offshoring destinations, though, increasingly, globalising Indian companies themselves may not lose out on business.

Mexico and China emerge the most attractive destinations in this respect, with the peso actually depreciating 1.2% against the dollar and the Chinese yuan appreciating just 5% vis-à-vis the greenback. The rupee has appreciated almost 15% over the past 12 months.

As Mathrani and Bhosale of Deutsche Bank observe Indian biggies have also learnt to manage their costs well by better utilisation rates, lower travel costs and more fine-tuned capital expenditure are leading to lower depreciation, without negatively impacting growth.

On the flip side, however, as outgoing Nasscom president Kiran Karnik observed on Tuesday, the rupee has hit the smaller companies much harder than the big guys.

“The appreciating rupee, by itself, is not the worry. It is just the fact that it has gone up too much too fast that is causing the pain particularly for smaller companies”, he said.

While the bigger companies, which account for almost 80% of the total IT exports from India, have the cushion of offshoring from elsewhere, the smaller ones clearly do not have that option.

But overall, the India offshoring story, even at a higher rupee, remains intact.

A Deutsche Bank analysis shows that even if the rupee appreciates a further 15-20%, cost advantages for outsourcing clients still remain attractive with a 30% arbitrage, even assuming that Indian vendors pass on all the margin pressure to them.

Talking of the makings of a US slowdown, analysts are unanimous there are no signs yet of IT budgets being affected, though there are concerns on this count going into late December and early January when the budgets are actually finalised.

However, even assuming that overall IT budgets do get cropped, opinion is that outsourcing and offshoring budgets will, in fact, increase precisely because of the smaller kitty now available for IT spends.

Clearly then, the medium- to long-term IT story remains intact, which, perhaps, explains the call put out on the tech counters by analysts.

Via DNA