(By
Swami Shanmugasundaram) With
the global economy in flux, investors have raised questions about the
growth prospects of IT service providers. This fear has pummeled some of
the top-tier service providers we cover, and current prices suggest a
significant curtailment of IT services spending in the near and medium
term. We think this is unlikely, as hiring patterns and order pipelines
indicate that the growth momentum remains strong in the near term.
Continued customer focus on cost efficiencies should help outsourcing
achieve higher penetration in the medium term. Against this backdrop, we
think narrow-moat firms Wipro (
WIT) and Infosys (
INFY) trade at large discounts, offering patient investors attractive risk/reward opportunities.
Demand for IT Services Remains Strong Despite Economic Uncertainties
Though
the global economy is on a slippery track, we expect IT service
providers to hold their ground in the near term. We haven't seen any
cracks in IT services spending so far, not even in discretionary
consulting services. Recent commentaries from Cognizant (CTSH),
Wipro, and Tata Consultancy Services indicate that it has been business
as usual in terms of deal signings in the past few months. Accenture (ACN)
recently closed its fiscal 2011 with record consulting and outsourcing
bookings; its outsourcing bookings were its highest in the past seven
years. Additionally, given the linear nature of the business model (high
positive correlation between employee growth and revenue growth), we
think employee hiring patterns are good leading indicators of growth.
All top-tier players have good records on resource planning and have
historically increased hiring primarily when they had good visibility on
their future demand. In that regard, continued strong hiring by these
companies backs up our outlook for a robust demand environment in the
near term.
Over the medium term, we expect demand to come from increased
adoption of outsourcing by companies around the world. Though 2009 was
one of the toughest years for IT service providers, we think it
eventually turned out to be a positive for their business as it helped
them acquire more new clients and expand their addressable markets. This
is in line with the industry's prior experience. Economic downturns or
slowdowns typically force companies to evaluate their IT spending and
look for new ways to cut expenses. Given the cost benefits associated
with outsourcing, we would be surprised if outsourcing doesn't gain more
traction in the coming quarters.