(Swami Shanmugasundaram ) We believe the market may be overlooking
Wipro's(WIT)improving
execution. The firm has made several key investments in the last 12-15
months to revive its fortunes, and recent results indicate the company
is on the right track. Wipro's continued focus on strengthening its
client and employee management programs, coupled with strategic
investments in consulting and underpenetrated verticals, should help it
win back lost market share, in our opinion.
Offshore Model Is on Target
Wipro continues to be a dominant player in the offshore outsourcing
sector. The firm is a pioneer of the offshore-centric model and used its
first-mover advantage to carve out a space for itself in the
information technology outsourcing market. The company has been
consistently ranked among the top four players in the offshore
outsourcing space and we see minimal threat to its position in the
medium term. Wipro's solid performance can largely be attributed to its
well-defined outsourcing strategy and solid execution skills. The firm's
growth was partly aided by increased adoption of global sourcing by
large enterprises in developed countries. Global IT outsourcing spending
increased at a faster pace in the late 1990s until the beginning of the
recession in 2008. As the market grew rapidly, it attracted new players
and competition accelerated. Wipro was one of the few companies that
not only managed to thrive in this environment, but also dominate it.
The company's revenue grew at a compound annual growth rate of 28%
during the last 10 years while its operating margin consistently stayed
above 20%.
The fundamentals of offshore outsourcing look robust even in the face
of recent macroeconomic trends. Offshore outsourcing is getting good
traction as global customers increasingly want to use these services
because of the cost advantage. This trend is more pronounced in Europe
and the Asia-Pacific region (excluding Japan), where offshore
penetration is less when compared with North America. Offshore service
providers have had limited success so far in penetrating Europe, which
accounts for roughly 30% of global IT services spending. As Europe opens
up, we believe it presents sizable opportunities for Tier 1 offshore
service providers. Given its excellent track record and brand name, we
think Wipro is well positioned to capitalize on these opportunities.
Management Reorganization Is Delivering Results
The recent string of solid results indicates that Wipro isn't far from
regaining its footing. The company's past performance was subdued
largely because of management's short-term focus during and in the
immediate aftermath of the Great Recession. During the recession years,
with an eye on offsetting the impact of slow growth on its margins,
Wipro overtightened its supply side and was reluctant to invest in
front-end capabilities. The company also wasn't proactive in chasing new
opportunities. Lack of investment on both the customer and employee
fronts led to a sharp decline in growth in subsequent quarters. The
timing couldn't have been worse, when pent-up demand exploded and Wipro
couldn't participate in some parts of the rally. In 2011, the company
lost to Cognizant(CTSH)
its long-held position (for more than a decade) as the third-largest
offshore service provider. In an effort to arrest the slide, Wipro
reorganized its management team and made significant investments to fill
the gap in its client and employee management strategies. Its
restructuring started delivering results in the second quarter of fiscal
2012.
Wipro has been fast-closing the gap with Cognizant and TCS in the last few quarters. Infosys'(INFY)
own execution issues led to a sharp decline in its recent performance,
and its top-line growth fell behind Wipro's in the March quarter. In
our opinion, Wipro has all the pieces in place and it is just a matter
of time before it catches up with its Tier 1 peers.
Wipro's renewed focus on employee satisfaction and engagement has led to
a sharp decline in attrition rates. Compared with its peers, Wipro had a
tough time in managing its supply side in recent years, and we believe
this was largely self-inflicted. In an effort to maintain its margins,
the company tightened its supply chain by restricting hiring to the
minimum and offering wage increases that lagged its peers. While these
actions helped Wipro to report solid bottom-line results during the
crisis, they came back to bite the company when demand rebounded
strongly during the recovery. The firm's attrition rate spiked, and in
some cases the company couldn't take up projects because it lacked
qualified resources. After learning the hard way, Wipro fine-tuned its
employment management practices and the results have been good so far.
The company reported a sharper improvement in broader attrition
rates--voluntary attrition declined to 14.4% from 20.9% during the last
four quarters. Additionally, we believe attrition at the senior
management level is largely in the past. Wipro's improved performance
during this period was partly helped by an industrywide decline in
attrition, but the magnitude of improvement at Wipro far outpaced its
competitors.
Wipro's Simplified Client Engagement Model Is More Agile and Customer-Centric
Wipro has made considerable strides in fine-tuning its account
management model--poor client-mining is the other major reason behind
Wipro's recent lackluster performance. While the company historically
has been good at hunting new clients, the same can't be said about its
client-mining (which, in simple terms, is getting more out key clients).
In our opinion, this was mainly due to a lack of specific account
management responsibility. In most cases, each account had multiple
touch points, which made it harder to establish accountability. Although
this approach worked well in the past, the changing industry landscape
has made it less effective. As the outsourcing industry matured, global
organizations have become more inclined to obtain greater value and
benefits out of every sourcing relationship. This requires more
collaboration between the client and IT service provider. Most of
Wipro's competitors changed their go-to-market strategy, and Wipro was
one of the last to get on board.
As part of its restructuring, Wipro simplified the account management
model and made it more customer-centric. The firm invested in domain
experts, enterprise architects, and experienced client managers. The
company rolled out a one-point accountability model and gave client
managers greater autonomy over their accounts. Additionally, to align
the interests of its client managers with those of the company, Wipro
changed the compensation structure. A significant portion of client
managers' compensation is variable and tied to the overall performance
of the account and client satisfaction.
Early results from these changes look very encouraging. The company
reported a notable increase in the number of $100 million and $50
million clients in the last four quarters.
There's More to Wipro Than the Market Can See
With Wipro currently trading about 30% below our fair value estimate of
$13 per share, we believe the upside outweighs the downside by a wide
margin. The offshore IT services market remains underpenetrated, with
penetration levels ranging from the low single digits to the midteens
across different service lines and geographies. For instance, the
penetration level is in single digits in Europe and Asia-Pacific, while
it trends in the low teens in North America. From an industry
perspective, financial services is an early adopter of offshore
outsourcing, but lately we are seeing increased traction from industries
such as energy, health care, and retail. We believe these developments
offer ample headroom for growth for Wipro in the medium term. In terms
of profitability, we think Wipro continues to possess a handful of
margin levers to offset any potential headwinds. Some of these levers
include increasing employee utilization and productivity, moving work
from onsite to offshore, and shifting to fixed-price contracts from
time-and-material projects. The company historically has used a
combination of these levers to maintain its profitability. Additionally,
unlike Infosys, Wipro's offerings don't come at a premium, so we don't
expect any threat to its margins in the future.
According to the research firm Gartner, worldwide IT outsourcing
spending is expected to grow by 4%-5% during the next four years. Given
companies' increased adoption of offshoring, we think offshore spending
will grow at a higher pace. We expect Wipro to beat the market given its
track record, delivery efficiency, and breadth of offerings.
Swami Shanmugasundaram is an equity analyst on the Technology Team.