it sector update 30 nov 2018 tech ‘yatra’ sector - tech yatra... · 2018-11-30 · it . sector...
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IT SECTOR UPDATE 30 NOV 2018
Tech ‘Yatra’
HDFC securities Institutional Research is also available on Bloomberg HSLB <GO>& Thomson Reuters
Indian IT : Antifragile While resilient businesses resist shocks, the ‘Antifragile’ actually get better. Despite rising volatility (business cycles, rapid paradigm shifts) and universal acceptance that Indian tech companies lack product (or innovation) DNA, their anti-fragility stands out. Most lately, this is visible in their rapid business re-alignment in the face of the ‘digital’ threat. Digital revenues in their revenue mix have scaled from low-teens to early-30s over the trailing three years.
Our recent ‘Tech Yatra’ across USA featured meetings with Indian as well as global entities, across the tech spectrum. We interacted with >50 experts across IT/ER&D services, IT Products, Enterprise buyers (BFSI, E&U) and Consultants. These included AWS, Google, SAP, Capgemini, Oracle, Salesforce, Accenture, Cognizant, EPAM, Chevron, Prudential Insurance, E&Y, ISG and others (including Indian IT svs cos).
The skeptics maintain that rapid-fire digital adoption and tech spend decisions moving away from CTOs hurt Indian IT as they mostly lack ex-CTO access. But enterprise systems of records (legacy) mesh inextricably with systems of innovation (digital). Indian IT cos have long tenured ‘tribal knowledge’ that is invaluable as their clients turn digital (rising digital penetration in F-500 accounts is adequate evidence).
Key trends include (1) Change in deal sourcing process (more sole-sourced/PoC-driven vs RFP), (2) A strong ‘cyclical’ shift towards captives, (3) Change in tech buyer landscape with CXOs (not just CTOs) driving digital tech spend as emerging tech drives new revenue
streams (rising opportunity for mid-size vendors), (4) Cloud and automation have shrunk deal size but thrown up new opportunities, and (5) Scalability and pricing continue to be key differentiators for Indian IT vs. consulting-led peers such as Deloitte/Accenture.
Meanwhile, contracting trends are robust with 25% YoY growth in deal wins, as corroborated by the Indian IT pack (esp. TCS, INFY, TechM, Mphasis, Mindtree, Zensar). Increase in deal size in digital is led by (1) IP-led models (2) Core system transformation programs and (3) Channel-first approach (increase in partnerships with cloud providers, RPA).
While Indian IT is rapidly pivoting to digital (TCS stands out), the compression of legacy business is expected to be only a gentle downward curve, not a step fall for sure. Within the declining legacy space, Indian IT (TCS, HCLT – IMS portfolio) continues to gain market share.
Indian IT is also building automation capabilities internally and moving to a more non-linear model (rev growth at 1.5x headcount growth over the past 5 yrs). Automation is expected to be a 5-10 year cycle and is trailing the cloud cycle by ~3 years.
Automation has also driven a cyclical shift to captives. New captive setups have risen significantly over the last two years. Change in onsite composition (more freshers and sub-contracting) is a result of work visa hurdles (visa applications are lower by 50% in last 3 yrs) and the tight labour market. While macros look buoyant currently, large enterprises highlighted tariff wars and Brexit as key risks.
Top picks: TCS, L&T Infotech, L&T Tech, Zensar and Majesco
Company CMP (Rs) RECO TP
(Rs)
TCS 1,959 BUY 2,400 Infosys 661 BUY 800 Wipro 315 NEU 325 HCL Tech 1,013 BUY 1,260 TechM 690 BUY 850 LTI 1,590 BUY 2,195 Mphasis 950 BUY 1,290 Mindtree 850 BUY 1,100 LTT 1,524 BUY 1,950 Hexaware 315 BUY 460 Cyient 600 BUY 850 Persistent 596 BUY 790 eClerx 1,061 NEU 1,140 Zensar 234 BUY 325 KPIT Tech 208 BUY 285 Sonata 305 BUY 445 Intellect 217 BUY 300 Majesco 465 BUY 730
Apurva Prasad [email protected] +91-22-6171-7327
Amit Chandra [email protected] +91-22-6171-7345
Akshay Ramnani [email protected] +91-22-6171-7334
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Executive Summary of Coverage Universe
S.No Name Mcap
(Rs bn)
Reco TP
(Upside %)
USD Rev
CAGR 18-21E
Target P/E (x) INVESTMENT THESIS
1 TCS 7,353 BUY 2,400 (22%) 10 24
(1) Scale and growth dominance of TCS’ digital business, (2) Strong growth visibility (USD 9.8bn deal TCV in 1HFY19), (3) Continuity in growth momentum in core verticals, (4) Efficient capital allocation. Top pick in tier-1 IT. We expect 10/15% CAGR in rev/EPS over FY18-21E. Our TP of Rs 2,400 implies 24x Sep-20E EPS.
2 Infosys 2,876 BUY 800
(21%) 9 18
(1) Strong and broad-based deal win trajectory, (2) Robust Core verticals (BFSI/Retail) trend and acceleration in Manufacturing and Hi-tech verticals, (3) Digital-led growth, and (4) Stability in large accounts. Expect rev/EPS CAGR of 9/12% over FY18-21E. Our TP of Rs 800 implies 18x Sep-20E EPS.
3 Wipro 1,424 NEU 325 (3%)
4 14
We remain NEUTRAL on Wipro based on (1) Growth lagging peers over the last five years (revenue CAGR of 5% vs 10% for Tier-1 IT), (2) Drag in legacy higher than peers (four quarter legacy CQGR of -2.2% vs -1.5% for peers), (3) Client specific issues, (4) Problems in HPS acquisition, and (5) Lower IT services margin profile. The company has scaled in Digital (+7.2% CQGR) and gained BFSI market share, but the overall portfolio mix is relatively weak. Revenue growth over FY19/20E also lags Tier-1 IT. Our revenue/EPS CAGR of 4/10% over FY18-21E compels us to assign a lower multiple. Our TP of Rs 325 is based on 14x Sep-20E EPS.
4 HCL Tech 1,411 BUY 1,260 (24%) 9 15
(1) Steady and sustainable recovery in IMS with strong pipeline and reduction in legacy portfolio compression beyond FY19E, (2) Strong Deal wins across services, (3) Continued growth across Mode-2 and Mode-3 business, and (4) Limited onsite risk and favourable risk-reward with attractive valuations. Rev/EPS growth at 9/11% CAGR over FY18-21E, TP of Rs 1,260 implies 15x Sep-20E EPS.
5 Tech Mahindra 614 BUY
850 (23%)
7 15
We are positive on TechM, based on (1) Recovery in Telecom with higher visibility on 5G spends, (2) Stability in LCC & Comviva, (3) Robust TCV wins, and (4) Significant improvement in margin profile (+680bps in last six quarters). Telecom (41.5% of rev) recovery was robust (strongest in the last fifteen quarters) led by strong TCV (USD 300mn). Digital (31% of rev, +30% YoY) is growing in-line with industry average and is driving growth in Enterprise segment. We expect USD revenue CAGR of 7% over FY18-21E led by Telecom/Enterprise CAGR of 3/10%. Tech Mahindra is available at ~11% discount to Tier-1 IT average with improving margin profile. TP of Rs 850 is based on 15x Sep-20E EPS.
6 L&T Infotech 274 BUY 2,195
(38%) 14 22
(1) Increasing penetration in Digital (37% of rev), (2) Ramp-up of large deals expected to accelerate BFSI and continuity in Retail, CPG & Pharma growth leadership, (3) Favourable delivery-mix with strong offshore leverage (leading among peers), (4) Stable top accounts’ outlook supported by strong client mining programs and (5) Marquee client base (61 of F-500) and robust management bandwidth. USD rev/EPS at 15/16% CAGR over FY18-21E and TP of Rs 2,195 implies 22x Sep-20E EPS.
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Executive Summary of Coverage Universe (cont’d…)
S.No Name Mcap
(Rs bn)
Reco TP
(Upside %)
USD Rev
CAGR 18-21E
Target P/E (x) INVESTMENT THESIS
7 Mphasis 184 BUY 1,290 (35%) 11 18
(1) Robust deal wins in Direct International and Blackstone portfolio opportunity, (2) Strategic partnership with DXC driving growth with core system transformation and cloud migration projects, (3) Increase in deal size/ duration, Europe expansion and Newgen/Digital driving growth in Direct Core, (4) S&M leverage across Direct and HP/DXC channel and solution-led sales. TP of Rs 1,290 implies 18x Sep20E-EPS (20x earlier).
8 L&T Tech 156 BUY 1,950 (28%) 20 22
(1) Broad-based growth across verticals (led by Process Industry/ Transportation) and recovery in Industrial Product, (2) Continuity in large deal wins and strong pipeline, (3) Improving business-mix leading to better margin profile, (4) Large account mining opportunity in T-30 accounts and limited competition in multiple verticals, (5) Solution/ platform strategy driving cross vertical opportunities (Hi-tech-Automotive). Expect rev/EPS at 20/28% CAGR over FY18-21E. TP of Rs 1,950 implies 22x Sep-20E EPS.
9 Mindtree 139 BUY 1,100 (29%)
14 20
(1) Traction in Digital (48% of rev) with larger deals, (2) Strong deal momentum and visibility in Travel & Hospitality, Retail & CPG and Technology & Media verticals, (3) Stable top accounts (marginal pricing increase in top ac) with secular growth ahead across T-20, (4) Margin accretion with pyramid rationalisation and delivery optimization (automation). USD rev/EPS to grow at 14/25% CAGR over FY18-21E and TP of Rs 1,100 implies 20x Sep-20E EPS (22x earlier).
10 Hexaware* 93 BUY 460
(46%) 13 18
(1) Continuity in IMS/BPM growth leadership, (2) Strong deal pipeline and larger deal size, (3) Strong traction in existing accounts ahead supported by ramp-up of large deal wins, (4) Geo expansion (Europe) and recovery in Enterprise Solutions (Microsoft partnership). Expect rev/EPS CAGR at 13/16% over CY17-20E. TP of Rs 460 implies 18x Sep-20E EPS (22x earlier).
11 Cyient 67 BUY 850
(42%) 12 16
Growth will come from (1) Recovery in Aerospace & Defense (34% of rev, +1.7% CQGR) (2) Ramp-up in DLM business (+35% YoY) and (3) Continued growth in Communication (24% of rev, +4.5% CQGR) & Transportation (12% of rev, +6.0% CQGR) verticals. Margin will expand with off-shoring and focus on IP & Solutions. Build in 12/14% revenue/EPS CAGR over FY18-21E. TP of Rs 850 is based on 16x Sep-20E earnings.
12 Persistent 48 BUY 790
(32%) 9 14
(1) Business re-alignment (merged Services and Digital segment and change in sales incentive structure) to drive growth in new accounts, (2) Improvement in deal pipeline (25-30% increase) in Healthcare/BFSI to support recovery in Digital, (3) Accelerite growth to be driven by ‘ShareInsights’ and ‘Neuro’. TP of Rs 790 implies 14x Sep-20E EPS (15x earlier) factoring 9/15% CAGR in rev/EPS over FY18-21E.
13 eClerx 41 NEU 1,140 (7%)
6 13
Structural change in business model impacted with change in delivery model (increase in onsite). (1) Increase in deal size of new logo wins, (2) Onshore-led demand growth supported by emerging accounts (30.6% of rev), (3) BFS (data & compliance services, automation) and Digital (large number of faster-growing emerging accounts) verticals to drive growth. NEUTRAL rating with TP of Rs 1,140 implies 13x Sep- FY20E-EPS, factoring USD rev/EPS CAGR at 6/11% over FY18-21E.
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Executive Summary of Coverage Universe (cont’d…)
S.No Name Mcap
(Rs bn)
Reco TP
(Upside %)
USD Rev
CAGR 18-21E
Target P/E (x) INVESTMENT THESIS
14 Zensar 53 BUY 325
(39%) 13 16
The company has totally transformed itself in the last two years (POC led sales). Growth will be led by (1) Recovery in Cloud & Infrastructure (CIS) business, (2) Mega deal wins worth USD 600mn TCV (highest ever) over FY18, (3) Revamped US sales engine, (4) Focus on penetrating Digital offerings in Top-30 strategic accounts, and (5) Acquisition of four Digital companies (Foolproof, Keystone, Cynosure & Indigo Slate). We build 13/27/26% Revenue/EBITDA/PAT CAGR over FY18-21E. Zensar is set to post the second highest earnings CAGR in our IT coverage universe and is available at ~6% discount to Mid-cap IT average P/E. TP of Rs 325 is based on 16x Sep-20E EPS.
15 KPIT Tech 41 BUY 285
(37%) 8 13
(1) PES growth driven by automotive (OEM & tier-1), (2) Limited client overlap between KPIT-ITS & Birlasoft and between KPIT’s ITS & PES division providing synergies. Expect rev/EPS CAGR at 8/22% over FY18-21E. TP of Rs 285 implies 13x Sep-20E EPS. KPIT-Birlasoft combined valued at Rs 285/share, with PES valued at Rs 150/share (20x FY20E) and KPIT-Birlasoft ITS at Rs 135/share (12x FY20E).
16 Sonata 32 BUY 445
(46%) 12 16
We like Sonata’s IP-focussed business model, capability to scale up top-accounts, robust margin expansion, high RoE (~31%) and healthy dividend yield (~3.4%). Focus on providing IP-led offerings is yielding results; IPs like Rezopia, Halosys and Brick & Click is gaining increased traction within top-clients. Strong growth in IP-led revenue (+8.6% CQGR) is aiding margin expansion. Focus on IPs and Platforms is also driving Digital revenue (35% of rev, +9.7% QoQ). We expect IITS USD revenue/EPS CAGR of 12/17% over FY18-21E. TP of Rs 445 is based on 16x Sep-20E earnings.
17 Intellect 27 BUY 300
(38%) 19 20^
Huge addressable market, Top-rated and digital ready product portfolio, significant improvement in deal wins, robust order book (Rs 12.50bn, ~99% of TTM revenue) reflects significant growth opportunity and non-linearity provide scope for margin expansion. Increased focus on execution, optimal usage of sales team and R&D, robust collections has led to significant reduction in cash burn in the last four quarters. Build in Revenue/EBITDA CAGR of 19/56% over FY18-21E. TP of Rs 300 is based on 2.2x EV/rev multiple.
18 Majesco 13 BUY 730
(57%) 19 12^
Our positive view is based on (1) Highly rated product portfolio, (2) IBM alliance benefits, (3) Improving deal wins, and (4) ramp-up in cloud revenues. Growth in cloud subscription (+29.1% QoQ, 12% of rev) is offsetting the impact of legacy shrinkage (-7% YoY). There is clear shift happening from the on-premise to cloud model. Based on current estimates, revenue from cloud will reach ~50% in FY20E and subscription (annuity stream) will reach ~20% of revenue. IBM partnership has been extended for the P&C segment, which is a bigger market and currently running POCs with Tier-1 P&C insurers. One large win from the IBM channel is expected in 2HFY19E. Expect revenue CAGR of 19% over FY18-21E and margins will expand from 2.8% in FY18 to 13.4% in FY20E. TP of Rs 730 is based on 2.2x EV/rev multiple.
Source: HDFC sec Inst Research, * Dec YE, ^ Implied P/E (valued at EV/Rev of 2.2/2.0x for Intellect/Majesco)
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IT Sector Valuation Universe
Company MCap (USD bn)
MCap (Rs bn)
CMP (Rs)
TP (Rs) RECO
P/E (x) EV/EBITDA (x) RoE (%) EPS CAGR% FY18-21E FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E
TCS 105.0 7,353 1,959 2,400 BUY 28.5 22.8 20.6 18.7 21.3 16.7 14.7 13.2 30.1 37.6 39.8 40.3 15% Infosys 41.1 2,876 661 800 BUY 19.5 17.4 15.7 14.0 13.4 11.5 9.9 8.6 24.5 24.6 25.9 26.3 12% Wipro 20.3 1,424 315 325 NEU 17.8 16.0 14.3 13.1 12.2 10.8 8.9 7.8 16.5 17.8 17.5 17.0 11% HCL Tech 20.2 1,411 1,013 1,260 BUY 15.7 13.5 12.6 11.6 11.8 9.7 8.7 8.0 25.3 26.5 25.3 24.2 11% Tech Mahindra 8.8 614 690 850 BUY 16.2 14.3 12.7 11.7 12.0 8.6 7.4 6.6 21.5 21.2 20.9 19.9 11% Tier-1 IT Median 17.8 16.0 14.3 13.1 12.2 10.8 8.9 8.0 24.5 24.6 25.3 24.2 11%
L&T Infotech 3.9 274 1,590 2,195 BUY 23.7 18.2 16.9 15.1 21.6 13.6 11.7 10.6 33.2 35.5 32.1 30.6 16% Mphasis 2.6 184 950 1,290 BUY 20.9 17.2 14.4 11.5 15.2 12.5 9.8 8.0 14.6 19.6 22.8 24.8 22% Mindtree 2.0 139 850 1,100 BUY 28.8 18.5 16.2 14.5 17.8 12.0 10.0 8.8 21.4 25.4 25.1 24.0 26% L&T Technology 2.2 156 1,524 1,950 BUY 32.8 22.1 19.1 15.5 26.5 16.3 12.9 10.4 27.7 32.9 30.6 29.6 29% Hexaware * 1.3 93 315 460 BUY 18.7 15.0 13.5 11.9 13.2 11.2 9.2 7.7 26.9 28.6 27.3 26.8 16% Cyient 1.0 67 600 850 BUY 15.5 13.9 12.0 10.6 10.8 8.5 7.1 6.0 18.1 19.6 20.2 20.5 14% Tata Elxsi # 0.9 62 1,002 1,120 NR 26.0 20.8 18.4 15.9 16.7 12.7 11.0 9.3 37.0 36.0 32.6 30.9 18% Persistent 0.7 48 596 790 BUY 14.8 12.9 11.3 9.8 7.8 5.5 4.5 3.6 16.0 16.4 16.7 17.1 15% eClerx 0.6 41 1,061 1,140 NEU 15.0 15.0 13.4 11.0 8.9 9.0 7.8 6.8 23.9 22.3 23.9 23.8 11% Zensar 0.8 53 234 325 BUY 22.0 14.7 12.4 10.8 12.9 8.8 6.9 5.7 15.1 19.6 19.8 19.5 27% KPIT Tech 0.6 41 208 285 BUY 16.3 10.8 9.7 8.8 10.0 6.4 5.6 4.7 14.8 19.3 18.5 17.7 23% Sonata 0.5 32 305 445 BUY 16.5 13.5 11.7 10.3 11.4 8.8 7.4 6.3 31.0 33.7 34.4 34.6 17% Intellect 0.4 27 217 300 BUY NM 26.0 19.1 12.5 NM 18.2 12.6 8.8 6.5 11.4 13.5 17.6 24% HGS # 0.2 13 644 755 NR 6.9 8.2 7.7 6.2 3.3 4.0 3.0 2.5 13.8 10.5 10.3 11.6 3% Majesco 0.2 13 465 730 BUY NM 16.3 11.5 9.4 NM 9.2 5.7 3.8 (1.5) 14.4 17.7 18.3 13% Mid-cap IT Median^ 18.7 15.0 13.4 11.0 12.9 9.0 7.8 6.8 21.4 22.3 23.9 24.0 17% Global Peers Accenture 103.7 NA NA NA NR 24.1 22.5 20.5 18.8 14.7 13.7 12.7 11.9 43.9 42.1 41.5 36.4 9% Cognizant 41.0 NA NA NA NR 19.0 15.7 14.1 12.7 12.9 9.6 8.9 8.1 14.1 18.3 21.0 20.0 11% DXC Tech 17.5 NA NA NA NR 7.9 7.6 6.9 6.1 4.3 4.9 4.6 4.4 29.0 15.6 17.2 17.4 9% Capgemini 20.0 NA NA NA NR 20.3 17.4 15.6 14.3 12.0 10.6 9.8 9.1 11.5 12.8 13.2 13.1 10% Atos 9.1 NA NA NA NR 21.2 9.2 7.8 7.3 9.1 5.0 4.2 3.9 13.4 16.4 18.2 17.9 12% Global Peers Median 20.3 15.7 14.1 12.7 12.0 9.6 8.9 8.1 14.1 16.4 18.2 17.9 10%
Source: Bloomberg, HDFC sec Inst Research, * Dec Y/E, ^ ex-Intellect, Majesco. #Fair Value, Intellect, Majesco, Cognizant, Capgemini & Atos EPS CAGR 19E-21E
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IT Sector P/E and EPS Growth Matrix
Source: HDFC sec Inst Research, Note: Size of Bubble represents M-cap
INFY
Wipro
HCL Tech TechM
L&T Infotech
MphasisHexaware
Mindtree
L&T Tech
Cyient
Tata Elxsi
TCS
Persistent
eClerx
Zensar
KPIT Tech
Sonata
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
FY 2
0E P
/E
EPS CAGR FY18-21E
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Stock Performance (%) Companies/ Indices 1M (%) 3M (%) 6M (%) 1-Y (%) 3-Y CAGR (%) 5-Y CAGR (%) IT Index 2.4 (6.8) 6.7 28.8 9.2 10.4 NIFTY 5.9 (7.1) 2.1 4.8 11.0 11.9 HDFC Sec coverage universe TCS 4.8 (5.4) 11.3 47.5 17.8 14.5 Infosys 2.5 (6.2) 9.5 35.6 8.2 9.4 Wipro (4.4) 6.1 19.7 5.4 3.4 5.4 HCL Tech 2.8 (1.9) 12.0 18.8 5.4 13.4 Tech Mahindra 3.5 (6.4) 1.4 38.5 9.2 10.5 L&T Infotech (6.2) (11.3) (5.2) 56.6 NA NA Mphasis (2.7) (23.7) (8.1) 31.0 24.1 18.1 L&T Technology (7.7) (8.8) 16.2 54.5 NA NA Mindtree 9.3 (17.9) (16.5) 54.9 5.7 19.2 Hexaware 0.5 (27.1) (29.0) (6.7) 8.0 21.4 Cyient (4.0) (16.2) (21.6) 7.5 6.9 17.6 Tata Elxsi^ 1.2 (28.2) (18.3) 4.7 4.4 54.4 Zensar 0.3 (25.5) (9.1) 36.0 3.7 29.3 Persistent 8.1 (29.0) (28.5) (8.2) (3.4) 7.8 eClerx 0.3 (1.8) (17.1) (21.3) (8.5) 4.5 KPIT Tech (3.9) (29.1) (23.3) 21.2 7.8 7.3 Sonata 8.2 (12.4) (17.7) 26.3 21.8 56.5 Intellect (15.9) (19.9) 2.3 53.4 (5.6) NA Majesco 4.6 (9.8) (8.2) (14.0) (4.1) NA HGS^ (2.6) (16.3) (29.6) (9.7) 11.3 8.7 Global Peers * Accenture 6.2 (4.5) 5.6 10.4 14.5 15.7 Cognizant 2.2 (8.9) (4.9) (1.9) 2.8 8.8 Capgemini (0.2) (7.2) (8.7) 7.3 7.7 17.1 Source: Bloomberg, HDFC sec Inst Research, *USD terms as compared to INR terms for Indian IT, ^ Not Rated
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Contents Strong deal trends ...................................................................................................................................................................... 9
Digital swings, legacy erosion prolongs ........................................................................................................................ 10
Automation: The new labour arbitrage ........................................................................................................................ 11
Captive acceleration and changing onsite composition................................................................................................. 12
Macros on narcos (tax cuts) ......................................................................................................................................... 13
Experts Section
Global Tech Services ....................................................................................................................................................... 20
Enterprise Tech Buyers ................................................................................................................................................... 24
Software Products/Innovators ........................................................................................................................................ 26
Indian Tech Services ........................................................................................................................................................ 30
Valuation Charts ......................................................................................................................................................... 33
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Strong deal trends There is strong traction in deal activity. As per ISG
data, 25% YoY growth in deal ACV is visible over the past two quarters. Factors driving large deals include (1) IP-led services model (e.g. TCS - Transamerica) (2) Balance sheet leverage (takeover of customer’s legacy assets) and (3) Digital Transformation Programs.
As per Everest, 857 new outsourcing deals were awarded in 1HCY18 as compared to an average of ~770 deals in the two year prior period, which is reflective of the acceleration in deal awards. Strong growth is seen in Financial services and Healthcare, driven largely by NorthAm.
NorthAm revenue (for tier-1 IT) is seeing acceleration with 3% CQGR over past two quarters as compared to 1.8% CQGR in the prior two years. Strong momentum is reflected in the >USD 100mn client bucket (tier-1 IT), with >7% CQGR growth in last two quarters as compared to 1.1% CQGR in the prior two years. This is also reflective of greater digital penetration within
the large accounts, as a large part of incremental business is digital and on a flat total account base.
Large accounts for midcap companies (aggregate of LTI, Mphasis, Mindtree, Hexaware, LTTS) have also grown over the past two quarters. The >USD 10mn client bucket has increased by >6% CQGR compared to ~3% CQGR over the prior 6-qtr period.
Apart from deals moving from PoCs to micro-services to core transformation, a strong channel-first approach (e.g. Google Cloud) is also supporting increase in deal size in digital. Most Indian IT companies have also recorded their strongest ever deal wins in recent quarters such as INFY (large deal TCV at USD 2bn), Mphasis, Mindtree (highest-ever in digital), Tech Mahindra, LTTS and Zensar.
Hiring trends are also indicative of growth acceleration. Net additions in 3QFY19 were 3x the quarterly average over the past three years. This trend is despite the slight uptick in attrition and increase in automation.
Global Contract Trend – TTM ACV Growth (YoY) Outsourcing Deals Trend (Nos)
Source: ISG, HDFC sec Inst Research Source: Everest, HDFC sec Inst Research
Strong momentum in large client bucket for both largecap and midcap IT Strong deal trends in recent quarters TCS booked deals of USD 9.9bn over the past two quarters, INFY’s large deal bookings at USD 2bn TCV in 2Q was its strongest ever Deal momentum in HCL strong with 44 transformational deal wins in 1HFY19 vs 28 in 1HFY18
846
774 759
715
857
600
650
700
750
800
850
900
1H C
Y16
2H C
Y16
1H C
Y17
2H C
Y17
1H C
Y18
(Nos)
35.2 37
.0
36.9
37.5
36.4 37
.7 38.7
39.4 40
.5
41.1 44
.0 45.8
25
30
35
40
45
50
4QCY
15
1QCY
16
2QCY
16
3QCY
16
4QCY
16
1QCY
17
2QCY
17
3QCY
17
4QCY
17
1QCY
18
2QCY
18
3QCY
18
(USD Bn)
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Digital swings, legacy erosion prolongs Revenue mix for Indian IT svs cos is pivoting towards
digital. Their deep ‘tribal knowledge’ provides credibility. However structural challenges persist in legacy, despite robust macros. There are significant changes in tech spending decisions. A shift from CIOs to CXOs is visible (including Chief Digital Officers, Chief Marketing Officers, Functional Heads, etc).
While cloud adoption has hit deal size (with lower duration), it has expanded the overall scope of business. Many enterprises are tilting towards a hybrid cloud environment vs. public cloud to mitigate data residency.
Indian IT’s pivot towards digital has been rapid, with TCS’ digital revenue up by 2.6x (legacy flat) over the past three years (8.4% CQGR). Digital has grown from 13% to 28% of rev. Meanwhile, INFY’s digital revenues have at 7.1% CQGR over the past year and stand at 31% in the mix. TCS stands out in the large cap pack in this regard, with least compression in
legacy revenues. Digital growth is 11.8% CQGR (4-qtr) and traditional business at -0.3% CQGR vs. industry at 8/-1.5% digital/traditional.
While digital is scaling, the compression of legacy business/technical debt is expected to be elongated (5-10 years gradual downward curve). Impact is largely seen in IMS, Testing and BPM services. While HCLT’s IMS growth has decelerated, it has gained market-share relative to DXC/Atos/Wipro. HCLT’s IMS has grown at 0.8% CQGR as compared to decline in peers over the past five quarters.
Some of the challenges of cloud experienced by enterprises include data privacy concerns, cost variability (increased usage with cloud and expensive to build industrial-scale) and lack of AI/ML expertise. While there are digital natives that have scaled in public cloud (Netflix), there are also instances of reversal from public cloud (Dropbox). We think legacy shrink will be longer than anticipated/feared.
Digital and Legacy Growth Trends (QoQ %) IMS Growth Comparison (QoQ %)
Source: Company, HDFC sec Inst Research, 4-qtr CQGR Source: Company, HDFC sec Inst Research, 6-qtr CQGR
TCS exhibiting fastest growth in digital and least legacy compression vs. peers HCL Tech gained market-share in a challenged IMS services
0.8
-0.5 -0.5
-1.3
-1.5
-1.0
-0.5
0.0
0.5
1.0
HCL
T
Wip
ro
DXC
Atos
(%)
7.4
11.8
7.1 7.2 8.0
-2.9-0.3 -0.3
-2.2 -1.5-4-202468
101214
Acce
ntur
e
TCS
INFY
Wip
ro
Aggr
egat
e
(%) Digital Legacy
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Automation: The new labour arbitrage Enterprise-wide adoption of RPA (robotic process
automation) is expected to shrink legacy IT business. Automation/cloud adoption is a 5-10 year cycle with higher adoption of automation in BFS and 30-50% cost take-out with BOTification (as low as ~USD 2/hr).
RPA deployment at scale is a large opportunity (e.g. ticket resolution, invoice processing) as compared to piecemeal deployment currently. RPA growth rates have been at triple digit for leading providers such as Automation Anywhere, UiPath and Blue Prism.
Blue Prism’s revenue has grown at 145% YoY in 1HCY18 and the customer base has grown from 34 in CY15 to 671 in 1HCY18 (448 in CY17) across 42 verticals. UiPath’s customers have increased from less than 100 in CY17 to over 1,800 currently.
Our interactions with experts suggest that the RPA cycle is trailing the cloud cycle by ~3 years. The services opportunity for automation is currently pegged at USD 20bn over 2020. This includes aligning RPA with industry processes. The key value proposition in automation is best exemplified in the release of 30,000 FTEs by Accenture. A key monitorable for Indian IT will be its rapid adoption of automation and building strong vertical capabilities.
Indian IT cos have rapidly invested in building automation toolsets, as reflected in increasing non-linearity. Revenue has grown at 1.5x headcount growth over the past five years as well as the last two years. As per Gartner, the RPA software market is expected to reach USD 680mn in CY18, 57% YoY and expected to grow to USD 2.2bn in CY22.
Worldwide RPA market Blueprism’s Customer growth (Nos)
Source: HFS, HDFC sec Inst Research Source: Company, HDFC sec Inst Research
Leading RPA providers such as Automation Anywhere, UiPath and Blueprism are growing >100% YoY Worldwide RPA market expected to grow >34% CAGR
991
1,458
1,962
2,501
3,069
-
500
1,000
1,500
2,000
2,500
3,000
3,500
CY17
CY18
CY19
CY20
CY21
(USD Mn)
34 124
448
671
-
100
200
300
400
500
600
700
FY15
FY16
FY17
1H18
(Nos)
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Captive acceleration and changing onsite composition Surprisingly, captive centers are on the rise and as per
Everest, 97 new global in-house centers (GICs) were setup in 1HCY18 vs. an average of 68 in the prior two year period. This trend is sharper in financial services. Some of the large European banks that are leading the shift to in-sourcing include UBS and DB.
Rising investment in captives (or global in-house centers) is also likely to increase attrition in IT services cos, esp. their digital workforce. Automation is also supporting the shift to in-sourcing. A paradigm shift in technology led by cloud/automation is enabling enterprises to own technology vs. third-parties.
Onshore workforce composition is changing, driven by rising hurdles around work visas in the US. While the US government has not been successful at formally changing visa regulations, several changes in administrative rules have made it more difficult for service providers to secure work visas (H-1B).
(1) Increase in denial rates, (2) Lengthening of visa approval process and (3) Greater scrutiny of H-1B applicants have also resulted in lower applications. Limited local tech supply relative to the buoyant demand is likely to increase on-site cost by greater on-site hiring numbers as well as increase in sub-contracting expenses. This is also reflected in increasing sub-contracting trend (mostly onsite) for Indian IT.
Indian IT cos are mitigating the on-site wage inflation risk by hiring more freshers on-site and creating an on-site pyramid. Visa applications by Indian IT have dropped by 50% over the past 2-3 years. Also, as the business mix shifts towards digital, the on-site mix has trended higher. A key monitorable will be Indian IT’s offshore leverage as digital scales.
New GICs setup (Nos) Accelerating Approved H-1B Initial Petitions (Nos)
Company FY15 FY16 FY17 TCS 4,674 2,040 2,312 Infosys 2,830 2,376 1,218 Wipro 3,079 1,474 1,210 HCL America 1,339 1,041 866 Tech Mahindra 1,576 1,228 2,233 L&T Infotech and L&T Tech 830 870 479 Mindtree 464 327 150 TOTAL 14,792 9,356 8,468
Source: NFAP, USCIS, HDFC sec Inst Research
Source: HFS, HDFC sec Inst Research
Increasing competition from captives/in-sourcing, increase in new captive setup reflective of this trend
58
70 6976
97
40
50
60
70
80
90
100
110
1H C
Y16
2H C
Y16
1H C
Y17
2H C
Y17
1H C
Y18
(Nos)
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Macros on narcos (tax cuts) The US economy has been buoyant on tax reforms
and discretionary spend is expected to remain strong. However recent commentary of leading companies has highlighted lingering concerns of tariff war (input cost pressure) and a tight labour market (wage inflation). The uncertainty around Brexit may also be a near-term deterrent and restrain tech budgets in UK.
Supported by tax cuts, US GDP accelerated to 4.2/3.5% growth in 2Q/3QCY18, compared to ~2% over the past three years. S&P 500 earnings growth is estimated (Bloomberg) to accelerate at 9% (CY19 over CY18) as compared to 4.4% CAGR over CY12-17.
Recent commentary from large enterprises is constructive, but cautious on geopolitics.
Caterpillar: “We feel good about the fundamentals of many of our end markets despite the presence of geopolitical risks and global trade tensions.”
UTC: “It's the geopolitical environment that is our biggest concern.”
Visa: “As always, there are risks to monitor, exchange rate shifts of course, the possibility of a hard Brexit; economic dislocations like we had in Argentina and Turkey; geopolitical changes like trade wars.”
Goldman Sachs: “We continue to monitor and manage our expense base carefully…”
JP Morgan: “There is divergence around the world. So, it’s led by U.S. strength, but still expecting there to be more convergence going forward. So, I actually think that our outlook is still quite optimistic on the global economy.”
P&G: “In China we haven’t seen any appreciable impact of tariff situation on consumer attitudes towards brands... there is nothing that we are aware of today that has significantly changed our outlook for our business in China.”
3M: “We see other signs of slowing in China, automotive build rates are down significantly. And that has a knock-on effect and so you see some broader softness in industrial as we go into Q4.”
US S&P 500 Growth Trend (YoY %) US S&P Financials Growth Trend (YoY %)
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research
USA GDP Growth Trend
Source: Bloomberg US Tax reforms-led uptick in CY18
1.83 2.8 2.3 2.2
4.23.5
-1
1
3
5
1QCY
17
2QCY
17
3QCY
17
4QCY
17
1QCY
18
2QCY
18
3QCY
18
(%)
-20
-10
0
10
20
30
40
50
CY09
CY10
CY11
CY12
CY13
CY14
CY15
CY16
CY17
CY18
E
CY19
E
Revenue Growth Profit Growth(%)
-20
-10
0
10
20
30
40
CY11
CY12
CY13
CY14
CY15
CY16
CY17
CY18
E
CY19
E
Revenue Growth Profit Growth(%)
IT : SECTOR UPDATE
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>US$100mn Clients Trend – Large-cap IT (Nos) >US$10mn Clients Trend– Mid-cap IT (Nos)
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research
Deal Split by Vertical (%) Infosys Large Deal TCV Trend (USD Mn)
Source: Everest, HDFC sec Inst Research Source: Company, HDFC sec Inst Research
Large accounts accelerating for both Tier-1 IT and Tier-2 IT Deal wins momentum in BFSI, Healthcare and Manufacturing with increase in share within overall deals
13 13 15 186 7 7 85 7 8 8
26 27 24 176 6 7 88 8 9 99 10 11 13
27 22 19 19
0
20
40
60
80
100
2015
2016
2017
1H20
18
(%)
BFSI HealthcareManufacturing GovernmentRetail & CPG Cyclical CommoditiesTech & Commun. Others
34 35 36 37 37 38 40 44
18 19 18 19 20 20 24 23 9 9 9 9 9 8 8 9
8 8 8 9 9 8 9
9
-2
0
2
4
6
8
10
12
20
30
40
50
60
70
80
90
3QFY
17
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
TCS InfosysWipro HCLTGrowth QoQ - RHS
(Nos) (%)
22 23 24 23 22 23 25 25
14 14 15 15 17 17 18 1917 16 16 16 15 17 19 218 8 8 9 10 10
10 1010 7 6 11 12 1212 14
-6
-4
-2
0
2
4
6
8
10
5
25
45
65
85
3QFY
17
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
LTI MphasisMindtree HexawareLTTS Growth QoQ - RHS
(Nos)(%)
664 806
657
731
779
905
1,11
6
2,02
9
-
500
1,000
1,500
2,000
2,500
3QFY
17
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
(USD Mn)
IT : SECTOR UPDATE
Page | 15
IMS - Revenue Market Share (USD Bn) Digital - As a % Of Revenue
Source: Company, HDFC sec Inst Research, TTM data Source: Company, HDFC sec Inst Research, Sept-qtr
Total Revenue Market Share (USD Bn) Digital - Revenue Market Share (USD Bn)
Source: Company, HDFC sec Inst Research, Sep-qtr annualised Source: Company, HDFC sec Inst Research, Sep-qtr annualised
60
45
31 31 31 30 28 28
010203040506070
Acce
ntur
e
Capg
emin
i
Wip
ro
TECH
M
INFY
Cogn
izant TCS
HCLT
(%) Large IMS market opportunity for HCLT to gain share vs. peers Digital % of rev for Indian IT cos lags global peers such as Accenture, Capgemini, in-line with Cognizant Scale dominance of Accenture’s digital vs. peers
HCLT3.0
Wipro2.3
DXC12.3
Atos8.4
Accenture24.4
Cognizant4.9
Capgemini6.8
TCS5.8
INFY3.6
Wipro2.6
HCLT2.3
TECHM1.5
Accenture40.6
Cognizant16.3 Capgemini
15.0
TCS20.9
INFY11.7
Wipro8.2
HCLT8.4
TECHM4.9
IT : SECTOR UPDATE
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Oracle Cloud & On-Premise Revenue Trend SAP Cloud & On-Premise Revenue Trend
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research
Amazon Web Services’ Revenue Growth Trend Salesforce Revenue Trend
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research
0.7 1.12.3 3.0
3.8 4.613.3 13.2
14.9 15.4 15.8 15.5
0
5
10
15
20
25
FY13
FY14
FY15
FY16
FY17
TTM
(EUR Bn) Cloud subscription & supportOn-premise licence & support
2.12.3
2.42.6
2.72.9
3.0
3.33.4
0
5
10
15
20
25
30
1.51.71.92.12.32.52.72.93.13.33.5
3QFY
17
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
3QFY
19
Revenue YoY % (CC) - RHS(USD Bn) (%)
Oracle Cloud and SAP Cloud have grown at 39/46% CAGR over the past five years Strong public cloud adoption reflected in AWS growth at ~50%, Microsoft Azure growth at 76% YoY Salesforce growth at ~25% YoY CC 4.64
7.88
12.22
17.46
23.34
-
5
10
15
20
25
30
2014
2015
2016
2017
TTM
50% CAGR
(USD Bn)
0.9 1.4 1.6 2.1 2.9 4.6
25.7 26.6 27.6 27.4 26.1 25.6
0
5
10
15
20
25
30
35
FY12
FY13
FY14
FY15
FY16
FY17
(USD Bn) Cloud Revenue On-premise Revenue
IT : SECTOR UPDATE
Page | 17
Accenture Outsourcing Deal Bookings Trend Accenture Outsourcing Revenue Trend
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research
NorthAm Revenue Trend - Large-cap IT Wipro & TCS Gaining Market Share In BFSI Vertical
Source: Company, HDFC sec Inst Research, Note: Aggregate of TCS, INFY, Wipro, HCLT, TECHM
Source: Company, HDFC sec Inst Research
3.3
4.54.2 4.2
3.4
4.6 4.65.0
4.0
4.6
5.8
4.7
-15-10-5051015202530
2.02.53.03.54.04.55.05.56.0
1QFY
16
2QFY
16
3QFY
16
4QFY
16
1QFY
17
2QFY
17
3QFY
17
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
(USD Bn)Outsourcing deal bookings YoY %
(%)
3.7 3.7 3.8 3.9 3.9 3.9
4.0 4.2
4.3 4.4 4.6 4.6
-6-4-20246810121416
3.0
3.5
4.0
4.5
5.0
1QFY
16
2QFY
16
3QFY
16
4QFY
16
1QFY
17
2QFY
17
3QFY
17
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
(USD Bn)Outsourcing revenue YoY %
(%)
6,65
2
6,69
4
6,82
1
6,92
9
7,05
1
7,09
2
7,30
2
7,50
6
0
2
4
6
8
10
6,200
6,400
6,600
6,800
7,000
7,200
7,400
7,600
3QFY
17
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
Aggregate Revenue YoY %(USD Mn) (%)
27.2 27.6 28.7 28.0 29.2 27.5
21.3 20.7 20.4 20.2 19.9 20.0
21.7 21.8 21.1 21.4 21.4 22.2
12.9 12.9 12.7 12.8 12.2 12.97.7 7.9 8.0 8.3 8.3 8.66.8 6.8 6.8 7.0 6.7 6.62.4 2.4 2.2 2.2 2.3 2.2
0%
20%
40%
60%
80%
100%
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
Accenture Cognizant TCS InfosysWipro HCLT TechM
Acceleration in NorthAm (core geography), revenue growth rate (sequential) doubled in last two quarters as compared to prior two years Reduction in H-1B dependency with ~50% lower applications/approvals in last 3 years TCS and Wipro BFSI revenue has grown at a CQGR of 1.7% and 3.5% respectively vs. 1.3% for aggregate BFSI (including Accenture and Cognizant)
IT : SECTOR UPDATE
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Net Additions: Large-cap IT Sub-contracting Expense/Revenue: Large-cap IT (%)
Source: Company, HDFC sec Inst Research, Note: Aggregate of TCS, INFY, Wipro, HCLT, TECHM
Source: Company, HDFC sec Inst Research, Note: Aggregate of TCS, INFY, Wipro, HCLT, TECHM
Attrition Trend: Large-cap IT Attrition Trend: Mid-cap IT
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research
Pick up in hiring with net additions in 3Q at 3x the quarterly average over the past three years Limited tech talent and strong demand has also increased sub-contracting expense, 4.7% CQGR in last year Attrition trending higher for Indian IT supported by improvement in demand environment Accenture/Cognizant’s attrition at 18/22% vs. Indian IT median at ~17%
9
11
13
15
17
19
21
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
TCS INFY WiproHCLT TECHM(%)
10
12
14
16
18
20
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
LTI Mindtree L&T TechCyient Persistent Zensar(%)
-20,000
-10,000
0
10,000
20,000
30,000
40,000
1QFY
17
2QFY
17
3QFY
17
4QFY
17
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
TECHM TCS Infosys Wipro HCLT(Nos)
10.0
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
1QFY
18
2QFY
18
3QFY
18
4QFY
18
1QFY
19
2QFY
19
(%)
IT : SECTOR UPDATE
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Experts Section S. No Company Category 1 Accenture Global Tech Services 2 Capgemini Global Tech Services 3 Cognizant Global Tech Services 4 EPAM Global Tech Services 5 KPMG Global Tech Services 6 EY Global Tech Services 7 CSS Corp Global Tech Services 8 Luxoft Global Tech Services 9 Ex Citibank Enterprise Buyers (BFSI) 10 Prudential Enterprise Buyers (BFSI) 11 Large US Bank Enterprise Buyers (BFSI) 12 Large European Bank Enterprise Buyers (BFSI) 13 Humana Enterprise Buyers (BFSI) 14 Large US Broking Firm Enterprise Buyers (BFSI) 15 Chevron Enterprise Buyers (Energy & Utilities) 16 Anadarko Enterprise Buyers (Energy & Utilities) 17 Direct Energy Enterprise Buyers (Energy & Utilities) 18 SAP Software Products/Innovators 19 SAP India Software Products/Innovators 20 Oracle Software Products/Innovators 21 Google Cloud Software Products/Innovators 22 Automation Anywhere Software Products/Innovators 23 Amazon Web Services Software Products/Innovators 24 Salesforce Software Products/Innovators 25 Hexaware Indian Tech Services 26 L&T Tech Indian Tech Services 27 Cyient Indian Tech Services 28 Zensar Indian Tech Services 29 Majesco Indian Tech Services 30 Sonata Software Indian Tech Services
We also met experts/former-employees at Infosys, Wipro, Mindtree, Microsoft (LinkedIn), Uber, New York Life
IT : SECTOR UPDATE
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Global Tech Services
Accenture
Accenture is the 2nd largest global IT services (consulting & outsourcing) company (USD 40bn revenue, 15% EBIT margin, USD 4.2bn PAT, M-cap USD 104bn) with 460,000 employees across BFSI (21% of rev), Communication, Media & Tech (20% of rev), Healthcare & Public services (17% of rev), E&U and Chemicals (14% of rev) verticals. The company’s client base includes 92 of F-100 and ~75% of F-500 clients and it’s the largest partner for SAP, Microsoft, Oracle, Salesforce and Workday.
Accenture started investing in Digital 7 years ago and has scaled the cloud business to USD 9bn (from USD 1bn five years ago). Accenture’s automation prowess demonstrated with transition of 30,000 FTEs in the last two years.
There are multiple paths to digital evolution (1) Move from back end to front-end solutions (2) Capturing more share in the Enterprise’s R&D budgets. Technology around connected devices is a massive market opportunity and Accenture is working actively with alliances such as GE and Siemens.
Competition includes McKinsey, Bain and Big-4 (mostly Deloitte, EY) for Accenture Strategy (1/3rd of business). TCS, IBM, Cognizant, Infosys are competitors for Accenture’s Technology & Process segment.
40% of business growth comes from large platforms such as Oracle, SAP, Workday, Microsoft and ~70% of deal wins are sole-sourced (non-RFP).
The company has 175 diamond clients (>USD 100mn annual revenue) which contribute ~50% to Accenture’s overall revenue (TCS/INFY >USD 100mn count are 44/23). A few client-specific ramp-downs are impacting Europe BFS which may continue till FY19.
European Telecom companies were challenged two years ago, now accelerating. Growth also seen coming back in Oil & Gas and Energy & Utilities verticals. Positive view on the growth markets of Japan, Australia, and Singapore.
Capgemini
Capgemini is a leading global (France headquartered) IT services company (EUR 13bn/USD 15.5bn rev, 12% EBIT margin, USD 20bn M-cap) with headcount at 210,000 (57% in global delivery). Key industry verticals include BFSI (27% of rev), Mfg, Auto & Life-science (22% of rev), CPG & Retail (18% of rev), Public sector (14% of rev) and E&U and chemicals (11% of rev). Geography composition stands at NorthAm (33% of rev incl. former iGate), France (21% of rev) and Rest of Europe (39% of rev).
The benefit of labour arbitrage has reduced significantly. Clients are looking at tech companies through a different lens now. Tech companies are business accelerators rather than cost cutters.
IT in-sourcing is a bigger trend visible. Clients want to bring back IT & skill related work in the organization. They want to implement Agile technology close to their location (onsite).
Time to market has become a very important driver. Enterprise clients want to work with service companies which have lower time-to-market and actionable POCs.
US tax breaks have led to more investments in ‘Change the Business’ which is part of discretionary spend. Retail, BFSI and Healthcare are spending more dollars on enhancing the customer experience and are changing the way they interact with customers.
Automation adoption is lower than anticipated. Automating the initial 10% of the work-flow is easier and that has happened at a rapid pace. Now the pace of automation of complex process is expected to be slower and requires much more innovation.
P&C insurance companies have been slower than US banks in adopting Digital technology for customer experience.
Off-shoring in Digital will lead to better margins but this will happen over the next three years.
IT : SECTOR UPDATE
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Cognizant
Cognizant is among leading global IT services company (USD 16bn rev, 20% EBIT%, ~USD 2bn PAT, USD 40bn M-cap) with 275,000 employees operating in BFSI (36% of rev), Healthcare (29% of rev), Products & Resources (21% of rev) and Com., Media & Tech (14% of rev) verticals. The current geo-mix includes NorthAm at 76% of rev and Europe at 18% of rev.
Non-digital-native Fortune-500 is running on massive legacy applications and database, its rationalisation/cloud-enablement will be a gradual process. Large tier-1 providers have the advantage of understanding the back-end systems of long tenured customers as well as possessing deep industry expertise.
Currently 70-80% of banks’ tech budget is in RTB (Run the Business) and broad shifts in banks’ spending is underway. Cost controls in banks’ RTB has moved beyond the vendor consolidation wave that started in 2008-09 into rationalising budgets within vendors currently.
Cognizant is undergoing three areas of transition – ‘what we do’ for clients is changing – (a) move from just running the IT systems to adapt to newer technologies, (b) building a better front-end and revamping the core back-end systems is a function of change in ‘clients’ expectations. The second big transition for Cognizant is to drive better operational discipline (started the delivery practice re-alignment three years ago), structured process to develop the pipeline and RFP process for enablement of better resource deployment.
As growth has slowed, from earlier >20% to 8-10%, third transition has been more focus on capital allocation. Cognizant started building a high-end consulting practice 10 years ago and now has over 6,000 consultants. BPO (among fastest growing services for Cognizant) is now ~10% of revenues.
EPAM, Luxoft and Globant are competition among midsized players while Accenture (toughest competitor) and TCS among Tier-1. Despite the scale, no one company can provide complete end-to-end services, therefore more partnerships will follow supported by alliances with AWS and automation tools such as UiPath and Blueprism.
EPAM
EPAM Systems is a global engineering and software development services provider (USD 1.8bn rev, 14% EBIT margin, USD 6bn M-cap) with Eastern Europe delivery heritage. Key industry verticals include BFSI (23% of rev), Travel & Consumer (22% of rev), Software & Hi-tech (20% of rev) and Media & Entertainment (18% of rev). Geography composition stands at NorthAm (60% of rev) and Europe (37% of rev).
Core engineering DNA is a strong differentiator with a product development mindset vs. maintenance mindset and EPAM evolved from product development for ISV (75% of rev in 2006 to 19% of rev) into product engineering across verticals. Strong product engineering capabilities with software providers has helped scale business (Expedia, Google).
60% of EPAM’s revenue via referrals/sole-sourced and deal size ACV is USD 0.25 – 0.75mn and project duration is 6-8 months. The company has ~80-90% revenue visibility for the year with ~90% repeat revenue. Legacy business’ share of revenue in single-digit.
T-10 accounts’ (34% of rev) average tenure has been ~10 years and T-20 accounts’ average tenure at ~8 years. Currently high T&M rev share based on the existing commercial structure with top accounts which is expected to move towards fixed-price contracts.
EPAM’s value proposition is different from Tier-1 as there is more focus on product development vs. larger player’s (Accenture) focus on selling multiple services to the client. EPAM’s rev/EPS CAGR over last 5 years has been 27/21%. Growth expected to be 20% over next 2-3 years.
Key verticals include Financial services (22% of rev), Travel & Consumer (22% of rev), Software, Hi-tech (19% of rev), Business information & media (17% of rev), Life-science, Healthcare (10% of rev). ~70% of delivery workforce of the company located in Belarus and Russia.
Luxoft, Globant closest competitors and Accenture Digital, Cognizant Digital are competitors within Tier-1 IT peer-set.
IT : SECTOR UPDATE
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KPMG
KPMG is a leading global consulting firm (Big Four) with global revenue at USD 26.4bn (including USD 10.2bn from advisory). 197,000 employees including 10,150 partners at KPMG.
Innovative companies are generally able to grow faster and new ‘challengers’ are emerging (e.g. Dyson vacuum cleaner and Electric Car- Tesla).
Building Agile organisations is getting more formally introduced in the Enterprise business models. Budget allocations to disrupt the status quo or ‘Change-the-business’ spend is increasing.
There is a strong need for additional leadership to drive innovations and direct the technology investments. Among the industry verticals, Financial services and Healthcare are active investors in newer technologies.
Automation, AI in workflow is changing productivity significantly and is at an inflexion point, the changes are as profound as the Industrial Revolution. Within Indian IT, TCS and Wipro were among earlier investors in RPA technologies.
Ernst & Young
E&Y is a leading global consulting firm (Big Four) with global revenue at USD 34.8bn (including USD 9.6bn from advisory). 261,000 employees including 18,000 partners, principals and directors at E&Y.
RPA is fast growing market and it offers ~200% ROI in the first year of investment. RPA services market will reach ~USD 18.8bn by 2020.
Data gathering and organising is a manual job and a lot of this can be automated using bots. BFSI is the largest spender and adopter of RPA technology.
Most of the efforts are in processes like HR, Tax Audit and Compliance. This is the area where companies are focusing and rapid automation can happen.
The three-year financial impact of RPA adoption by a client resulted in achieving 229% ROI and 15 month pay-back time. The benefits provided were (1) USD 4.1mn from Recruiting, training and facility savings and (2) USD 42.2mn from labor savings. Total savings were 960 FTEs and 3 years benefit of USD 50.3mn. The license fee paid for the RPA tool was USD 15mn.
Configuring bots is like configuring a key stroke. ~70% of building an RPA tool is like understanding the business process and having the domain knowledge of that particular industry. E&Y has gathered this knowledge over years and works with specialists like Automation Anywhere, Blue Prism and UiPath to build the tool for clients. Time to implementation is the key for a RPA tool.
Focus on cost savings will result in ~30-40% of the FTE to be replaced by bots. Automation is also eliminating the need for recurring maintenance contracts.
Pricing for an ordinary bot as low as ~USD 2/hour, which makes it much cheaper than FTEs. This will lead to 30-50% of routine maintenance work going to bots in the next 5 years. Banking, Oil & Gas, Retail are all resorting to cost cutting on IT, especially maintenance contracts.
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CSS Corp
CSS Corp is a mid-tier IT company with revenue of ~USD 170mn mostly focused on the TMT vertical. The company offers services like Engineering, Implementation, Testing and Support.
Difference between IT Services and Technology Services has been magnified with the advent of Digital Technology. Companies which do not change will be out of business.
Technology is enabling new business models and spend has shifted from the back office to the front office. Decision making is shifting from the CIOs to Business heads. CIOs controlled ~95% of the IT spend, which has now come down to ~50%, and is going to fall further.
With Cloud and Digital, CMO is only interested in getting business outcome by using Technology and not interested in technical issues like server, architecture etc.
Currently CSS’s sales efforts are driven by real world POCs vs. PPTs earlier. Conversational AI is going to be the next big thing and most of the POCs are based on this technology (e.g. use-cases on Amazon’s Alexa).
Emergence of cloud has shrunk the deal sizes but has increased the scope of work. It’s easier for agile mid-cap IT companies to win deals vs. a large legacy player.
Large IT players are doing ‘tuck-in’ acquisition to bring agility, but will have to sacrifice on margins and RoE. For enterprises, IT companies are expected to bring in tech solutions for revenue generation and not just deploy solutions to contain costs.
On-premise implementation is reducing and there’s increasing trend of platform-led growth. Generic automation product cannot be successful; it has to be aligned with business processes (AA, UiPath have different views).
Luxoft
Engineering and consulting services company (USD 1.1bn M-cap) focused on the BFSI (55% of rev) and Automotive (22% of rev) verticals, headquartered in Switzerland. Revenue of USD 907mn, grown at a 23% CAGR over five years. Revenue per employee is USD ~70K vs USD 50-55K for Indian peers. Luxoft is targeting revenue of USD 1.5bn by FY22.
The company has diversified from financial services to other segments like Automotive (22% of rev) and Digital Enterprises (23% of revenue). Within BFSI has it has diversified from investment banking to other areas of capital market.
In 2015, 70% of revenue came from BFSI and ~80% from top-5 clients, now BSFI has fallen to 55% of revenue and Top-5 clients contribute 47% to revenue.
Focus is to drive growth from Automotive and Digital (AI, Cloud, Platform, Blockchain). Automotive is seeing increased traction and will be the key revenue driver. Positive read-through for LTTS and Tata Elxsi (Automotive ER&D), KPIT (PES).
The reason for higher billing and high revenue per employee is the highly skilled work force; more than 80% of employees are PhDs and Masters. Attrition rate is low (~10%) vs. industry (~17%).
Luxoft’s top-2 clients’ (DB & UBS) revenue has been flat (impacted by in-sourcing) whereas excluding Top-2 client revenue growth has grown at a healthy CAGR of 38% over the last four years.
High performing accounts have grown at a CAGR of 22% and the focus is on growing the USD 5-25mn account bucket.
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Enterprise Tech Buyers Ex-Citibank
Shifts in technology changing delivery models from Waterfall development to Agile. Potential of core system transformation is massive.
Regulatory scrutiny post 2008 drove investments in legacy systems and large scope for service providers. Large part of digital dollars is in shifting applications to cloud e.g. porting applications from IBM mainframe into IBM Cloud.
Prudential Financial
Prudential Financial is a leading provider of insurance, investment management and investment products (USD 1.4tn AUM, USD 60/7.8bn rev/PAT, USD 40bn M-cap).
Only those processes which are less critical are getting outsourced. Digital projects are initially done in-house with the help of tech vendors.
Business heads are running the digital initiatives and owning them, much more than CTOs and CIOs.
Traditional spend is being squeezed to increase digital spend. Legacy spend will not go away but pricing for traditional services is going to be under pressure. Cost cutting is achieved by squeezing traditional vendors.
Not very comfortable with public cloud and shifting of customer data on cloud. Cagey on letting out data on the cloud and hosted applications. But the initial fear is subsiding and some applications are hosted on outside servers (Salesforce, Office 365 etc).
Taking support of vendors like EY and KPMG for Automation of processes.
Large US & European Bank
Indian IT needs to become more technology driven organisation which will require change in DNA.
Large opportunity in terms of tech skill sets in Eastern Europe geography. Talent diversity not as big within Indian IT companies.
Data is a key concern and banks are paranoid about public cloud while continuously evaluating cloud options such as hybrid. Cost reduction most critical aspect for cloud transition.
Banks are breaking-up into multiple units which is further decentralising the tech buying decisions.
Humana
Humana is a Kentucky, US-based health insurer (top-5 in US) with 14 million members/customers and total premium, services and investment revenue at USD 54bn and PAT at USD 2.5bn (M-cap at USD 42bn).
Industry is moving from pyramid to diamond structure and there is shortage of data scientists. Scope changing with doing same amount of work with fewer people or exponential amount of work with same people.
Going paperless is a large opportunity for insurance carriers in California which are still on legacy systems. Insurance is 10-yrs behind the technology curve and there are large opportunities in distribution, underwriting, renewal.
Large US Broking Firm
Leading brokerage with 11mn clients, >USD 1TN in assets and custodial service to >6,000 registered investment advisors. Revenue at USD 5.5bn and M-cap at USD 30bn.
Big financial services opening their own APIs and there is greater amenability to private cloud vs. public cloud. Trend of more assets/data being held outside a bank with Fintech (e.g. Alipay).
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Anadarko
Anadarko Petroleum is a leading global oil & gas exploration and production companies with 1.44 BBOE of proven reserves and sales volume of 0.67mn BOE daily production (M-cap USD 26bn).
US oil & gas exploration will rise rapidly leading to large demand for technology services. There is increasing competition from China in R&D and in AI.
There is a shortage of quality IT service providers. Digital spend is increasing by 20-30% every year (large opportunity in AI/ML). Google is a key partner for the company.
Chevron
Chevron Corporation is among the leading global integrated energy companies with upstream, midstream and downstream operations. Revenue at USD 135bn, 2.7mn BOE daily production (USD 9bn PAT, M-cap at USD 220bn).
Leadership and sales are critical for service provider. Frugality has made Indian IT successful and there is talent at-scale in Indian IT. Role of service providers to bridge the gap between verticalised tech (provided by Schlumberger), Google/AWS infrastructure and enterprise’s processes.
The spend cuts in Opex/Capex have been ~40-50% in the last 5 years with revenue compression. The company has moved processes to cloud with Microsoft. High cost utility IT and a small portion of spend is moving to digital.
Focus is to build IT systems for sustainability and scalability and develop functionality over technologies such as AWS. Strong technical partnerships with Cloudera, Microsoft. Software development skill-sets more important than domain skill sets.
Direct Energy
Direct Energy is among the leading retail providers of electricity, natural gas and home and business energy-related services (>USD 14bn rev) with 20mn B2C customers and 1.5mn B2B customers. Direct Energy’s customers are demanding more digital services.
Challenges of margin pressure, swings in energy usage (lower utilization) and customer expectations of digital services driving tech spends. Tech spend includes focus on gross margin, increasing efficiency and reducing risk
While >50% of tech spend is in system of records/legacy (2-5% annual compression in the budget while flat overall budget at ~USD 1bn), there is continuous evaluation of Build vs. Buy vs. bot (automate). There is consolidation of vendors as compared to a more fragmented vendor base earlier.
Extensive use of automation (chatbots) with Automation Anywhere and Azure/AWS for AI capabilities. Finding capabilities/ tech skills at scale is a big challenge.
New ways in energy trading using blockchain technology driving spend in system of innovation/digital. There are only few vendors with strong capabilities in Microsoft Dynamics. The company has among the largest SAP implementation in the world.
Deep understanding of business, opportunity within the problem and iterative working are critical for systems of innovation/digital and done mostly in-house supported by cloud providers and open source tools.
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Software Products/Innovators
SAP
SAP is the leading global software provider (largest in ERP) with revenue of EUR 23bn (operating margin of 21%), 413,000 customers, 94,900 employees and 17,000 partners globally (M-cap USD 112bn). Revenue includes cloud subscription (22% of rev), Licence (61%) and services (17%). Geographical composition stands at Americas (41% of rev), EMEA (43% of rev) and APJ (16% of rev).
SAP is transforming itself from a traditional ERP focused organisation to Cloud, Business network, Business applications and Innovation Company.
SAP is moving its large customer base to a new Digital core, which is S4 HANA. The total number of S4 HANA customers stand at 6,900, up 70% YoY, out of which ~40% are net-new customers.
The Callidus (customer experience suite of solutions) acquisition helped SAP in improving customer experience on cloud. Callidus CRM was integrated with SAP Hybris’ cloud portfolio to enhance the cloud offerings.
SAP Leonardo is an intelligent enterprise offering built on SAP HANA. Leonardo combines Design Thinking, Machine learning, Big Data, IoT, Data Intelligence, Blockchain and Analytics capabilities to make enterprises smarter, smoother and completely digital (intelligent enterprise).
SAP has heavy reliance on its strategic partners’ ecosystem. Indian partners have picked up deep insights on the business and processes of their clients. Indian IT players are good in building PoCs and have evolved rapidly to the changing environment.
Shift to cloud-related work will continue for the next 5-10 years. Only ~10% of the shift has happened. Cloud has faster consumption of innovation and has higher predictability of revenue.
SAP cloud subscription and support revenue (20% of rev) is expected to grow at 28-30% revenue CAGR to reach Euro 8.5bn in 2020. C4 HANA and S4 HANA would be major cloud growth-drivers.
SAP India
SAP strategy is to build intelligent enterprise (CRM, Digital core, People Management, Network management etc.). Innovation is happening in this area and SI partners are mirroring SAP’s strategy when they interact with their clients.
SAP has integrated intelligent technology in its platform and suite. S4 HANA enables analytics and transactions on the same platform, which is a unique feature. This is a big opportunity and requires upgradation of the existing on-premise implementations.
Enterprise clients were reluctant to shift to cloud and change the existing systems two years ago, now the adoption is much higher within the existing client base.
On-premise implementation will not vanish but will co-exist as a hybrid model. The hybrid cloud model is also gaining a lot of momentum especially in sectors which are regulated (such as BFSI).
There has been a lag traditionally between the financial performance of SAP and its partners historically, but with cloud this lag is expected to reduce.
Deployment cycles have become shorter and thus will create more volume of work and higher value for the SI partners.
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Oracle
Oracle Corporation is the leading global software provider (2nd largest ERP) with revenue of USD 40bn, 430,000 customers, 137,000 employees and 25,000 partners globally (M-cap USD 180bn). Revenue includes license (16% of rev), support (66%), hardware (10%) and services (8%). Geographical composition stands at Americas (56% of rev), EMEA (28% of rev) and APAC (16% of rev).
Enterprises are becoming more and more interested in AI, ML and transformative technology to reduce cost and drive efficiencies. IoT is collecting real time data using network. Containers are server-less computing using the programs that have already been built.
Oracle Autonomous cloud solution is making the cloud smart and requires limited human intervention. Currently, cost of software operation on cloud has gone up in some cases and security is a major issue which needs to be addressed. Putting a firewall is tough and assigning similar rules for all the vendors on the cloud is a big challenge.
First generation of cloud shift was mostly customer managed. ~90% of the current cloud market falls in that category. The drawback of this model is that it’s difficult for the enterprises to adapt to the fast-changing cloud technology. The cost of managing eventually becomes higher and the whole concept of shift to cloud become expensive.
Enterprises want more customised cloud experience. Oracle Autonomous cloud front-end will be customised but at the back end it auto-upgrades and auto-patches. Enterprise clients don’t have to spend on high cost resources and will only focus on custom application development on top of the autonomous cloud.
In the next five years huge shift will happen to the autonomous cloud model. The features of the autonomous cloud will be ‘self-driving’, ‘self-securing’ and ‘self-repairing’.
This will bring in a lot of new opportunities for System Integrators like TCS, Accenture and Infosys as the shift happens to autonomous cloud. Customers using autonomous cloud include Hertz, Veritone, Cargo Smart, Bajaj Electricals.
Oracle has gone through the on-prem to cloud journey in the last five years. Oracle ERP cloud has witnessed immense growth in the recent one year especially after the acquisition of NetSuite.
NetSuite was a USD 9bn acquisition completed in 2016. NetSuite has single system for running business on cloud and Oracle acquisition provided it global scale and reach.
There are ~2100 ERP cloud customers (+62% YoY) out of which ~50% are net-new to Oracle. ~15% of Oracle on-premise customers are using Oracle cloud ERP.
Oracle ERP has been successful in large enterprises, some of the marquee customers are Airbnb, Lloyds Bank, Bank of America, Tesco Fedex etc. Lloyd bank consolidated 39 countries’ ledger into single global ledger and BoA achieved single unified platform for financial management and reporting.
In terms of cloud adoption, JP Morgan and BoA are the leaders whereas other mid to small US banks are still figuring out their cost models. Hedge funds have adopted a lot of innovation especially after the financial crisis.
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Google Cloud
Cloud transition has been the biggest disrupter in recent times. The total market size is huge (~USD 150bn). Amazon AWS is the biggest player with ~50% market share followed by Microsoft Azure, IBM and Google cloud.
Google was a late entrant in the Public cloud market but large market opportunity. Google was the pioneer of cloud technology and has strong data storage capabilities. Google cloud was initially built for internal consumption. Hence it was difficult for the developer community to develop applications initially.
Amazon AWS is developer friendly and has an API based architecture and it attracted developers from across the world. The developers built applications on Amazon AWS platform for solving various business problems and provided access to enterprise customers via APIs. This is one of the reasons for the success of Amazon AWS.
Google Cloud has a more complex architecture as compared to AWS. Google runs on containers like Kubernetes. Kubernetes, developed by Google and maintained by Cloud Native (a non-profit computing foundation) is an open-source platform for automating deployment, scaling, and operations of application ‘containers’ across multiple host computers.
Cloud adoption has been fast in Retail & Media as compared to Manufacturing and Pharma industry verticals.
Automation Anywhere
Automation Anywhere (AA) is a developer of robotic process automation (RPA) software and is among the leading global vendors (US based). Key customers of AA include Unilever, Google, LinkedIn, Tesco, ANZ, Cisco, Comcast, Siemens. AA’s platinum partners include Accenture, IBM, Cognizant, Infosys, Wipro, Genpact, E&Y, KPMG, Deloitte, PWC, ISG.
With technology adoption human effort is being eliminated constantly across industries, sectors like agriculture, textiles, Auto etc. IT helped speed up every other industry, and now it is cannibalising itself.
Out of the USD 90tn global GDP, USD 4tn is IT (including data centers, platforms, services, software, and communication). Human efforts constitute ~USD 27tn of the global GDP. 30% of the human efforts can be automated, which is ~USD 8tn market opportunity.
Automation Anywhere is working on creating a Digital workforce. Human workers execute six kinds of processes traditionally (1) Capture, (2) Enrich, (3) Validate, (4) Perform, (5) Analyze and (6) Report. Most of the basic functions can be replaced by bots.
The total opportunity is USD 20bn for services related to Automation.
Large banks are adopting Automation to increase efficiency and save cost. 10-20% of the BPO workforce can be automated. Bots are billed at ~USD 5K/bot (per annum) and will be on a subscription-based model.
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Amazon Web Services (Amazon)
Amazon Web Services (AWS) has ~1,280 partners, and ~160k customers. Amazon AWS’ revenue is growing at 50% YoY and achieved USD 27bn run-rate with ~50% market share (AWS had 6-7 years headstart vs. peers).
AWS (12% of Amazon’s rev and 55% of operating profit) is growing at 10% CQGR over the past four quarters with operating margin of 30%. 90% of Fortune 100 are AWS’ customers and 60% of its partners are from outside the US.
Important reasons for cloud migration are (1) Cost savings, (2) Speed, (3) Opportunity to run security and compliance easily, (4) Possibility of more innovations and (5) Easier to run PoCs on cloud (lower cost).
Transition to cloud is accelerating and shift to cloud is a 10-year cycle. Tier-1 IT companies have a big legacy component to protect thus the transition is a challenge. The services companies are winning deals supported by their existing client relationships.
Hi-tech & media, Retail have been early adopters of cloud. Netflix is running all services on AWS. Banks and Insurance industry are shifting gradually due to regulatory hurdles.
Salesforce
Salesforce is world’s leading CRM software provider (20.3% market share) with revenue of ~USD 13bn (USD 106bn M-Cap), of which 93% is License revenue and 7% is Services. Salesforce revenue growth target is at 20-21% for CY20.
Salesforce has grown at 6% CQGR over the past six quarters. Among geographies, Americas contribute 78% to revenue, EMEA and APAC contribute 11% each. Salesforce Platform (23% of rev) and Marketing Cloud & Commerce cloud (16% of rev) are the fastest growing segments.
The services opportunity for SIs is 2-5x of the licence sales and it depends on the complexity and scale. The total services opportunity emerging from the Salesforce ecosystem is ~USD 40-50bn. Accenture is the largest SI for Salesforce and charges premium for its services.
Digital transformation has happened for individual function like sales, marketing but integration of multiple systems at the enterprise level is still underway. Major competitor is Microsoft Dynamics AX. Pricing for Dynamics is lower price than Salesforce and price sensitive customers tilt towards Microsoft Dynamics product.
Among industries, Hi-Tech & professional services were early movers in cloud CRM adoption. Financial Services & Retail industries are growing rapidly, Healthcare is picking-up while Manufacturing is mostly ERP focused.
Accenture, PWC, Infosys and Cognizant are dominant partners within Salesforce ecosystem.
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Indian Tech Services
Hexaware
Unintended consequences of strong US economy is a super-tight labour market (tech unemployment near-zero) and increasing barriers for visa. Labour market tightening can impact revenue realisation or increasing the cost of fulfillment. Pricing re-negotiations happens over quarters, however fulfillment is a near term challenge.
Automation, Cloud and Customer experience transformation are driving digital. Automation adoption cycle expected to be ‘decade-long’, and multiple short-waves within automation.
Transform customer experience is driving incremental spend. Automation driving contraction of traditional spends and Cloud driving Application development business. In the medium-term a lot of application development spends are driven by movement to cloud which is expected to be a 5-year journey.
The most powerful transformations will lie in the overlap of (1) Automation, (2) Cloud and (3) Customer transformation. Service provider organization will need to look like technology organization/ digital native. Cloud and machine learning will become foundational skill.
P&C is undergoing generational transformation of its core systems and insurance industry is playing catch-up in digital. Investments onsite in training, local fresher hiring will yield result in the medium term
Increased captive hiring is also impacting attrition and wage inflation. Hexaware’s client sets are less prone to captives with higher AMCs, Mortgage securitisation composition. There is higher captive impact in IBs and Banking within BFSI.
L&T Technology Services
Multi-vertical and technology including IPs are a strong differentiator for LTTS. Balance between DNA of engineering and managing ROI critical. LTTS’ top-30 accounts spend USD 75bn in ER&D and size of opportunity for LTTS very big.
LTTS has scaled from 1,500 people in 2010 to >13,000 people currently. The company has created 200 people CTO organisation which includes hires from IIT. Engineers released from tail account pruning have helped in the recent large deals.
Multi touch-points in customer organisation and multi PoCs will increase the win-rate.
Unlike IT services, captive centers for ER&D are more critical. Switching vendors in ER&D is lower than IT services. French ER&D companies looking to increase India and US workforce. Strong analytics and platform-led approach of Eastern European vendors (EPAM).
Transportation and telecom Hi-tech largest opportunity within ER&D but competition is high. Nvidia, Intel, Apple are clients in Hi-tech; Honda, BMW in automotive.
No competition in Plant engineering and Industrial; Medical: HCLT, Wipro; Telecom & Hi-tech: Aricent; Aerospace: Cyient, Quest and HCLT; Air traffic management & In-flight: HCLT; Automotive: mechanical more competition (~25 vendors); Auto electronics: Tata Elxsi, KPIT, Off-highway: Cyient
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Cyient (Aerospace & Defence)
Prat & Whitney account grew in double digits from 2005 to 2012 as they were developing a new V2500 commercial engine after 40 years. The engine went into commercial use in 2014. From 2014-18 there was a lull phase but things have started to stabilise now. Aerospace & Defence vertical grew 9% CC in FY18.
UTC aims to outsource only 25-28% of their engineering work to vendors. This percentage went up to 40% in 2017-18 due to lack of internal engineering talent. Thus UTC did a vendor restructuring exercise. Cyient lost the least wallet share and remains a key partner. UTC is ~14-15% of revenue and 95% work is Aerospace and 5% OTIS.
Aftermarket is an area which has huge growth potential. The aftermarket spending will last for the next 30 years and has higher margins. Cyient wants to become a supply chain player with a low cost base in India. They want to become the ‘Motherson Sumi’ of the Aerospace industry. Cyient has capability in precision manufacturing, avionics parts, radars etc.
Business model is shifting from Services (95% of rev) to Solution (~5%). Services comprises of Design (60%), Build (10%) & Maintain (25%) while Solutions is primarily IPs and platforms (Design is 4% and Build is 1% of rev).
The company aims to derive ~25% of rev from Solutions in the next three years and ultimately scale it to 80% over the next 10 years.
There is major shift in engagement model and conversation with clients. Parameters such as cost , scale, skills, offshore/onsite, T&M/Fixed pricing are changing to Innovation/IP, Solutions, Domain, Operational excellence, outcome based business propositions.
Zensar Technologies
Composition for IT services is going to change in the next five years and it’s an opportunity for companies which are smaller in size and agile.
Zensar first transformed itself into a Digital company; customers and deal makers started to recognise this change. Zensar started getting invitation for large deals and has done well in winning some of them.
Won USD 800mn of TCV and most of the wins have been against Tier-1-ex Accenture. In fact there are few deals in the tune of USD 100mn+ in the market (less than 10). The current deal pipe-line remains strong and the reasons for winning are capability, point of view, differentiation and positioning.
Zensar internally runs on custom made mobile apps. These apps are updated every month. This helps employees to think and innovate.
Zensar has ~30 different platforms for 50 different business processes and this can be tailor-made for different companies. This is a key ingredient for Return on Digital (RoD) led sales pitch. All the deal wins in the last 18 months (USD 800mn TCV) has RoD at the center.
40 of the customers are using the RoD platform and the company has completely changed the service catalogue. Zensar has learnt to be selective in the playing field and has achieved success in the recent past.
Removed/rationalised 72 clients (Non-core) in the last two years and increased USD 5mn+ accounts from 5 two years back to 17 last quarter. Focus on platforms and patents will help in building non-linear stream of revenue. Benefits of non-linearity will kick-in with scale.
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Majesco
Large US P&C insurances prefer to implement multi-year transformation programs in phases. The pre-sales effort is longer in larger deals. Insurers are also evaluating a lot of greenfield initiatives. Spend is 70% on the front-end and 30% is touching the core.
Insurance companies were taking the add-on approach and started to build parallel systems for Digital transformation. These solutions tend to fail when the scale becomes big.
P&C had the highest impact of shift to cloud. This pace of drag in on-premise revenue has been coming down (was down 7% YoY).
Cloud implementation cycle has come down and the cloud products have become standardised. Shift to cloud subscription revenue (~12% of rev currently) will aid margin expansion.
Majesco is actively engaged with IBM and is working on a large deal which is in the PoC stage. Majesco also extended its IBM relationship for P&C segment for the US region. Order book will increase when the PoC is converted into deal wins.
IBM was lagging in the cloud market compared to Amazon AWS, Google Cloud, Microsoft Azure and Oracle cloud. Thus the new deal wins from the IBM channel was slower than expected.
IBM recently acquired Red-hat for USD 34bn (one of the largest acquisitions ever) and has become the world's number one hybrid cloud provider. Insurance companies prefer the hybrid cloud model due to regulatory constraints. ~80% of the Insurance companies in US are running on IBM mainframes.
IBM related deal flow is expected to improve in the next six months. Opportunity size is big over the next five years with revenue scope of USD 300mn.
Sonata Software
Platformation strategy (services wrapped over IPs) is the key differentiator. Platforms and IPs have been created largely because of the product engineering DNA.
Out of the IP portfolio, Rezopia (Travel), Brick & Click (Retail), Retina (Analytics engine) and Halosys (Unified mobile Platform) are doing well. IP-led revenue has grown at a CQGR of 8.6% over the last seven quarters. The potential of IP-led revenue is 3x in the next three years.
Microsoft has positioned Dynamic AX as a mid-segment ERP and is gaining a lot of traction. Sonata is the preferred vendor for Microsoft ISV development center in Europe and works very closely on Microsoft Dynamics AX platform.
Go to Market (GTM) strategy with Microsoft is helping Sonata enter into large enterprises clients and showcase their IPs.
Rezopia is doing well in Middle East and Australia. Recent wins are Queensland railways and Saudi Arabian railways for reservation system. IP-led model is based on pay-per-use model which is scalable and margins leverage with scale.
The company’s main strategy is (1) Selling services along with IPs, (2) Focus on Platformation, (3) Scale key strategic accounts and (4) Increase wallet share in the Microsoft account.
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Valuation Charts NIFTY IT Index Valuation Trend (P/E 1-yr fwd) IT Index Valuation Trend vs NIFTY
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research
IT Index Valuation and Earnings Growth Trend Indian IT Valuations Discount to Accenture (P/E 1-yr fwd)
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research
IT index valuations currently at ~5% discount to NIFTY vs. historical premium of ~10% IT Index has de-rated by 15% over the past quarter from 19x P/E to 16x currently (historical average at 16.5x)
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ov-1
1Ju
n-12
Jan-
13Au
g-13
Mar
-14
Oct
-14
May
-15
Dec-
15Ju
l-16
Feb-
17Se
p-17
Apr-
18N
ov-1
8
NIFTY IT Index Median+1 SD -1 SD
IT : SECTOR UPDATE
Page | 34
IT Sector EV/EBITDA (x) Trend IT Sector P/B (x) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research TCS P/E (1-yr fwd) Trend Infosys P/E (1-yr fwd) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research
5
7
9
11
13
15
Nov
-08
Nov
-09
Nov
-10
Nov
-11
Nov
-12
Nov
-13
Nov
-14
Nov
-15
Nov
-16
Nov
-17
Nov
-18
EV/EBITDA (1Yr Fwd) AVG
2
3
4
5
6
Nov
-08
Nov
-09
Nov
-10
Nov
-11
Nov
-12
Nov
-13
Nov
-14
Nov
-15
Nov
-16
Nov
-17
Nov
-18
P/B (1Yr Fwd) AVG
-
500
1,000
1,500
2,000
2,500
8
13
18
23
28
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-
100
200
300
400
500
600
700
800
8
10
12
14
16
18
20
22
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E )P/E (1-yr fwd) AVG P/E (x) Price
IT : SECTOR UPDATE
Page | 35
Wipro P/E (1-yr fwd) Trend HCL Tech P/E (1-yr fwd) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research Tech Mahindra P/E (1-yr fwd) Trend L&T Infotech P/E (1-yr fwd) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research
-
50
100
150
200
250
300
350
400
89
101112131415161718
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E) P/E (1-yr fwd) AVG P/E (x) Price
-
200
400
600
800
1,000
1,200
1,400
1,600
5
7
9
11
13
15
17
19
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-
500
1,000
1,500
2,000
2,500
10
12
14
16
18
20
22
24
Jul-1
6
Sep-
16N
ov-1
6Ja
n-17
Mar
-17
May
-17
Jul-1
7
Sep-
17N
ov-1
7Ja
n-18
Mar
-18
May
-18
Jul-1
8
Sep-
18N
ov-1
8
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-100 200 300 400 500 600 700 800 900
8
10
12
14
16
18
20
Nov
-13
Feb-
14M
ay-1
4Au
g-14
Nov
-14
Feb-
15M
ay-1
5Au
g-15
Nov
-15
Feb-
16M
ay-1
6Au
g-16
Nov
-16
Feb-
17M
ay-1
7Au
g-17
Nov
-17
Feb -
18M
ay-1
8Au
g-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
IT : SECTOR UPDATE
Page | 36
Mphasis P/E (1-yr fwd) Trend Mindtree P/E (1-yr fwd) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research L&T Technology P/E (1-yr fwd) Trend Hexaware P/E (1-yr fwd) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research
-
200
400
600
800
1,000
1,200
1,400
579
11131517192123
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000
10121416182022242628
Nov
-16
Feb-
17
May
-17
Aug-
17
Nov
-17
Feb-
18
May
-18
Aug-
18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-
100
200
300
400
500
600
0
5
10
15
20
25
30
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-
200
400
600
800
1,000
1,200
1,400
5
10
15
20
25
30
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
IT : SECTOR UPDATE
Page | 37
Cyient P/E (1-yr fwd) Trend Persistent P/E (1-yr fwd) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research eClerx P/E (1-yr fwd) Trend KPIT Tech P/E (1-yr fwd) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research
-100 200 300 400 500 600 700 800 900 1,000
5
10
15
20
25
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
(100)
100
300
500
700
900
1,100
1,300
1,500
0
5
10
15
20
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-200 400 600 800 1,000 1,200 1,400 1,600 1,800
579
11131517192123
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-
50
100
150
200
250
300
350
579
11131517192123
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
IT : SECTOR UPDATE
Page | 38
Zensar P/E (1-yr fwd) Trend Sonata P/E (1-yr fwd) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research Intellect EV/Revenue (1-yr fwd) Trend Majesco EV/Revenue (1-yr fwd) Trend
Source: Bloomberg, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research
-
50
100
150
200
250
300
350
400
0
5
10
15
20
25
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-50 100 150 200 250 300 350 400 450
02468
1012141618
Nov
-13
May
-14
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
-18
(Rs)(P/E)P/E (1-yr fwd) AVG P/E (x) Price
-
50
100
150
200
250
300
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Nov
-14
May
-15
Nov
-15
May
-16
Nov
-16
May
-17
Nov
-17
May
-18
Nov
- 18
(Rs)(EV/R)EV/Rev (1-yr fwd) AVG EV/Rev (x)
Price
-100 200 300 400 500 600 700 800
0.20.40.60.81.01.21.41.61.82.0
Nov
-15
Feb-
16
May
-16
Aug-
16
Nov
-16
Feb-
17
May
-17
Aug-
17
Nov
-17
Feb-
18
May
-18
Aug-
18
Nov
-18
(Rs)(EV/R)
EV/Rev (1-yr fwd) AVG EV/Rev (x)Price
IT : SECTOR UPDATE
Page | 39
Rating Definitions BUY : Where the stock is expected to deliver more than 10% returns over the next 12-month period NEUTRAL : Where the stock is expected to deliver (-)10% to 10% returns over the next 12-month period SELL : Where the stock is expected to deliver less than (-)10% returns over the next 12-month period Disclosure: We, Apurva Prasad, MBA, Amit Chandra, MBA & Akshay Ramnani, CA, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. HSL has no material adverse disciplinary history as on the date of publication of this report. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Research Analyst or his/her relative or HDFC Securities Ltd. does not have any financial interest in the subject company. 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IT : SECTOR UPDATE
Page | 40
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