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| IT will stagnate |
| Devangshu Datta / New Delhi Apr 19, 2009, 21:03 IST |
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Every IT industry analyst uses Infosys' results and guidances as a benchmark. While the 2008-09 full-year results more or less met expectations, the advisory for 2009-10 was worse than expected. The IT major said that it expected next year's top-line to shrink in dollar terms. If the rupee remains weak versus the dollar, it is possible that rupee returns might be positive.
The guidance shouldn't be a total surprise since the Q4, 2008-09 revenues also shrank 2 per cent in dollar terms. The Infosys ADR dropped immediately by 9 per cent and rupee share prices also declined within a couple of sessions. The dampening effect on the entire industry was reflected by the CNXIT index losing ground in a week when most other sectors gained.
Every IT firm will have to weather hard times in 2009-10. The weaker players could be pushed to the wall. It is the complete lack of demand in the key North American market that is the biggest problem. But Japan and the EU are also in recession and Asia is unlikely to see much growth.
Against this gloomy backdrop, it is difficult to judge if Tech Mahindra's buyout of Satyam (SCS) came at a reasonable price. While there are synergies between Tech Mahindra and SCS, SCS' complicated financials and legal troubles could take years to sort out. In the near-term, Tech Mahindra may be under pressure raising funding for the buyout.
In mergers and acquisition situations, a simple rule often works for traders: Short the buyer and buy the target company. But with SCS having already hit the Tech Mahindra offer price, it is no longer a viable strategy. Tech Mahindra could still be a sell but this is only a matter of proportion since the entire IT industry appears to be bearish.
As an industry, IT is strongly correlated to the global economy and especially to the US. In the current circumstances where global GDP could stagnate through the next year, the prospects are poor. Much of the IT industry is cash-rich. That gives it a better chance of riding out the recession. But most company-specific and all sector growth targets are likely to be missed.
Some IT players may survive by dint of grabbing market share in existing lines of business, either through aggressive M&A action, or by dint of organic competition. But the industry as a whole will have to seek new markets and it will have to do so under conditions that are not propitious.
Nevertheless, there are still vast unexplored opportunities. For one, no Indian company has made serious inroads into products. The induction of infotech by Indian governments (Centre and states) is likely to increase. Indian IT penetration into the European Union and Japan is low and Indian corporates are also well-placed to generate revenues from China, given their growing presence in the country.
As things stand, even moderate current valuations appear stretched. At the height of the IT boom, in early 2000, the CNXIT was trading at average price-earnings of 250-plus, which was a trifle expensive even for an industry generating annual earnings per share growth of 60 per cent.
The sector is now trading at around price-earnings of 12. But that is still too expensive given that it is likely to generate negative earnings per share over the next year. There could be a major bounce sometime in 2010-11 but by then, the contours of industry leadership may have changed. One interesting factor is reasonable dividend yields. However, it's an open question if dividends will or even should, be maintained under the circumstances.
I've recommended IT several times as a potential hedge in situations where the rupee is weak. As things stand, that appears to have been the wrong call. It seems as though the business cycle for the industry is going to get worse before it gets better. If that is so, the timing for buying into the sector is probably wrong.
There will be decent stock-specific opportunities arising in the industry over the next year or two, even if the sector as a whole stagnates for a while. Valuations are likely to correct further downwards. Some companies will show the ingenuity and determination to cement their positions during adverse conditions. But this is much more of a wait-and-watch situation than one where a shotgun buying approach is likely to pay off.
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