Mid-cap IT firms stumble through Q1 over client pressure, H1B visa costs

After a year of above-estimated performance, Q1FY20 has ended on a dismal note for most of the mid-cap IT services firms, with client pressure and visa costs eating into their growth numbers. Barring Mphasis, the performance of most companies has been lacklustre, as client spending took a major setback for these vendors.

Analysts have noted the strong demand for talent has not only spiked visa and employee costs for these companies, it has also made it difficult for them to redeploy employees at short notice in case any clients pull back, resulting in margin pressure. Even during their bull run in FY19, analysts had expressed concerns that the mid-caps’ client mix could be a possible weak link in their growth story.

For Pune-based Persistent Systems, revenue growth was limited to the top five clients, with the top six to 10 accounts declining 20.7 per cent quarter on quarter (QoQ) and non-top 10 client revenues dropping 3.8 per cent QoQ (in dollar terms). The company missed analyst estimates on both revenue and margins as revenues of digital and Accelerite (its wholly-owned subsidiary, which is focused on software products) declined 5.9 per cent and 39.7 per cent, respectively, however, its primary IP revenues barely stabilised.

“Our US business grew by 1 per cent, our European business declined by 1 per cent in this quarter, mainly driven by cross-currency impact. Customers in the 11 to 20 buckets grew faster than Mindtree and achieved 3.6 per cent growth sequentially,” said Mindtree Chief Executive Officer Rostow Ravanan during the analyst call. Lower IT revenues and higher billing days further affected the rate realisation despite higher deal total contract value reported during the quarter.

Of course, Mindtree had a volatile quarter from a management perspective as well due to the L&T acquisition but Ravanan noted even some of their peer group commentary indicated there were some ups and downs in banking, financial services, and insurance (BFSI) currently.

Similarly, one of the most-favoured mid-caps of FY19, Cyient, reported revenue decline in two key clients across aerospace and defence and communication, leading to a sharp revenue decline of 5.2 per cent QoQ. “But the drop in top five clients was a mere $2 million QoQ (top 6-10 was flat QoQ) and the sharpest decline was in non-top 10 clients that was down $6.6 million QoQ, a dip of 8.7 per cent QoQ,” said Ravi Menon, research analyst, Elara Capital.

Larsen & Toubro Infotech (LTI), another strong player in the mid-cap space, reported Ebit margin at 16 per cent, a drop of 170bps QoQ, owing to rupee appreciation, investments in sales, and visa cost. In Q2FY20, the company’s margins are expected to take a hit of 170bps, owing to salary increase. 

LTI confirmed the worst was over for the company, with regards to decline in revenues from top clients though it expects decline in revenue from one top-10 client in the BFS vertical in Q2FY20. 

On the bright side, the companies are confident about their acquisitions and have indicated more inorganic growth in pipeline to support revenue growth.