Client concentration hurts IT companies
Mid-tier and large information technology (IT) services companies, which depend too much on one large client or a set of clients for revenues have started to feel the pinch. The recent quarter financial performance of such companies has shown that the sluggish growth of these large clients (accounts) affected their overall performance to a great extent. If one discounts the performance of such large accounts, these companies have grown in a healthy pace.
This was evident, for example, in performance of MphasiS, Tech Mahindra, and Sasken.
Take for instance the fourth quarter numbers of Tech Mahindra. While the company clocked $1 billion in revenue for the financial year, business excluding BT (British Telecommunication) grew 27 per cent year-on-year and nine per cent sequentially.
Revenue from BT, the firm’s largest client contributing 40 per cent, has been declining over the last few years. But sluggish growth at BT made Tech Mahindra record a revenue growth of 6.6 per cent on a year-on-year basis and 4.2 per cent on a quarter-on-quarter basis.
The other instance is Bangalore-based MphasiS, an HP company. Hewlett Packard (HP) that owns over 60 per cent stake in the company contributes close to 67 per cent to its revenue. HP recently slashed its profit forecast and the impact was evident on MphasiS. Revenues from HP were nearly flat sequentially while direct revenue grew by 8.5 per cent for the same period. MphasiS is getting hurt as HP continues to look for pricing cuts.
“Having a large client can be like a double-edged sword. It can work either way. What matters in such a scenario is the client position (in terms of business growth and so on) and what is the role of the vendor in the client's road map. This applies to everyone. MphasiS that was trading at 13 to 14 times, just over the last two quarters has come down to 10 to 11 times in valuation,” said Rohit Anand, Research Analyst, PINC Research.
Despite the fact that MphasiS’ direct channel added 17 clients and the revenue share increased to 33 per cent on a sequential basis, the concern on future growth of the firms continues. “However, uncertainty remains as to how the HP channel dynamics (67 per cent of revenue) will play out in terms of volumes and/or pricing. We believe that no matter how things pan out, one must come at the expense of the other for MphasiS. This is unlike other players in the industry, who are seeing a stable to upside bias on pricing and strong volume growth,” said Research Analyst Kuldeep Koul and Ashish Chopra of Motilal Oswal in their report.
“Over-dependence on a client or higher revenue from a set of clients is a concern. It is one of the reason why companies with high client concentration will trade at a discount to a company that is better diversified. The dependence on single client or client concentration issue has already played out in case of many firms. Even a large firm like Infosys Technologies has paid heavily for having BT as one of its top clients. BT, that contributed around $400 to $450 million to Infosys, is at present a $100-million account,” said an analyst tracking these firms on condition on anonymity.
In most of the cases, the dependency on a single largest client is because the firm either started as its captive unit or has a substantial shareholding of the company. Tech Mahindra was started as a joint venture between BT and Mahindra and Mahindra. India's largest BPO firm Genpact, was a captive of GE. Even now GE’s contribution to the firm's revenue is around 36 to 38 per cent. Business process outsourcing (BPO) firm WNS was started as a captive of airline British Airways (BA).
The situation is severe in mid-cap firms. There are also instances when a client because of its nature of work that it shares with a vendor becomes crucial. Telecom software solutions firm Sasken is an example. Recently, when Nokia announced its plans to discontinue its operating systems Symbian in favour of Microsofts Window’s mobile platform, it meant an impact of $25 million (around Rs 112 crore) for Sasken.
While analyst believe that mid-cap IT firms will be able to grow their top-line, the concerns are on the supply side and pricing. “The differentiation story is already been written about. But if you are offering the same services that other too are, then to get new logos one will have to be aggressive on pricing. Besides with supply side issues like wage hikes, attrition and little help on the pricing front, mid-cap IT firms will be under pressure,” said an analyst of a leading brokerage firm.
Moving away from a single client has never been an easy task. Whether it has been in the case of Genpact, WNS, EXL Services, Aricent or Tech Mahindra. Other than acquiring Mahindra Satyam (erstwhile Satyam Computer Services), Tech Mahindra has also managed to increase revenue from non-BT clients. “While BT is the most important client. Our incremental demand will come from other areas,” said Vineet Nayyar, Vice Chairman, MD and CEO of Tech Mahindra. Rather for the first time in the first quarter of FY11 Tech Mahindra's non-BT revenue touched $500 million. Genpact has been reducing its revenue from GE by growing the other business. The recent acquisition of Headstrong is expected to bring dowm GE contribution to 28 per cent.
In case of MphasiS the focus is clearly to grow non-HP business. “Almost 98 per cent of our HP business comes through HP-Enterprice Services. If you look at few quarters you would realise that incremental business which was coming has been lower and lower from HP-ES channel and that is the trend we saw in Q1 as well. At the same time as far as our transformation is concerned, we have created a dedicated sales team to look at having specific growth beyond Enterprise services,” said Ganesh Ayyar, Group CEO, MphasiS in an analyst call post March 31, 2010 results.