IT firms get sucked into global quicksand

The Lehman Brothers' bankruptcy filing is proving to be the last straw on the camel's back for domestic IT firms, which were expecting the second half of this financial year to improve their earnings prospects.

The aftershocks are expected to affect the expansion and hiring plans of these companies. In fact, analysts are expecting the IT sector to underperform on the bourses in the next six to nine months.

Fear stems from the fact that the US and the UK account for almost 80 per cent of revenues of all Indian IT companies. Moreover, the banking, financial services and insurance (BFSI) vertical — which has been hit the most — accounts for over 40 per cent of the overall revenues of the Indian software sector.

Pain in the BFSI segment results in re-negotiation of pricing, further lag in deal-making, and fewer and smaller-sized contracts.

It is estimated that Lehman Brothers has outsourced deals amounting to Rs 550-700 crore annually to many IT firms, including majors like Tata Consultancy Services, Infosys and Wipro.

The Bank of America's buyout of Merill Lynch would also have some adverse impact. Its consolidation with Merill Lynch could result in the duplication of outsourced deals to domestic IT firms, and consequently truncation of some deals, which will result in loss of revenue.

eClerx, a knowledge process outsourcing company, has already announced that nearly 13 per cent of its revenue for FY09 was expected from Lehman. Other IT firms are expected to have a 1-3 per cent revenue exposure to Lehman, which analysts consider "significant".

Credit Suisse analysts further caution that a U-shaped recovery in the US, which implies that the bottom is still a couple of quarters away, will only compound the problems. Its European team too has cut GDP forecasts aggressively.

The first-cut impact for Indian IT companies, they explain, would come due to their high exposure to financial services' customers that are facing significant corporate action.
 

SECTORAL IMPACT

* Incremental pricing may weaken, and be renegotiated downwards

* Weakening of YoY growth rates

* Contracts are taking longer to be awarded

* Start dates are getting deferred

* No significant deal expected in the BFSI space for at least a year

* Consolidation and mergers of banks could lead to reduced IT spends

* Benefits from fall in rupee may get limited by over-hedging

* Offshoring to India may face backlash as firms issue pink slips to US employees

* Small-cap Indian IT firms’ weaker offshore models to suffer most

* With the bottom a couple of quarters away, problems will continue

"Furthermore, our US strategists believe that de-leveraging of financials could lead to around $5 trillion in assets being sold. Thus, we should also brace for the second-level impact, which should come from other parts of the economy slowing down," they reason.

The over 7 per cent weakening of the Indian rupee against the US dollar, it appears, is the only silver lining to the cloud for the Indian IT firms as they earn in dollars and spend in rupees. Hence, revenues will automatically shore up for the quarter ending September 30, 2008.

However, this may no longer be the case since the benefits of a weak rupee may get severely limited by the hedging policies of these firms.

For instance, during the April-June quarter, most IT firms posted forex losses — TCS (Rs 75.3 crore); Infosys (Rs 80 crore); Satyam (Rs 36 crore); and Wipro (Rs 68.30 crore). Besides, Wipro made a mark-to-market (MTM) provision of Rs 934 crore with a hedging of $2.6 billion.

The short-term effects will immediately show on the results of the second quarter (July-September), which historically has been a strong one for Indian IT firms.

Some companies may even issue a downward guidance or the figures may hover around the lower band of the guidance they provided.

Even the first quarter (April-June) was marked by a muted rupee-term guidance, and no upward revision in dollar-term guidance, an uncertain global business environment, forex losses due to over-hedged positions, and low volume growth by the top four domestic IT companies.