Indian Tech Giants – Is de-rating on cards ??

Tech Wobble ….

The reported earnings from the top tech giants in the last two weeks couldn’t have been more divergent . While the Bangalore based titans disappointed once again , their peers elsewhere surprised the market by beating the street estimates. It may be tempting to attribute the continuing lackluster results from Infy and Wipro to company or management specific issues . But that alone fails to  fully explain the fall from grace.    While some of these may have been due to deficient managements , deeper trends are at play .Signs of underlying cracks for the sector can’t be ignored  . 

 In the past ,  sector had grown at high teens at regular fashion at high return ratios . As a result it got used to rich valuations in the form of high earning multiples i.e. peak cycle valuation .   But the decks are turning now . With the sector past its prime ,  the time for high teen growth may be over for ever.  Slowing hiring ( as reflected by hiring projections by heavyweights)  , muted guidance from global peers like IBM , Accenture , CTS & Oracle , soft outlook from TPI index  etc portend difficult times . Even if these are for short to medium term , long term trend  is equally challenging . Hackett , Florida based consulting firm in outsourcing , predicts that migration of services to India will slow down after 2014 and will stop by 2022 . That is a very bold and ominous prediction . The study cites following reasons for such a ruinous forecast :

 

If you add the threat of impending immigration bill , it becomes certain that this patchy outlook is here to stay . But for the crutches of Rupee over last year or so , sector would already be in deep trouble . 

 But the investors look fully not convinced , going by the rich multiple they are willing to pay for the top gun in the Industry i.e. TCS   , though short-term underperformance has pulled the valuation down for their peers like Infosys and Wipro . Probably , they suffer from the hangover of the historic peak cycle valuation . They fail to recognize when the sector matures into  a more normal growth phase , valuation does adjust to a lower multiple . Such was the case with Bharti or Hero Honda when the respective sectors turned from blistering growth to more mature phase . IT hopefulls  will come to terms soon or face the ire . 

With such  distressing signs for tier-1 , it will be tempting to assume death-knell for small and medium players . Ironically , small and medium companies will have more leg room and breathing space as SME sectors in the western parts start being more open to offshoring , precisely when the larger ones overseas  are close to fully tapping the offshoring potential. 

Watch out for challenging  times for IT as valuations adjust to the new normal . That may not stop with IT  as  slowing demand in that sun rise sector  will have larger implications for India’s wider economy esp. in lifestyle consumption , real-estate and other dependent sectors .  Interesting  times ahead !!!!

 ArunaGiri . N

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