It Sector Equity Research Report
IT Sector Equity Research Report
January 14, 2011
IT-Tier 1 IT Services
THEMATIC
Humpty Dumpty sat on a wall…
Analyst contact
Ankur Rudra, CFA
Tel: +91 22 3043 3211 ankurrudra@ambitcapital.com
Tier 1 Indian IT firms have outperformed the Sensex by 14% over the last twelve months and are trading at ~20x FY12 P/E. Such share prices imply long term revenue growth rates >20% over FY11-16 and sustained margin performance. Our reverse DCF analysis indicates that this will be tough to achieve given: a) the increasingly competitive stance taken by western competitors, b) the changing sources of competitive advantage, and c) structural wage inflation in India. Whilst the Tier 1 IT vendors are likely to show strong ongoing momentum in CY11, this is already priced into current valuations whilst the likely (and painful) evolution of the current business model is at presently being ignored by the stockmarket. Tier 1 IT firms have clearly seen a cyclical recovery in BFSI led spending. Recent positive newsflow about the US economy and tech spending has also helped. However, with sector up 35% over the last 12 months and trading at 16-22x FY12 earnings most of the positives seem priced in. Indeed, our estimates suggest that the market is pricing in 20%+ 10 year revenue CAGR and maintenance of current EBITDA margins over the next 10 years. With the top three firms clocking over $5bn in revenues and with margins at a three year high, do the Indian IT firms have long term competitive advantages to justify their current valuations? Short term drivers remain strong: The primary short term growth driver for the industry has been the recovery in BFSI spending, post merger integration work and pent up demand in other verticals due to frozen budgets during the downturn. We expect most of these drivers to remain strong over the next 6-9 months, with Infosys, TCS and HCLT best placed to benefit. Structural shift in spending from ADM to EAS: There is an underlying
January 14, 2011
IT-Tier 1 IT Services
THEMATIC
Humpty Dumpty sat on a wall…
Analyst contact
Ankur Rudra, CFA
Tel: +91 22 3043 3211 ankurrudra@ambitcapital.com
Tier 1 Indian IT firms have outperformed the Sensex by 14% over the last twelve months and are trading at ~20x FY12 P/E. Such share prices imply long term revenue growth rates >20% over FY11-16 and sustained margin performance. Our reverse DCF analysis indicates that this will be tough to achieve given: a) the increasingly competitive stance taken by western competitors, b) the changing sources of competitive advantage, and c) structural wage inflation in India. Whilst the Tier 1 IT vendors are likely to show strong ongoing momentum in CY11, this is already priced into current valuations whilst the likely (and painful) evolution of the current business model is at presently being ignored by the stockmarket. Tier 1 IT firms have clearly seen a cyclical recovery in BFSI led spending. Recent positive newsflow about the US economy and tech spending has also helped. However, with sector up 35% over the last 12 months and trading at 16-22x FY12 earnings most of the positives seem priced in. Indeed, our estimates suggest that the market is pricing in 20%+ 10 year revenue CAGR and maintenance of current EBITDA margins over the next 10 years. With the top three firms clocking over $5bn in revenues and with margins at a three year high, do the Indian IT firms have long term competitive advantages to justify their current valuations? Short term drivers remain strong: The primary short term growth driver for the industry has been the recovery in BFSI spending, post merger integration work and pent up demand in other verticals due to frozen budgets during the downturn. We expect most of these drivers to remain strong over the next 6-9 months, with Infosys, TCS and HCLT best placed to benefit. Structural shift in spending from ADM to EAS: There is an underlying