Deal cancellations due to Ukraine crisis may impact IT vendors' revenues

The Ukraine-Russia crisis is expected to create headwinds for IT vendors, including those in India, as deal cancellations with several multinationals exiting Russia could impact their revenues. Infosys, Wipro and TCS are among companies that will be declaring their Q4 results next week.

Analysts say that the crisis could result in a revenue impact of 1-5 per cent and a delayed decision-making cycle over the next few quarters. Several multinationals have already cancelled contracts with Russian-based companies and the local governments there, which could result in cutbacks for employees.

Analysts at Dolat Capital, Rahul Jain and Divyesh Mehta, said higher commodity prices could impact costs. Potential consumer demand softness due to high inflation will also be a factor that could hurt the topline of Indian IT vendors.

No scope for pricing hike

“There will be no case for a pricing hike in CY22 to cover wage-inflation, as clients face cost pressures in the core business. Lower spends over CY22 and CY23 due to the current situation and cost environment puts “Digital Transformation” / tech spend on the soft pause in boardrooms,” the two said in a note to investors.

Multiple large corporations have also already voluntarily announced complete/partial exits from Russia (at least 230 full exits). While these companies may not have a large share of business in Russia (most would be 1-5 per cent), this impact would imply modest/muted corporate growth in the coming years, Jain and Mehta said.

“We think the growth rates that the street is building are broadly following the ‘best in a decade’ kind of IT spends scenario and do not incorporate any risk from potential impact from the war-induced macro-impact and thus are at significant risk and might see gradual cuts over the coming quarters,” they added.

But analysts at brokerage house Prabhudas Lilladher, quoting the management at certain IT services companies, said that in spite of the crisis, there will be a healthy deal pipeline with no impact yet seen on decision making. The lack of mega-deals is expected to reduce TTM (trailing 12 months) TCV (total contract value) on a YoY (year on year) basis, but “we expect deal ACV (annual contract value) to remain strong”, they said.

Climbing attrition rates

However, perhaps the biggest downside for Indian IT services companies has been the climbing attrition rates. This will impact margins because of higher employee expenses. The demand environment continues to be strong, led by continued deal momentum led by sectors such as BFSI. “The companies continue to see a demand tailwind in terms of investment in newer technologies like cloud transformation,” ICICI Direct said.

Analysts at Prabhudas Lilladher said they expect margins to decline by 40-80 bps QoQ due to headwinds from aggressive hiring. This led to a drop in utilisation and backfilling of attrition with lateral recruits at higher costs, partially offset by rupee depreciation and operating leverage. “Margins are expected to decline by around 150 bps YoY due to increased supply-side pressures and roll out of wage hikes twice in the last one year,” they said.

Analyst Aditi Patil said there could be a healthy growth in headcount in Q4 as well as in FY23 given demand is chasing supply. “We believe quarterly attrition will stabilise this quarter but is still at elevated levels. LTM (last 12 month) attrition is expected to inch up. The Russia-Ukraine crisis is likely to add pressure on ER&D (engineering and R&D) talent supply,” she said.

She also said some of the key developments that need to be watched include the impact of current macro/geopolitical uncertainties on tech spending, scope for gaining market share from vendors who have a considerable supply-side presence in Ukraine and war-affected regions in Eastern Europe, especially for ER&D,  growth and margin outlook for FY23, durability of demand, and commentary on attrition, sub-con costs and resumption of travel.

Great strides in ER&D

A recent Nasscom report said that in the last two decades, great strides have been made in the Indian ER&D services sector, and it is expected to reach $63 billion by 2025, up from $31 billion in 2019.

India’s current share of the global ER&D outsourcing market is 30 per cent and is expected to reach 50 per cent within a decade. The nation has around 1,300 ER&D global capability centres across industry verticals operating at a scale that makes them amongst the largest technology hubs for the parent organisation, the report said.