Why IT sector cannot ignore the writing on the wall

The third-quarter results for FY21-22 for top companies in the IT sector, TCS, Infosys and Wipro were declared last week, with the first two delivering better-than-expected results while the third’s performance was not impressive but within its guided band.

The third quarter is seen as a seasonally weak quarter because of a long holiday season and hence the performance of all the three was laudable.

However, there are pain points which a majority of the IT companies in India will have to deal with. The first is that they are not bagging the billion-dollar deals anymore which was earlier seen as a norm. But even deals half that size have dried up.

For the October-December quarter in 2020, Infosys won deals worth $7.3 billion. For the same period in 2021, the total deal size dropped to $2.53 billion. But the narrative remains the same from the management. Salil Parekh, the Infosys CEO & MD had said soon after his company bagged those blockbuster deals that execution of client relevant strategy focused on digital transformation continues to drive superior growth.

After 12 months, Parekh repeated the same statement stating, “Our strong performance and market share gains are a testament to the enormous confidence our clients have in us to help them in their digital transformation. This stems from four years of sustained strategic focus on areas of relevance for our clients in digital and cloud, continued re-skilling of our people, and deep relationships of trust that our clients have with us.”

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Even if one takes away the $3.2 billion deal from Daimler, it is nearly doubles the total deal size 12 months later.

TCS has however been an exception winning deals worth a total of $7.6 billion during the third quarter this fiscal compared with $6.8 billion during the same period last fiscal.

Wipro closed the third quarter with a total deal size of $590 million compared with $600 million 12 months ago.

Analysts however have been positive about all three companies and retained their buy rating on these stocks. “While mega-deals, which bolstered the TCV (total contract value) numbers in FY21, have been missing in FY22, there seem to be a strong flow of $50 million deals in the market, which has led to a 12 per cent growth in TCV for TCS and 27 per cent growth in ACV for Wipro in 3QFY22. Due to some mega-deals in 3QFY21, Infosys’ TCV growth in 3QFY22 (YoY basis) has taken a big hit (-65 per cent), but it is still in line with the previous quarters of FY22,” Girish Pai of stockbroking firm, Nirmal Bang wrote in his note to investors.

“Growth remained broad-based and deal momentum robust, with digital transformation rapidly scaling across verticals and regions,” ICICI Securities’ analyst Pardiker wrote in his note to investors.

The writing-on-the-wall kind of situation hasn’t escaped the notice of Infosys’ management though. It has already started discussions with its clients in terms of price increase amid cost pressure due to supply-side challenges. It said that the clients recognise the situation and are now receptive to the discussion which is a good thing for the company.

Also read: Infosys, TCS announce 12% profit in Q3; Wipro’s growth at 2.3%

Salil Parekh in his commentary said there has been some level of stability in terms of pricing and “what we saw in the specific deal that we closed in Q3 versus Q2 on the longer-term, the larger share in the past we’ve put in place a very focused effort on communicating the value that we are helping create with our clients through the digital programs. We are also seeing as shared wage increases we’ve done.”

It must be admitted that like all other industries, the IT sector too has been on the back foot because of the third wave of Covid which caught the country completely unawares.

It does indicate that the digital growth story will continue for some more time and so will work from home. As per the third-quarter results, digital now accounts for 58 per cent of revenues for Infosys and thereabouts for other major IT services companies as well.

Another issue that all IT companies face is the rising attrition levels which they in the respective commentaries have said may no longer be a major challenge going forward. While TCS achieved its fresher target during the quarter itself and plans to add more in the next few quarters, Infosys has increased its annual target of hiring to 55,000 from 45,000 earlier. There has been a considerable increase in holding back talent with higher wages, regular increments and gone a bit further increasing sub-contracting.

“These supply-side pressures in conjunction with impending cost headwinds like travel/office resumption should translate into largely lower than pre-Covid margins,” ICICI Securities’ Heenal Gada said.

While the outlook looks rosy for most of the domestic IT services’ companies as of now, the situation is bound to change once the current Covid wave subsidies and the pandemic eases into an endemic resulting in the change of the dynamics of the industry.