of 52
8/2/2019 IT Barclays 20111007
1/52
EQUITY RESEARCH 7 October 20
INDIAN SOFTWARE & IT SERVICES
Adjusting to the new normal; initiate coverage
We initiate coverage of the Asia ex-Japan Software & IT services sector with a
2-Neutral view. For the Indian IT companies we bring under coverage, we assign
ratings of 1-Overweight on Infosys (PT INR3,050, +24% potential upside) and HCL
Tech (PT INR485, +23%), 2-Equal Weight on Tata Consultancy (PT INR1,150, +10%)
and 3-Underweight on Wipro (PT INR340, +4%).
The new normal of growth: Compared with typical 30-40% revenue CAGR in the
previous cycle (2003-07), growth rates over the next five years could be in the high
teens for the large Indian IT vendors. Growth will likely be driven by: 1) increased
outsourcing as customers seek a more flexible cost model; 2) limited availability of
technical staff in the developed world; and 3) a shift to new business models led bythemes of cloud, mobility and social networking, among others.
Assuming weak economies but not a recession: Indian IT vendors generate more than
90% of revenues from the developed world, hence the health of these economies is
important for the health of the sector. While we accept that current economic uncertainty
limits visibility, our economists argue that uncertainty is unlikely to turn into recession.
CIO survey indicates reasonable growth in 2012: A survey of 100 CIOs by Barclays
Capitals technology team indicates expectations for low single-digit y/y growth (1.8%
y/y) in overall tech budgets in 2011 and 2012. Recent results from Accenture and
Oracle also suggest the uncertainty has failed to impact software and services spend.
Uncertainty takes its toll on sector multiples: Uncertainty in the global macro
environment is reflected in share prices of Indian IT companies. While cuts in consensus
earnings estimates have been modest (the worst so far is a drop of 8% for Infosys),
multiples have compressed as investors worry about future growth. Despite our comfort
with high-teens revenue and EPS CAGR for large Indian IT vendors for the next five years,
we believe valuation multiples could remain depressed in the current environment.
Infosys and HCL Tech 1-OW; Tata Consultancy 2-EW; Wipro 3-UW: A significant
decline in revenue from one client of Infosys (1-OW) has led to low expectations and
hence a return to reasonable valuations (15.6x 12-month forward P/E). We believe a
recovery in the EPS growth trajectory could be a catalyst for strong share price
performance for Infosys. We also highlight HCL Tech (1-OW) on the back of its good
revenue growth and valuations (12.2x 12-month forward P/E). While TCS (2-EW)
should continue to deliver growth near-term, further margin expansion looks unlikely
and, thus, a 10% valuation premium to Infosys is not justified, in our view. While we
consider Wipro (3-UW) a strong Indian IT company, we believe it could face challenges
in growth and margin as it executes its new go-to-market strategy. Sustained local
currency weakness would provide room for EPS upgrades across the sector.
Barclays Capital does and seeks to do business with companies covered in its research reports. As aresult, investors should be aware that the firm may have a conflict of interest that could affect theobjectivity of this report.
Investors should consider this report as only a single factor in making their investment decision.
This research report has been prepared in whole or in part by research analysts based outside the USwho are not registered/qualified as research analysts with FINRA.
PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 44.
INITIATING COVERAGE
Asia Ex-Japan Software & IT Services
2-NEUTRALfrom N/A
For a full list of our ratings, price targets andearnings in this report, please see table onpage 2
Asia Ex-Japan Software & IT Services
Bhuvnesh Singh
+91 22 6719 6314
BSIPL, Mumbai
Vaibhav Dhasmana
+91 22 6719 [email protected]
BSIPL, Mumbai
8/2/2019 IT Barclays 20111007
2/52
Barclays Capital | Indian Software & IT Services
7 October 2011 2
Summary of our Ratings, Price Targets and Earnings Estimates in this Report
Company Rating Price Price Target EPS FY1 (E) EPS FY2 (E)
Old New 05-Oct-11 Old New %Chg Old New %Chg Old New %Chg
Asia Ex-Japan Software & IT Services 0-NR 2-Neu
HCL Technologies (HCLT IN / HCLT.NS) N/A 1-OW 395.10 N/A 485.00 - N/A 32.23 - N/A 37.75 -Infosys Ltd. (INFO IN / INFY.NS) N/A 1-OW 2454.30 N/A 3050.00 - N/A 136.60 - N/A 158.04 -
Tata Consultancy Services (TCS IN / TCS.NS) N/A 2-EW 1043.50 N/A 1150.00 - N/A 54.15 - N/A 60.80 -
Wipro Limited (WPRO IN / WIPR.NS) N/A 3-UW 327.90 N/A 340.00 - N/A 22.10 - N/A 25.49 -
Source: Barclays Capital Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency.
FY1(E): Current fiscal year estimates by Barclays Capital. FY2(E): Next fiscal year estimates by Barclays Capital.
Stock Rating: 1-OW: 1-Overweight 2-EW: 2-Equal Weight 3-UW: 3-Underweight RS: RS-Rating SuspendedSector View: 1-Pos: 1-Positive 2-Neu: 2-Neutral 3-Neg: 3-Negative
http://my.barcapint.com/ERG/displayCompany.jsp?ticker=HCLT.NShttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=INFY.NShttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=TCS.NShttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=WIPR.NShttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=WIPR.NShttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=TCS.NShttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=INFY.NShttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=HCLT.NS8/2/2019 IT Barclays 20111007
3/52
Barclays Capital | Indian Software & IT Services
7 October 2011 3
CONTENTS
INVESTMENT SUMMARY.................................................................................................................. 4Companies could still deliver growth despite weak economies...................................................... 4Initiating coverage: Infosys (1-OW), HCL Tech (1-OW), Tata Consultancy (2-EW), Wipro (3-
UW)................................................................................................................................................................ 5Valuation and risks..................................................................................................................................... 6THE NEW NORMAL OF GROWTH................................................................................................ 9Expect a slowdown in growth................................................................................................................. 9Indian IT value proposition remains strong ......................................................................................... 9Shifting to a more flexible financial model ......................................................................................... 10New frontiers for IT services .................................................................................................................. 12HIGHLY CORRELATED TO US ECONOMIC GROWTH ................................................................ 14US is the largest end-market ................................................................................................................. 14Global outlook........................................................................................................................................... 16However, uncertainty does not result in a recession ....................................................................... 16CIO SURVEY BUILDS A STRONG BOTTOM-UP CASE FOR IT SERVICES SPENDING .............19CIOs are still building growth................................................................................................................ 19Software and services remain top priorities....................................................................................... 20Recent results of global software and IT services companies support findings ........................ 21VALUATIONS .................................................................................................................................... 22Valuations have corrected significantly .............................................................................................. 22Currency impact ....................................................................................................................................... 24
INFOSYS (1-OW, PT INR3,050, +24%): OUTPERFORMING LOWERED EXPECTATIONS......25HCL TECH (1-OW, PT INR485, +23%): INDUSTRY LEADING GROWTH ................................. 29TATA CONSULTANCY (2-EW, PT INR1,150, +10%): HEADWINDS AHEAD........................... 35WIPRO LTD (3-UW, PT INR340, +4%): EXECUTION WOES....................................................... 39
8/2/2019 IT Barclays 20111007
4/52
Barclays Capital | Indian Software & IT Services
7 October 2011 4
INVESTMENT SUMMARY
We initiate coverage of the four large-cap Indian IT vendors with 1-Overweight ratings
on Infosys (PT: INR3,050 for potential upside of 24%) and HCL Tech (PT: INR485 for
potential upside of 23%), a 2-Equal Weight rating on Tata Consultancy (PT: INR1,150,
potential upside of 10%) and a 3-Underweight rating on Wipro (PT INR340 for potentialupside of 4%). We believe that Indian IT companies should be able to weather the
impact on their revenues of the weak global economic environment and deliver a CAGR
for revenue of 16-19% for the next three years. Low operating leverage should lead to
stable operating margins. Furthermore, depreciation of the Indian rupee could lead to
margin expansion and EPS upgrades. On the other hand, heightened macro uncertainty
could keep valuation multiples depressed for these names. Thus, we initiate coverage of
the Asia ex-Japan Software & IT Services sector with a 2-Neutral view.
Companies could still deliver growth despite weak economies
The new normal of growthIncreased penetration of offshore services, coupled with weak economic growth in the
developed world, should lead to a lower growth trajectory for Indian IT services companies.
Compared with the typical 30-40% y/y revenue growth in the previous cycle (2003-07), we
believe that growth rates in the current cycle, over the next five years, could be in the high
teens for the large Indian IT services companies. Growth will likely be driven by: 1) increased
outsourcing as customers seek a more flexible cost model; 2) limited availability of technical
staff in the developed world; and 3) a shift to new business models led by themes of cloud
computing, mobility and social networking, among others.
We remain cognizant of the fact that the four large-cap Indian IT vendors together now
employ more than 500,000 staff. Along with demand issues, scalability could be another bigfactor driving growth rates.
Assuming weak economies but not a recession
Indian IT vendors are largely focused on providing IT services to corporates in the developed
world, with the US and the UK accounting for more than 60% of the revenues of the large IT
vendors. The companies strong value proposition could keep revenue growing despite a
weak macroeconomic backdrop; however, a recession could significantly impact revenues
and profits. While we agree that the economic outlook remains uncertain, Barclays Capitals
economists believe uncertainty is unlikely to turn into recession. We are thus comfortable
with our forecasts of revenue growth in the high-teens for the Indian IT vendors for the next
five years.
CIO survey indicates reasonable growth in 2012
A bottom-up survey of 100 CIOs by Barclays Capitals technology team in September
indicates expectations for low single-digit y/y growth (1.8% y/y) in overall tech budgets in
2011 and 2012. Despite the current economic uncertainty, the confidence in positive
growth for 2011 indicates that underlying business is suffering more from low visibility than
actual revenue pressure. This is also reflected in the recent quarterly results of global
software and IT services companies that have continued to report strong and above-
consensus results.
Our top picks in the sector are
Infosys and HCL Tech
8/2/2019 IT Barclays 20111007
5/52
Barclays Capital | Indian Software & IT Services
7 October 2011 5
Figure 1: Indian IT Services revenue growth comparisons, % y/y
0%
5%
10%
15%
20%
25%
30%
FY12E FY13E
Infosys TCS Wipro HCL
Source: Barclays Capital estimates
Initiating coverage: Infosys (1-OW), HCL Tech (1-OW), TataConsultancy (2-EW), Wipro (3-UW)
We initiate coverage of Indias four largest IT services companies within the Asia ex-Japan
software & IT services sector. While the sector drivers are common to the group, we believe
that share performance could vary significantly on the back of differing investor
expectations and company-specific issues.
Infosys Limited (1-OW): We initiate coverage of Infosys with a 1-Overweight rating and
12-month price target of INR3,050, implying a target multiple of 17.5x and potential
upside of 24%. A significant decline in revenues from one of its largest clients, British
Telecom, is likely the key factor behind weak revenue performance in the past six
quarters. However, we expect this decline to end soon as BTs share of the total revenuepool becomes much lower. This should aid EPS growth. Furthermore, we find Infosyss
margin guidance for FY2012 (fiscal year ending March 2012) conservative and we
expect actual numbers to come in ahead of guidance. Finally, limited use of currency
hedging could help Infosys in the current environment of rupee depreciation.
HCL Technologies (1-OW): We initiate coverage of HCL Tech with a 1-Overweight
rating and 12-month price target of INR485, taking a 30% discount to Infosyss target
multiple, for a target P/E of 12.5x. We believe HCL should be able to maintain its
industry-leading growth on the back of strong performance in its infrastructure services
business. HCL is also well positioned to exploit any resurgence in growth in the
enterprise solutions business through its recent acquisition of UK-based Axon.
Furthermore, a turnaround in its BPO (Business Process Outsourcing) business could
lead to some margin expansion for HCL while its peers face margin pressure. HCL is also
a beneficiary of current rupee depreciation on account of its low hedge positions.
Tata Consultancy Services (2-EW): We initiate coverage of TCS with a 2-Equal Weight
rating and a 12-month price target of INR1,150, implying a target multiple of 17.5x.
While we like TCS, we find it difficult to justify its 10% P/E multiple premium over
Infosys and expect this to correct going forward. We also believe TCS could now face
headwinds in margin expansion, except if the rupee depreciates, and hence operating
profit growth should be largely in line with growth at Infosys.
8/2/2019 IT Barclays 20111007
6/52
Barclays Capital | Indian Software & IT Services
7 October 2011 6
Wipro Limited (3-UW): We initiate coverage of Wipro with a 3-Underweight rating and
a 12-month price target of INR340, taking a 30% discount to Infosyss target multiple
for a target P/E of 12.5x. While we believe that Wipro has strong domain and vertical
knowledge, execution has been a drag on the companys performance. Recent
management restructuring has focused on improving execution but comes at a time
when the overall growth environment could be weakening. We thus believe that there is
a high probability of slippage in Wipro achieving its growth targets and hence advise
investors to be cautious on this name.
Figure 2: Indian IT services companies EPS growth comparisons
(y/y) FY09 FY10 FY11 FY12E FY13E FY14E
Infosys 28% 5% 9% 14% 16% 17%
TCS 3% 33% 26% 22% 12% 21%
Wipro 15% 24% 15% 2% 15% 16%
HCL Tech -5% 5% 33% 23% 22% 17%
Source: Barclays Capital estimates
Valuation and risks
We use P/E as our primary valuation method for the Indian IT vendors. We look at the
historical P/E multiple range and future growth prospects to determine an appropriate
forward multiple for our price targets. Our price targets are 12-months forward, hence we
apply our target P/E multiple to 24-month forward EPS (an average of our EPS forecasts for
FY13 and FY14) to derive our price targets. For Infosys and TCS, we apply target P/E
multiples of 17.5x, which is in line with their past five-year averages and appropriately
adjusted for our growth expectations for the companies over the next three years. In the
case of HCL Tech, we use a 30% discount to Infosyss target multiple, in line with the
historical average trading discount for the shares. For Wipro, our 30% discount to Infosyss
multiple is at the low end of its historical discount because we perceive a higher risk to the
companys earnings growth going forward.
Downside risks for the group: 1) a sharp deceleration in the global economy with a
possibility of recession, which could impact the demand for IT services; 2) restrictions on
the issuance of work visas in the companies key markets; 3) significant price competition
from other offshore and global IT vendors and 4) significant rupee appreciation.
Upside risks for the group: 1) a stronger-than-expected recovery in demand; 2) a reduction
in macroeconomic uncertainty, leading to multiple expansion; and 2) significant
depreciation of the rupee.
Figure 3: India IT services comparative valuations
P/E (x) EPS (INR) ROE (%)
Ticker RatingPrice
INRPrice target
INR
Potentialupside to PT
(%)
MarketCap
US$ bn FY12E FY13E FY12E FY13E FY11E FY12E
Infosys INFO IN 1-OW 2,454 3,050 24% 28.47 17.9 15.5 136.6 158.0 27% 27%
HCL Tech HCLT IN 1-OW 395 485 23% 41.39 12.2 10.5 32.30 37.75 23% 23%
TCS TCS IN 2-EW 1,044 1,150 10% 5.53 19.3 17.2 54.2 60.8 37% 34%
Wipro WPRO IN 3-UW 328 340 4% 16.33 14.8 12.9 22.1 25.5 20% 19%
Note: Prices as of 5 October 2011. Stock ratings: 1-OW: 1-Overweight, 2-EW: 2-Equal Weight, 3-UW: 3-Underweight.Source: Bloomberg, Barclays Capital estimates
8/2/2019 IT Barclays 20111007
7/52
Barclays Capital | Indian Software & IT Services
7 October 2011 7
Figure 4: India IT services summary of relative share price performances
3-month 12-month YTD
Infosys -13% -18% -27%
TCS -12% 9% -10%
Wipro -18% -27% -29%
HCL Tech -17% -6% -10%
Nifty 50 -12% -20% -20%
MSCI Asia ex Japan -22% -18% -22%
MSCI Asia Tech -16% -12% -22%
Note: Prices as of 5 October 2011.Source: Bloomberg, Barclays Capital
Figure 5: Infosys 12-month forward P/E based on
consensus estimates
Figure 6: Infosys valuations relative to Nifty 50 positive
indicates Infosys at premium
0
5
10
15
20
25
30
35
40
Oct-01
Oct-02
Oct-03
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
-20%
-10%
0%
10%
20%
30%
40%
50%
Oct-09
Dec-09
Feb-10
Apr-10
Jun-10
Aug-10
Oct-10
Dec-10
Feb-11
Apr-11
Jun-11
Aug-11
Source: Datastream, Barclays Capital Source: Bloomberg, Barclays Capital
Figure 7: TCS 12-month forward P/E based on consensus
estimates
Figure 8: TCS valuations relative to Infosys positive
indicates TCS at premium
0
5
10
15
20
25
30
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
-50%
-40%
-30%-20%
-10%
0%
10%
20%
30%
40%
50%
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
8/2/2019 IT Barclays 20111007
8/52
Barclays Capital | Indian Software & IT Services
7 October 2011 8
Figure 9: HCL Tech 12-month forward P/E based on
consensus estimates
Figure 10: HCL Tech valuations relative to Infosys negative
implies HCL Tech at discount
0
5
10
15
20
25
Oct-01
Oct-02
Oct-03
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
-100%
-90%
-80%
-70%
-60%
-50%
-40%
-30%
-20%
-10%
0%
Oct-01
Oct-02
Oct-03
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
Figure 11: Wipro 12-month forward P/E based onconsensus estimates
Figure 12: Wipro valuations relative to Infosys Wipro nowat a discount
0
510
15
20
25
30
35
40
45
50
Oct-01
Oct-02
Oct-03
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
-50%
-30%
-10%
10%
30%
50%
70%
90%
Oct-01
Oct-02
Oct-03
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
8/2/2019 IT Barclays 20111007
9/52
Barclays Capital | Indian Software & IT Services
7 October 2011 9
THE NEW NORMAL OF GROWTH
Despite the strong value proposition of the Indian IT services companies, weak economic
growth in the developed world should lead to a lower growth trajectory for the large
Indian companies. Compared with the prior cycles (2003-07) average y/y revenue
growth of 30-40%, growth rates over the next five years could be in the high teens.Growth is likely to be driven by: 1) increased outsourcing as customers seek a more
flexible cost model; 2) limited availability of technical staff in the developed world; and 3)
a shift to new business models led by themes of cloud computing, mobility and social
networking, among others.
Expect a slowdown in growth
We believe that the revenue growth of the top four Indian IT services companies could be
limited to the high teens over the next five years. This compares with average 30-40% y/y
revenue growth from 2003 to 2007. We believe that change in the global economy and the
increasing scale of the companies will lead to this downshift in the growth trajectory. We
also note that as offshore penetration increases, the growth rate of the industry overall
should slow. This is visible in data for the past 15 years.
Figure 13: Infosys revenue growth rates, CAGR for each period
80%
39%
19%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
FY1995-2000 FY2001-07 FY2007-13E
Increased scale of business and macro
concerns causing growth downshift
Source: Barclays Capital estimates
Indian IT value proposition remains strong
Nevertheless, the value proposition of offshore delivery is clearly visible in the lower cost of
offshore resources compared with onshore resources in developed economies. Taking
Infosys as an example, we note that the companys offshore billing rates are close to one-third of its onsite billing rates.
This gap is also visible in the revenue per employee of offshore IT firms compared with firms
that offer IT services onsite at client locations. Taking Infosys and Accenture as examples,
we find that Infosyss revenue per employee is only 33-35% of Accentures revenue per
employee, per company data. Sceptics might argue that this gap is largely on the back of
differing value addition of the two companies we disagree. Infosys EBIT per employee is
US$3,300/annum compared with US$4,300/annum for Accenture, indicating significantly
lower gap in value addition between both companies.
8/2/2019 IT Barclays 20111007
10/52
Barclays Capital | Indian Software & IT Services
7 October 2011 10
Figure 14: Infosys onsite and offshore billing rates
0
20,000
40,000
60,000
80,000
100,000120,000
140,000
160,000
180,000
Sep-08
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
Mar-10
Jun-10
Sep-10
Dec-10
Mar-11
Jun-11
Onsite Offshore BlendedUS$ per annum
>60% discount between onsiteand offshore billing rates
Source: Company data, Barclays Capital
Figure 15: Revenue and margin gap highlights the pricing advantage of Infosys vsAccenture (based on last reported quarter)
32.3
12.5 3.3 4.3
0
5
10
15
20
25
30
35
40
Revenue Operating profit
Infosys Accenture
per employee items (US$ 000 per quarter)
Source: Company data, Barclays Capital
Shifting to a more flexible financial model
Clients are increasing the proportion of outsourcing in their overall mix of IT services work,
which has been one of the main reasons for the sectors growth, which we still expect to be
at a mid- to high-teens rate for the next five years. While greater efficiency and capabilities
of IT vendors could be one reason for growth in outsourcing, a more important factor couldbe a desire by clients to shift to a more flexible financial model.
We note that Indian IT vendors have business models with very low leverage. This allows
them to weather fluctuations in revenues better than their customers, which may be more
leveraged. In particular, IT services vendors have:
Low operating leverage: The margins of Indian IT vendors have remained in a narrow
range despite significant fluctuations in their revenue expectations. Vendors have
managed to reduce operating leverage by: i) greater use of variable pay; ii) shifting
8/2/2019 IT Barclays 20111007
11/52
Barclays Capital | Indian Software & IT Services
7 October 2011 11
resources from high-cost onsite locations to low-cost offshore locations; and iii)
reducing various discretionary costs (eg, travel, G&A) during periods of weak growth.
Low financial leverage: The balance sheet of most Indian IT vendors is largely debt-free
and holds significant amounts of cash.
Figure 16: Infosys EBIT margins for the past decade
0%
10%
20%
30%
40%
50%
FY2000
FY2001
FY2002
FY2003
FY2004
FY2005
FY2006
FY2007
FY2008
FY2009
FY2010
FY2011
High margins, fairly stable in a narrow range
Source: Company data, Barclays Capital
Figure 17: Indian IT vendors Net cash levels as of FY2011
0
20
40
60
80
100
120
140
160
180
Infosys TCS Wipro HCL Tech
INR bn
Source: Company data, Barclays Capital
Staffing constraints in the developed world
The lack of trained technical staff in the developed world is now encouraging many
customers to focus on India (and to some extent China, Eastern Europe and Latin America)
to source skilled resources. We note that companies like Microsoft and Google, among
others, have established large centres in offshore locations largely to source the best talent
rather than to save costs.
8/2/2019 IT Barclays 20111007
12/52
Barclays Capital | Indian Software & IT Services
7 October 2011 12
Figure 18: US unemployment rates overall and for graduates 25 years and older
0
2
4
6
8
10
12
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Overa ll Graduates 25 yr and older
%
Source: Bureau of Labor Statistics, Barclays Capital
New frontiers for IT services
The Indian IT services industry, which cut its teeth at the beginning of this decade on
modernization and implementation of legacy code (old code that was written for different
requirements), is now faced with incremental opportunities in the form of cloud computing,
virtualization and mobility application development.
This does not undermine the importance of application maintenance (largely for legacy
code) as this still retains an important role, at between 18% and 46% of revenues for the
top-four Indian IT services vendors. This situation is likely to continue, we believe, since
upgrades to new platforms are not always beneficial or necessary, and even when an
upgrade is necessary, incremental business flows the way of the IT services vendors.
Figure 19: India IT Services Application development and maintenance as % of total
revenue (last reported quarter)
0%
5%
10%15%
20%
25%
30%
35%
40%
45%
50%
Infosys TCS Wipro HCL Tech
Source: Company data, Barclays Capital
8/2/2019 IT Barclays 20111007
13/52
Barclays Capital | Indian Software & IT Services
7 October 2011 13
New opportunities for the sector are likely to come from developing solutions around
shared services on the cloud, infrastructure, platforms for new processes and virtualization.
The shared nature of these services could also provide penetration into the small and
medium-size business market (SMB), the first success in which has been seen with the SaaS
(Software as a Service) model, a US$8.5bn market in 2010 with an impressive growth rate
of 15.6% CAGR in 2010-14E, according to industry researcher Gartner.
Figure 20: Global SaaS (software as a service) market
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
2007 2008 2009 2010 2011E 2012E 2011E 2012E
Content, communications, collaboration Office Suites
Digital Content Creation CRM
ERP SCM
Pro jec t & port fo lio management Other Applicat ion So f tware
US$m
Source: Gartner estimates
Virtualization is another area that is providing incremental growth opportunities, where
labour-based services like assessment, design and planning, testing, optimization and
change management are all under the purview of IT services companies, already a US$4bn
opportunity worldwide, according to Gartner.
Figure 21: Global virtualization consulting and implementation services
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
2008 2009 2010 2011E 2012E 2013E
Server DesktopUS$m
Source: Gartner estimates
8/2/2019 IT Barclays 20111007
14/52
Barclays Capital | Indian Software & IT Services
7 October 2011 14
HIGHLY CORRELATED TO US ECONOMIC GROWTH
The US remains the largest end-market for Indian IT companies. Clearly, the health of the
US economy is the key for Indian vendors. Thus, revenues of these vendors remain highly
correlated to US GDP growth.
Our base case scenario is of slow US economic growth but not a recession. While the
current uncertainty is disconcerting, our economists clearly show that there is a limited
chance of this turning into a full-blown recession in the US.
US is the largest end-market
Indian IT Services companies generate more than half their revenues from the US. The
European exposure is close to 20% with more than half of this exposure to the UK rather
than Eurozone countries. Taking Infosys as an example, we note that the companys
revenue growth has a high correlation to US economic parameters (Figures 24-27).
Figure 22: Revenue exposure to various geographies US has a dominant share, June2011 quarter
0%
10%
20%
30%
40%
50%
60%
70%
North America Europe India RoW
Infosys TCS Wipro HCL Tech
Source: Company data, Barclays Capital
Figure 23: Real GDP % over previous period, saar
1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12
US 3.9 3.8 2.5 2.3 0.4 1.3 2.0 2.5 2.5 2.5 3.0 3.0
UK 1.4 3.7 1.5 1.2 3.1 0.6 0.5 0.5 1.1 1.2 1.4 1.5Euro area 1.4 4.3 2.5 -2.0 1.9 0.7 0.6 0.9 1.4 1.8 2.6 2.9
Source: Barclays Capital estimates
8/2/2019 IT Barclays 20111007
15/52
Barclays Capital | Indian Software & IT Services
7 October 2011 15
Figure 24: US GDP growth vs. Infosyss revenue growth rate
Figure 25: US investment in equipment and software vs.
Infosyss revenue growth rate
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
-5%
0%
5%
10%
15%
20%
25%
30%US Real GDP growth QQ
Infosys QQ growth rate RHS
-10%
-8%
-6%
-4%
-2%
0%
2%4%
6%
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
-5%
0%
5%
10%
15%
20%
25%
30%
US Investment in equipment and software QQ
Infosys QQ growth rate RHS
Source: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital
Figure 26: US industrial production vs. Infosyss revenuegrowth rate
Figure 27: US personal consumption vs. Infosyss revenuegrowth rate
-20%
-15%
-10%
-5%
0%
5%
10%
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
-5%
0%
5%
10%
15%
20%
25%
30%
US Industrial production YY
Infosys QQ growth rate RHS
-6%
-4%
-2%
0%
2%
4%
6%
8%
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
-5%
0%
5%
10%
15%
20%
25%
30%
US personal consumption QQ
Infosys QQ growth rate RHS
Source: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital
8/2/2019 IT Barclays 20111007
16/52
Barclays Capital | Indian Software & IT Services
7 October 2011 16
Global outlook
With such high correlations to the developed world economies, the key question for
investors in Indian IT services companies is the health of the global economy.
Barclays Capitals house view is of weak US growth in 2011, with some recovery expected in
2012. We agree that the current uncertain environment limits our visibility; however, we
believe that policymakers are more sensitized to the current slowdown, leaning on the
experience from 2008 and hence likely to be more proactive with fiscal and monetary
measures. According to US economist Troy Davig1, the scope and need for further fiscal
and monetary stimulus is clearly more constrained than in 2008, but additional measures
on both counts are likely.
What about the current lack of visibility?
Our US economist Troy Davig notes that uncertainty plays only a modest role in economic
decisions when confidence is high but can have a more negative influence when confidence
is depressed. We find that heightened uncertainty can cause firms to postpone hiring and
investment decisions, which often plays a role in slowing economic activity.
The current uncertainty has caused a downward revision to the forecasts of our economists
with their FY2011/12 growth rate forecast cut by 80/100bps over the past 6 months.
Figure 28: The US confronts another uncertainty shock
0
10
20
30
40
50
60
70
67 74 81 88 95 02 09
Uncertainty Index (Bloom / VIX)
Index August
2011
Source: Chicago Board Options Exchange, Nick Bloom, Haver Analytics, Barclays Capital
However, uncertainty does not result in a recession
Building on the analysis of the above section, our US economist Troy Davig finds limitedevidence that uncertainty could lead to a recession.
The resurgence in uncertainty and sovereign risk concerns in Europe, as well as any
attendant potential spillover to the US, has raised concerns about another recession in the
US. While our economics team is not forecasting a near-term recession, the slow pace of
growth so far this year and prospect for fiscal tightening pose some risk.
1 Please refer to the 14 September 2011 report Uncertainty shocks and recessionary risks (click here)
Back to the big question
8/2/2019 IT Barclays 20111007
17/52
Barclays Capital | Indian Software & IT Services
7 October 2011 17
Figure 29: An increase in uncertainty exerts a persistentweight on business confidence
Figure 30: and job growth
-4.5
-4.0
-3.5-3.0
-2.5
-2.0
-1.5
-1.0-0.5
0.0
1 3 5 7 9 11 13 15 17
Effect on NFIB smal l business optimi sm index of a
10 point increase in the VIX index (+/- 2 std devs)
Months after initial shock to the VIX
-70
-60
-50
-40
-30
-20-10
0
1 3 5 7 9 11 13 15 17
Effect on private non-farm payrolls of a
15% increase in the VIX index, thousands
Months after initial shock to the VIX
Source: Barclays Capital Source: Barclays Capital
Figure 31: Business confidence remains subdued Figure 32: Pessimism + uncertainty = weak job growth
85
90
95
100
105
110
115
120
Jan-86 Jan-91 Jan-96 Jan-01 Jan-06 Jan-11
NFIB small business optimism index
Index
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
10 20 30 40 50 60 70
NFIB small business optimism 110
Private nonfarm payrolls, % chg, m/m
Uncertainty Index
Source: NFIB, NBER, Haver Analytics, Barclays Capital Source: NFIB, CBOE, Nick Bloom, Haver Analytics, Barclays Capital
Figure 33: Forecast showing a recovery Figure 34: Even as absolute annual forecasts have seen adownward revision
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12
US Real GDP % over previous period, saar
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
12M ago 6M ago 3M ago 1M ago Current
2011 2012% YY US GDP
growth
Source: Barclays Capital estimates Source: Barclays Capital estimates
8/2/2019 IT Barclays 20111007
18/52
Barclays Capital | Indian Software & IT Services
7 October 2011 18
An analysis of the NBER model to predict the probability of a recession and Barclays
Capitals estimates is presented below, and can be referred to in detail in Troy Davigs report
14 September 2011 report Uncertainty shocks and recessionary risks(click here).
In contrast, recent economic data should allay some fears the US ISM and Chicago PMI
both continued to trend above the 50 expansion/contraction mark, with the August-
September ISM data especially showing strength in the non-manufacturing/services
segment. Even in the manufacturing segment, ISM data has continued to come ahead of
forecast with a rebound in production in the month of September.
Figure 35: Warning signals have risen, but do not indicate a
near-term recession
Figure 36: Forward-looking warning signals have also risen,
but do not indicate a near-term recession
0.0
0.2
0.4
0.6
0.8
1.0
Jan-87 Jan-93 Jan-99 Jan-05 Jan-11
Probabili ty of NBER-defined recession
0.0
0.2
0.4
0.6
0.8
1.0
Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Pro bability the US will be in an NBER-defined recession in 3 mo nths
Pro bability the US will be in an NBER-defined recession in 6 mo nths
Probability
Source: Bureau of Economic Analysis, NBER, Haver Analytics Source: Bureau of Economic Analysis, NBER, Haver Analytics
Figure 37: Monthly Chicago PMI Figure 38: US ISM index
0
10
20
30
40
50
60
70
80
90
100
Feb-00
Ma
r-01
Ma
r-02
Ma
r-03
Feb-04
Ma
r-05
Ma
r-06
Ma
r-07
Feb-08
Ma
r-09
Ma
r-10
Ma
r-11
Overall New orders
Inventory New employee
30
35
40
45
50
55
60
65
70
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Overall Non manufac Manufact
Source: Kingsbury International, Barclays Capital Source: Institute for Supply Management, Barclays Capital
https://live.barcap.com/go/publications/content?contentPubID=FC1747320http://my.barcapint.com/BC/barcaplive?url=%2FDDL%2Fservlets%2Fdv.search%3FdocID%3D102787811%26resultPrefix%3DDDL&LLPreviousMenuCode=INTRANEThttp://my.barcapint.com/BC/barcaplive?url=%2FDDL%2Fservlets%2Fdv.search%3FdocID%3D102787811%26resultPrefix%3DDDL&LLPreviousMenuCode=INTRANEThttps://live.barcap.com/go/publications/content?contentPubID=FC17473208/2/2019 IT Barclays 20111007
19/52
Barclays Capital | Indian Software & IT Services
7 October 2011 19
CIO SURVEY BUILDS A STRONG BOTTOM-UP CASE FOR IT SERVICES SPENDING
Results from the Barclays Capital September 2011 survey of 100 CIOs in the US and
Europe (published 7 September 2011, Barclays Capital CIO Survey: September 2011;
click here) reflect the weak environment through pared down growth expectations
compared with the findings in the April survey. However, participants in the survey arebuilding a reasonable 1.8% y/y increase in tech spending in 2011, with a similar increase
expected in 2012.
CIOs are still building growth
Based on the analysis of our US and Europe-based technology analysts, for 2011,
respondents now expect spending to increase about 1.8% in 2011 compared with
expectations of 3.3% growth forecast in the April survey, and 55% expect growth in 2011
vs. 63% in the prior survey. With regard to 2012, respondents expect spending to increase
1.7%, with 54% expecting growth and 20% expecting declines.
Figure 39: Barclays Capital CIO Survey September 2011 What is your best estimate forwhat your overall IT spending will be in 2012 y/y?
0%
5%
10%
15%
20%
25%
30%
35%
Up 10%+ Up 5-10% Up 0-5% Flat Down 0-
5%
Down 5-
10%
Down
10%+
%o
fRespondents
54% expect growth
in 2012; 20%
expect decli nes
Responses still showexpectations for low-single digit
overall IT spending growth in
2012
Source: Barclays Capital CIO Survey September 2011
Figure 40: What is your overall IT spending trend for 2H11 y/y (prior survey vs current)?
0%
5%10%
15%
20%
25%
30%
35%
40%
Up 10%+ Up 5-10% Up 0-5% Flat Down 0-
5%
Down 5-
10%
Down
10%+
Apr-11 Aug-11
17% expect declines
vs. 16% last survey
47% expect growth in
2H11 vs. 56% last
survey
Overall 2H11 IT spending
expectations show some
moderation vs April 2011
Source: Barclays Capital CIO Survey September 2011
https://live.barcap.com/go/publications/content?contentPubID=FC1745052https://live.barcap.com/go/publications/content?contentPubID=FC17450528/2/2019 IT Barclays 20111007
20/52
Barclays Capital | Indian Software & IT Services
7 October 2011 20
Software and services remain top priorities
IT services, along with software applications, is the top relative priority for 2H11 IT
spending, which makes sense to us given these industries later-cycle nature (relatively
more defensive moving into a potential economic downturn). This is a positive 2H11 lateral
for Indias IT services sector overall (relative to other technology sectors), in our view, with
more than one-third of the respondents listing software and services as top priorities.
Figure 41: Of your current budget, what is your biggest IT spending priority for 2H11 vs 1H11?
0%
2%
4%6%8%
10%12%14%
16%18%20%
SW-
Applications
ITServices
NoPriorities
Storage
Networking
Servers
PCs
SW-
Infrastructure
Virtualization
Other
%o
fRespondents
Applications and IT Services are
top priori ti es; Storage
Continues to Rate Well
19% of respondents favour IT
services as top priority
Source: Barclays Capital CIO Survey September 2011
With IT services a top relative priority for 2H11, companies appear to be hiring IT services
vendors for a number of reasons, with improved response rates across various tasks (cost-
cutting, ERP implementation, business transformation, risk management, analytics).
Interestingly, ERP implementation received the largest number of responses with cost
cutting remaining the next priority, which should likely provide initial resilience for most
outsourcing names going into a potential downturn.
Figure 42: Several reasons to hire an IT services vendor this year
0
10
20
30
40
50
60
Cutcostsfr
om
operation
s
Implement/upgrade
ERPorother
software/system
s
Transformb
usin
ess
model/strateg
y
Manageriskm
ore
effectively
Applypredictive
analyticsto
understand
customersbet
ter
#ofTotalRespondents
Apr-11 Aug-11
Focus on cost-cutting should
ensure resilience into downturn
Source: Barclays Capital CIO Survey September 2011
8/2/2019 IT Barclays 20111007
21/52
Barclays Capital | Indian Software & IT Services
7 October 2011 21
Recent results of global software and IT services companiessupport findings
The strength of demand for IT services and software is also evident from the recent results
of global IT services and software companies. For example, Accenture showed good overall
growth across regions and industry verticals with its results for August 2011 and reaffirmed
its full-year guidance despite factoring in the macro slowdown. Oracle confirmed a strongincrease in large license deals during its results briefing for August 2011 in September 2011
showing a 45% increase in deals greater than US$3m, while IBM reported good execution in
software and services with improvement in new contract signings. In Europe, SAP too
reported similar positive trends with strong license growth and large deal signings.
Figure 43: Accenture, Oracle, SAP, IBM results commentaries takeaways for IT services
Company Key takeaways from latest results
AccentureAug11 quarter
Revenue growth of 14% y/y in constant currency, above consensus estimates
Reaffirmation of 2012 revenue and EPS target even after adjusting for a weak macro
Conversion of bookings to revenues showing an acceleration
Visibility remains strong contracted revenue was up 13% Y/Y, largely due to strong outsourcing
OracleAug11 quarter
New software license revenue was up 17% Y/Y, building off 25%Y/Y growth last year
Deals >US$3m, which form 21% of revenue, growing at 45% Y/Y
Deals >US$0.5m showing a 44% YY growth
IBMJun11 quarter
Services signings up 16% Y/Y (+8% in constant currency)
17% Y/Y increase in outsourcing signings from large deal closures in emerging economies
Services backlog increased 2% Y/Y
SAPJun11 quarter
22% Y/Y core organic license growth
New deal signings up 34% Y/Y, 17% of new deals >US$5m
Source: Company data, Barclays Capital
8/2/2019 IT Barclays 20111007
22/52
Barclays Capital | Indian Software & IT Services
7 October 2011 22
VALUATIONS
Valuations have corrected significantly
Forward multiples for the four Indian IT vendors have corrected substantially for the year to
date. However, valuations remain significantly ahead of the previous cycles lowest
multiples.
Cuts in consensus EPS estimates have been modest; the worst was a cut of 8%. Wipro
suffered the biggest correct in consensus estimates with cuts of 5% for FY2012 and 8% to
FY2013, while HCL Tech has seen recent upgrades in the consensus view.
EPS estimates have also
corrected
Figure 44: Infosys 12-month forward P/E (consensusestimates) vs. maximum, minimum, average since Jan 2008
Figure 45: TCS 12-month forward P/E (consensusestimates) vs. maximum, minimum, average since Jan 2008
0
5
10
15
20
25
30
35
40
Sep-01
Jun-02
Mar-03
Dec-03
Sep-04
Jun-05
Mar-06
Dec-06
Aug-07
May-08
Feb-09
Nov-09
Aug-10
May-11
Max
Min
Avg
0
5
10
15
20
25
30
Oct-04
Jun-05
Feb-06
Oct-06
Jun-07
Feb-08
Oct-08
Jun-09
Feb-10
Oct-10
Jun-11
Max
Min
Avg
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
Figure 46: HCL Tech 12-month forward P/E (consensusestimates) vs. maximum, minimum, average since Jan 2008
Figure 47: Wipro 12-month forward P/E (consensusestimates) vs. maximum, minimum, average since Jan 2008
0
5
10
15
20
25
Sep-01
May-02
Jan-03
Sep-03
May-04
Jan-05
Sep-05
May-06
Jan-07
Sep-07
May-08
Jan-09
Sep-09
May-10
Jan-11
Sep-11
Max
Min
Avg
0
5
10
15
20
25
30
35
40
45
50
Oct-01
Jun-02
Feb-03
Oct-03
Jun-04
Feb-05
Oct-05
Jun-06
Feb-07
Oct-07
Jun-08
Feb-09
Oct-09
Jun-10
Feb-11
Oct-11
Max
Min
Avg
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
8/2/2019 IT Barclays 20111007
23/52
Barclays Capital | Indian Software & IT Services
7 October 2011 23
Figure 48: Infosys year-to-date changes in consensus EPS
forecasts: -8% for FY12 YTD
Figure 49: TCS year-to-date changes in consensus EPS
forecasts: almost flat since May 2011
100
110
120
130
140
150
160170
180
n-11
eb-11
ar-11
pr-11
ay-11
un-11
ul-11
ug-11
ep-11
ct-11
FY12E FY13E
30
35
40
45
50
55
60
65
n-11
eb-11
ar-11
pr-11
ay-11
un-11
ul-11
ug-11
ep-11
ct-11
FY12E FY13E
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
Figure 50: HCL Tech year-to-date changes in consensusEPS forecasts: upgrades post June 2011 results
Figure 51: Wipro year-to-date changes in consensus EPSforecasts: -6% YTD for FY12 EPS
15
20
25
30
35
40
Jan-
11
Feb-
11
Mar-
11
Apr-
11
May-
11
Jun-
11
Jul-
11
Aug-
11
Sep-
11
Oct-
11
FY12E FY13E
20
2122
23
24
25
26
27
28
29
30
Jan-11
Feb-11
Mar-11
Apr-11
May-11
Jun-11
Jul-11
Aug-11
Sep-11
Oct-11
FY12E FY13E
Source: Datastream, Barclays Capital Source: Datastream, Barclays Capital
8/2/2019 IT Barclays 20111007
24/52
Barclays Capital | Indian Software & IT Services
7 October 2011 24
Currency impact
The Indian rupee has depreciated -9.6% against the US dollar and -5.8% against the British
pound in the past three months. We note that most companies indicate that a 1%
depreciation in the rupee should lead to a 30-40bps expansion in their operating margins.
This implies that a 1% depreciation in the rupee should lead to a 1.5-2% increase in EPS.
While the Indian rupee is currently at INR49.15/US$1, Barclays Capitals economics team
expects the rupee to appreciate to INR47.2/US$1 by December 2011, INR45/US$1 by
March 2012 and INR44.50/US$1 by September 2012.
Our forecasts for Indian IT vendors build in these estimates for the currency. However, if the
INR/US$ exchange rate stays at the current level, we could expect an increase of more than10% in our EPS estimates for the four companies.
Figure 54: Forex hedge cover as a % of revenues, quarter ending Jun-11
0%
20%
40%
60%
80%
100%
120%
Infosys TCS Wipro HCL Tech
Source: Barclays Capital estimates
Could rupee depreciation lead to
EPS upgrades?
Figure 52: INR/USD exchange rate Figure 53: INR/GBP exchange rate
42
44
46
48
50
52
Jul-11
Aug-11
Sep-11
Oct-11
-9.6% depreciation of INRINR/USD
70
72
74
76
78
Jul-11
Aug-11
Sep-11
Oct-11
-5.8% depreciati on of INRINR/GBP
Source: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital
8/2/2019 IT Barclays 20111007
25/52
Barclays Capital | Indian Software & IT Services
7 October 2011 25
INFOSYS (1-OW, PT INR3,050, +24%): OUTPERFORMING LOWERED EXPECTATIONS
We initiate coverage of Infosys with a 1-Overweight rating and 12-month price target of
INR3,050, based on a target P/E multiple of 17.5x. A significant decline in revenue from
one of its major clients, British Telecom, could be the key factor behind the weak
revenue performance of Infosys in the past six quarters. This revenue decline could endsoon as British Telecom now has a lower contribution to revenue mix thereby leading to
a positive surprise on growth. Furthermore, we find Infosyss margin guidance for the
year ending March 2012 conservative and we expect actual numbers to come in ahead
of guidance. Finally, low hedging could help Infosys amid the current rupee
depreciation.
Investment summary
Best revenue growth amongst peers: Infosys has exhibited the best organic revenue
growth among the large-cap Indian IT companies in the past decade. This is largely a result
of strong execution by the company rather than lucky strategic breaks. For example, Infosys
was one of the last major Indian IT vendors to invest in BPO, but it has managed to buildone of the best BPO practices, in our opinion.
Strong margin focus: The capability of Infosys management is reflected in its ability to not
only deliver the best revenue growth but also to deliver it along with the strongest margins
and limited use of balance sheet. We believe this reflects companys strong internal
processes and systems, along with a top-tier sales team.
Near-term cautious commentary reflects conservative stance: Infosyss management
team has been cautious in the past few quarters on the back of its worries about the macro
environment. We note that Infosys is the only large Indian IT company to give guidance and,
hence, it is usually more transparent about its market views. Management has also been
clear that it has seen limited (if any) impact on the business but worries that macro
weakness could impact revenue.
Valuations look inexpensive: Infosys is trading at a mid-point of it P/E multiples for the
past five years a period that includes the financial crisis period of 2008-09. It is also
trading at its lowest premium to the Indian market and is actually at a 9.8% discount to
TCS. We base our target price on a P/E of 17.5x, which we view as fair despite market
uncertainty.
Figure 55: Infosys statistical abstract
Year to Net profit EPS EPS P/E P/B ROE Div. yield
31-March (INR mn) (INR) growth (%) (x) (x) (%) (%)
2011A 68,230 119.45 9.0 20.5 5.1 27.1 2.52012E 78,052 136.60 14.4 17.9 4.5 26.7 1.7
2013E 90,339 158.04 15.7 15.5 3.8 26.5 1.9
2014E 105,362 184.26 16.6 13.3 3.2 26.1 2.3
Source: Company data, Barclays Capital estimates
INFO IN / INFY.NS
Stock Rating
1-OVERWEIGHTSector View
2-NEUTRAL
Price Target
INR 3050.00
Price (05-Oct-2011)
INR 2454.30
Potential Upside/Downside
+24%
8/2/2019 IT Barclays 20111007
26/52
Barclays Capital | Indian Software & IT Services
7 October 2011 26
COMPANY SNAPSHOT
Infosys Limited Asia ex-Japan Software & IT Services
Income statement (INRmn) 2011A 2012E 2013E 2014E CAGR
Revenue 275,010 335,581 391,771 458,485 18.6% S tock Rating 1-OVERWEIGHT
EBITDA 89,640 104,142 119,234 135,480 14.8% S ector View 2-NEUTRAL
EBIT 81,020 94,992 109,114 124,340 15.3% Price (05-Oct-2011) INR 2454
Pre-tax income 93,130 109,085 124,816 143,798 15.6% Price Target INR 3050
Net income 68,230 78,052 90,339 105,362 15.6% Ticker INFO IN / INFY.NS
EPS (INR) 119.45 136.60 158.04 184.26 15.5%
Diluted shares (mn) 571.18 571.41 571.61 571.81 0.0% Investment case
Margin and return data (%) Average
EBITDA margin 32.6 31.0 30.4 29.5 30.9
EBIT margin 29.5 28.3 27.9 27.1 28.2
Pre-tax margin 33.9 32.5 31.9 31.4 32.4
Net margin 24.8 23.3 23.1 23.0 23.5
ROIC 48.5 47.0 49.2 52.1 49.2
ROA 23.1 23.2 22.5 21.8 22.7 Upside case INR 4000ROE 27.1 26.7 26.5 26.1 26.6
Balance sheet and cash flow (INRmn) CAGR
Fixed assets 57,170 59,680 61,560 62,420 3.0%
Cash and equivalents 168,780 191,823 245,253 300,941 21.3%
Total assets 312,630 359,875 442,599 523,171 18.7%
Current liabilities 36,230 44,819 68,913 81,106 30.8%
Long term liabilities 3,370 4,100 4,100 4,100 6.8% Downside case INR 1850
Total liabilities 39,600 48,919 73,013 85,206 29.1%
Net debt/(funds) - - - - NA
Shareholders' equity 273,030 310,956 369,586 437,965 17.1%
Change in work ing capi tal (5 ,550) (10,590) (824) (8,709) NA
Cash flo w f ro m o perat ions 71,300 76,613 99,635 107,792 14.8%
Capital expenditure (12,240) (11,660) (12,000) (12,000) NA
Free cash flow 59,060 64,953 87,635 95,792 17.5%
Upside/downside scenarios
Valuation and leverage metrics Average
P/E (x) 20.5 17.9 15.5 13.3 16.8
EV/EBITDA (x) 14.1 12.0 10.3 8.7 11.3
FCF yield (%) 4.2 4.6 6.3 6.8 5.5
EV/sales (x) 4.6 3.7 3.1 2.6 3.5
Price/BV (x) 5.1 4.5 3.8 3.2 4.1
Dividend yield (%) 2.5 1.7 1.9 2.3 2.1
Total debt/capital (%) 0.0 0.0 0.0 0.0 -
Net debt/EBITDA (x) - - - - -
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics EPS projections
Total headcount 113,796
Volume growth (%) 23.4 16.6 22.0 17.0
Pricing growth (%) 2.6 3.4 -1.1 -0.2
Onsite as % of revenues (%) 51.2 51.2 51.6 51.5
Source: Company data, Barclays Capital estimates Note: FY end Mar
Why a 1-Overweight? We expect Infosys to sustain
revenue growth in the high teens for the next five
years on the back of its strong value proposition.
This s hould allow t he s ha res to t rade at 1 7. 5x
forward P/E, leading us to our target price of
Rs3,050.
Strong rebound in discretionary IT spending could
l ead to a more positive revenue and margin
scenarios. This would improve both EPS (~15%) and
multiples (to 20x) and hence the shares could trade
close to R s4,000.
A weaker macro scenario could lead to both EPS
downgrades (down ~15%) and multiple
compression (to 12.5x), indicating a share price of
Rs1,850.
0
2
4
6
8
10
2011A 2012E 2013E 2014E
1.2
1.25
1.3
1.35
1.4
1.45
1.5Line item 1 Line item 2
DownsideCase
INR1850
(-20.2%) PriceTarget
INR3050
(31.5%)
Upside
Case
INR4000
(72.4%)
925
1925
2925
3925
4925
25-Oct-10 5-Oct-11
DownsideCase
INR1850
(-24.3%) PriceTarget
INR3050
(24.6%)
Upside
Case
INR4000
(63.4%)
925
1925
2925
3925
4925
25-Oct-10 5-Oct-11
0
50
100
150
200
2011A 2012E 2013E 2014E
INR
8/2/2019 IT Barclays 20111007
27/52
Barclays Capital | Indian Software & IT Services
7 October 2011 27
Figure 56: Decade-long EBITDA margins
15%
20%
25%
30%
35%
40%
45%
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Infosys TCS Wipro HCL
Source: Company data, Barclays Capital
Figure 59: Infosys Sept 2011 quarter estimates
INR mn Sep-11 est. YY QQ
Revenue 83,445 20% 11%
EBITDA 23,793 13% 20%
EBIT 23,793 13% 22%
Net profit 19,130 10% 11%
EPS (INR) 33
Source: Barclays Capital estimates
Figure 57: Infosys q/q revenue growth has seen limitedgap between the Top 4 in the past four quarters
Figure 58: Infosys 12-month historical forward P/E vsmaximum, minimum and average since January 2008
0%
2%
4%
6%
8%
10%
12%
14%
Sep-10 Dec-10 Mar-10 Jun-10
Infosys TCS Wipro HCL TechQQ
0
5
10
15
20
25
30
35
40
Oct-01
Jul-02
Mar-03
Dec-03
Sep-04
Jun-05
Mar-06
Dec-06
Sep-07
May-08
Feb-09
Nov-09
Aug-10
May-11
Max
Min
Avg
Source: Company data, Barclays Capital Source: Datastream, Barclays Capital
8/2/2019 IT Barclays 20111007
28/52
Barclays Capital | Indian Software & IT Services
7 October 2011 28
Figure 60: Infosys business mix
Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11
Geographical mix
North America 64.7% 65.9% 66.6% 66.1% 67.3% 65.8% 64.7% 63.7% 64.2%
Europe 24.7% 23.2% 21.9% 22.5% 20.3% 21.8% 21.8% 22.1% 21.3%
India 0.9% 1.2% 1.2% 1.4% 1.7% 2.1% 2.2% 2.7% 2.6%
ROW 9.7% 9.7% 10.3% 10.0% 10.7% 10.3% 11.3% 11.5% 11.9%
Industry mix
Insurance, Banking and Financial services 33.0% 33.5% 34.6% 34.8% 36.1% 35.4% 36.2% 35.7% 35.4%
Manufacturing 20.5% 19.3% 19.3% 20.2% 19.5% 18.9% 19.6% 20.4% 20.3%
Retail 13.2% 14.1% 13.1% 13.0% 13.2% 14.4% 14.5% 14.5% 16.1%
Telecom 16.9% 16.2% 16.2% 15.3% 14.1% 13.3% 12.5% 11.9% 10.6%
Utilities 5.7% 5.9% 6.1% 5.8% 6.0% 6.3% 6.1% 5.8% 5.7%
Transportation & Logistics 2.3% 2.3% 1.8% 1.8% 1.8% 1.8% 1.8% 2.1% 1.8%
Services 4.9% 5.0% 5.1% 4.9% 4.8% 5.2% 5.0% 5.2% 0.0%
Others 3.5% 3.7% 3.8% 4.2% 4.5% 4.7% 4.3% 4.4% 0.0%
Service offerings
Application development 19.3% 18.1% 17.8% 16.8% 16.9% 15.6% 15.6% 16.1% 16.1%
Application maintenance 23.2% 22.7% 24.5% 22.8% 23.9% 23.5% 22.5% 22.0% 22.3%
Business Process Management 6.1% 6.2% 5.9% 6.2% 5.7% 5.6% 5.6% 5.6% 5.4%
Consulting Services and Package Implementation 24.4% 23.8% 23.3% 26.0% 24.9% 25.8% 25.9% 25.4% 25.2%
Infrastructure Management 6.6% 7.8% 7.1% 7.2% 6.9% 6.2% 6.0% 6.1% 5.9%
Product Engineering Services 2.4% 2.3% 2.4% 1.8% 2.1% 2.5% 2.6% 2.4% 3.2%
System Integration 3.8% 4.4% 4.1% 4.5% 4.2% 5.7% 5.6% 6.1% 6.3%
Testing Services 6.2% 6.2% 6.5% 6.6% 7.3% 7.6% 7.6% 7.3% 7.5%
Others 4.0% 4.4% 4.5% 3.1% 3.4% 3.3% 3.3% 3.6% 3.3%
Product revenues 4.0% 4.1% 3.9% 5.0% 4.7% 4.2% 5.3% 5.4% 4.8%
Source: Company data, Barclays Capital
Valuation
Our 12-month target price of INR3,050 for Infosys is based on a P/E of 17.5x, which we
apply to the average of our EPS estimates for FY2013 and FY2014, which is INR171. Our
target multiple for Infosys is in line with Infosyss past five-year average.
For the Indian IT vendors, we believe P/E is the most appropriate valuation method because
earnings best incorporate the two main drivers of the business: revenue growth that is a
result of new contract signings and margin resilience that comes from operational
efficiencies and the position in the IT services value chain.
We rate Infosys as 1-Overweight because our price target represents 24% potential upside
at the high end of its peers amid our expectations of positive surprises for revenue growth.
Risks
The risks that could keep our price target from being achieved, in our view, include the
following: 1) a weaker global macroeconomic scenario could slow down the process of
incremental business from new and existing customers; 2) management changes over the
past couple of years have caused some overhang, with any further shuffle in top
management being a risk; and 3) demand unevenness has caused some issues in
management of staffing levels that has had a margin impact and should be monitored.
8/2/2019 IT Barclays 20111007
29/52
Barclays Capital | Indian Software & IT Services
7 October 2011 29
HCL TECH (1-OW, PT INR485, +23%): INDUSTRY LEADING GROWTH
We initiate coverage of HCL Tech with a 1-Overweight rating and 12-month price target
of INR485, based on a 30% discount to our target multiple for Infosys. We believe that
HCL Tech should be able to maintain its industry-leading growth rate going forward on
the back of strong performance of its infrastructure business. HCL also appears wellpositioned to exploit any resurgence in growth of its enterprise solutions business
through its acquisition of Axon. Furthermore, a turnaround in its BPO business could
lead to small margin expansion for HCL going forward while peers face margin
pressure. HCL is also a beneficiary of the recent rupee depreciation on the account of its
low hedge positions.
Investment summary
Strategy change to focus on revenues: HCL Techs management has been able to deliver
one of the strongest revenue growth rates in the Indian IT sector for the past eight quarters.
Its relentless focus on large contracts, the strong positioning of its IT infrastructure business
and its good execution capabilities could be key to this achievement. HCL Tech alsoannounced new contracts totalling US$2bn in past six months, indicating that business
momentum remains favourable for the company.
Margins could surprise near-term: HCL Techs EBITDA margin has expanded by 220bps in
past three quarters on the back of: 1) manpower rationalization that has expanded gross
margin by 110bps; and 2) reduced operating costs as a percentage of overall revenues.
Going forward, the company should be able to further leverage its margins on the back of:
1) changing employee mix towards more junior people; 2) its BPO business breaking even
and returning to profitability; and 3) a further reduction in G&A expenses.
Axon buy leverages HCL Tech to upturn in the market: The acquisition of Axon in 2008
allowed HCL Tech to enter the lucrative market of enterprise solutions. While the current
uncertain market environment could keep this business muted for a while, we believe thatany recovery in the market would lead to significant growth for HCL Tech.
Reasonable valuations: HCL Tech is trading at discounts of 24% to Infosys and 30% to TCS
despite HCL Techs higher operating profit growth rate. A part of this discount could be due
to perceived weakness in the business model, but we believe that valuations could be
supported around a P/E of 12.25x.
Figure 61: HCL Tech statistical abstract
Year to Net profit EPS EPS P/E P/B ROE Div. yield
30-June (INR mn) (INR) growth (%) (x) (x) (%) (%)
2011A 17,139 25.1 33.08 15.8 2.7 22.3 1.2
2012E 22,276 32.3 28.82 12.2 2.2 23.0 1.2
2013E 26,188 37.8 16.88 10.5 1.8 22.9 1.2
2014E 31,242 44.8 18.61 8.8 1.5 22.2 1.2
Source: Company data, Barclays Capital estimates
HCLT IN / HCLT.NS
Stock Rating
1-OVERWEIGHTSector View
2-NEUTRAL
Price Target
INR 485.00
Price (05-Oct-2011)
INR 395.10
Potential Upside/Downside
+23%
8/2/2019 IT Barclays 20111007
30/52
Barclays Capital | Indian Software & IT Services
7 October 2011 30
COMPANY SNAPSHOT
HCL Technologies Asia ex-Japan Software & IT Services
Income statement (INRmn) 2011A 2012E 2013E 2014E CAGR
Revenue 160,451 198,086 225,489 264,597 18.1% S tock Rating 1-OVERWEIGHT
EBITDA 27,526 34,766 40,336 47,391 19.9% S ector View 2-NEUTRAL
EBIT 22,552 29,055 33,979 40,016 21.1% Price (05-Oct-2011) INR 395
Pre-tax income 22,004 29,286 33,979 40,016 22.1% Price Target INR 485
Net income 17,139 22,276 26,188 31,242 22.2% Ticker HCLT IN / HCLT.NS
EPS (R) 25.07 32.30 37.75 44.78 21.3%
Diluted shares (mn) 683.52 689.65 693.65 697.65 0.7% Investment case
Margin and return data (%) Average
EBITDA margin 17.2 17.6 17.9 17.9 17.6
EBIT margin 14.1 14.7 15.1 15.1 14.7
Pre-tax margin 13.7 14.8 15.1 15.1 14.7
Net margin 10.7 11.2 11.6 11.8 11.3
ROIC 19.8 22.8 25.8 28.6 24.2
ROA 11.6 13.3 14.1 14.6 13.4 Upside case INR 725ROE 22.3 23.0 22.9 22.2 22.6
Balance sheet and cash flow (INRmn) CAGR
Fixed assets 64,849 65,548 61,821 59,385 -2.9%
Cash and equivalents 22,692 32,062 46,533 67,071 43.5%
Total assets 148,073 167,380 185,404 214,367 13.1%
Current liabilities 34,188 35,396 34,683 35,217 1.0%
Long term liabilities 6,974 7,108 6,857 6,857 -0.6% Downside case INR 250
Total liabilities 62,668 60,954 59,341 59,875 -1.5%
Net debt/(funds) (1,186) (13,612) (28,733) (49,271) NA
Shareholders' equity 85,405 106,479 126,176 154,679 21.9%
Change in work ing capi tal (5 ,1 96) (7,525) (9,204) (10,326) NA
Cash flo w f rom operat ions 16,917 20,462 23,342 28,291 18.7%Capital expenditure (9,101) (4,613) (4,450) (4,450) NA
Free cash flow 7,816 15,849 18,892 23,841 45.0%
Upside/downside scenarios
Valuation and leverage metrics Average
P/E (x) 15.8 1 2.2 10.5 8.8 11.8
EV/EBITDA (x) 9.0 7.1 5.6 4.4 6.5
FCF yield (%) 3.4 6.7 8.2 10.3 7.1
EV/sales (x) 1.6 1.2 1.0 0.8 1.1
Price/BV (x) 2.7 2.2 1.8 1.5 2.1
Dividend yield (%) 1.2 1.2 1.2 1.2 1.2
Total debt/capital (%) 20.1 14.8 12.4 10.3 14.4
Net debt/EBITDA (x) (0.0) (0.4) (0.7) (1.0) (0.5)
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics EPS projections
IT Services revenue (%) 71.2 69.8 69.2 69.0
Infrastructure revenue (%) 23.3 25.6 26.4 26.7
BPO revenue (%) 5.5 4.6 4.4 4.3
Source: Company data, Barclays Capital estimates Note: FY end Jun
Why a 1-Overweight? Good tracti on in the IT
Services business, strong infrastructure offering and
a turnaround i n BPO business shoul d l ead t o
industry leading revenue growth and an
improvement in margins. Valuing shares at a 30%
d iscount to In fo sys multiple gives us a target o f
Rs485.
A strong rebound in discretionary spending could
help EPS (+15%) and mult ip les (+16x). Thus, the
share could trade close to Rs725.
A significantly weaker macro scenario could lead to
both EPS downgrades (down 20%) and multip le
compression (to 8x), indicating a share price of
Rs250.
0
2
4
6
8
10
2011A 2012E 2013E 2014E
1.2
1.25
1.3
1.35
1.4
1.45
1.5Line item 1 Line item 2
28
48
68
88
108
25-Oct-10 5-Oct-11
DownsideCase
INR250
(-36.7%) PriceTarget
INR485
(22.6%)
UpsideCase
INR725
(83.3%)
125
325
525
725
25-Oct-10 5-Oct-11
0
10
20
30
40
50
2011A 2012E 2013E 2014E
INR
8/2/2019 IT Barclays 20111007
31/52
Barclays Capital | Indian Software & IT Services
7 October 2011 31
Figure 66: HCL Tech Sept 11 quarter estimates
INR mn Sep-11 est. YY QQ
Revenue 47,836 29% 11%
EBITDA 8,005 33% 1%
EBIT 6,616 38% -1%
Net profit 5,211 58% 2%
EPS (INR) 7.57
Source: Company data, Barclays Capital estimates
Figure 62: HCL Tech y/y revenue growth accelerated in
past two years
Figure 63: HCL Tech BPO moving towards profitability; IT
services has seen a margin recovery in the past two quarters
0%
5%
10%
15%
20%
25%
30%
35%40%
45%
50%
2004 2005 2006 2007 2008 2009 2010 2011
-15%
-10%
-5%
0%
5%
10%
15%
Sep-10
Dec-10
Mar-11
Jun-11
Sep-11
Dec-11
Mar-12
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
15%
16%
17%
18%
19%
20%
21%
BPO IT services (RHS)
EBITDA margin (%)
Source: Company data, Barclays Capital Source: Company data, Barclays Capital
Figure 64: HCL Tech 12-month historical forward P/Ebased on consensus estimates
Figure 65: HCL Tech relative to Infosys, negative indicatesHCL Tech at discount
10
11
12
13
14
15
16
17
Oct-09
Dec-09
Feb-10
Apr-10
Jun-10
Aug-10
Oct-10
Dec-10
Feb-11
Apr-11
Jun-11
Aug-11
-50%
-45%-40%
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
Oct-09
Dec-09
Feb-10
Apr-10
Jun-10
Aug-10
Oct-10
Dec-10
Feb-11
Apr-11
Jun-11
Aug-11
Source: Bloomberg consensus estimates, Barclays Capital, Bloomberg Source: Bloomberg, Barclays Capital
8/2/2019 IT Barclays 20111007
32/52
Barclays Capital | Indian Software & IT Services
7 October 2011 32
Figure 67: Enterprise Application Service (EAS) revenues saw a huge boost from Axonacquisition
0%
5%
10%
15%
20%
25%
30%
Mar-08
May-08
Jul-08
Sep-08
Nov-08
Jan-09
Mar-09
May-09
Jul-09
Sep-09
Nov-09
Jan-10
Mar-10
May-10
Jul-10
Sep-10
Nov-10
Jan-11
Mar-11
May-11
Source: Company data, Barclays Capital estimates
Figure 68: HCL Tech Key business segments Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11
Geographic mix
US 58.9% 58.7% 57.0% 59.5% 61.5% 58.0% 57.1% 54.3% 54.4%
Europe 28.5% 29.0% 29.5% 26.7% 24.6% 26.7% 26.6% 27.0% 27.1%
APAC 12.6% 12.3% 13.5% 13.8% 13.9% 15.3% 16.3% 18.7% 18.5%
Service offering
Enterprise application services 23.6% 21.9% 22.4% 21.4% 22.2% 21.7% 21.3% 21.4% 20.9%
Engineering and R&D services 19.4% 18.7% 18.0% 19.0% 19.6% 18.7% 18.5% 17.7% 17.8%
Custom application 29.7% 30.7% 30.5% 29.9% 29.6% 31.3% 31.8% 32.0% 31.8%
Infrastructure services 17.6% 19.4% 20.3% 22.2% 22.4% 22.3% 22.8% 23.4% 24.5%
BPO services 9.7% 9.3% 8.8% 7.6% 6.2% 6.0% 5.7% 5.4% 4.9%
Verticals
Financial services 24.8% 26.3% 26.1% 25.5% 24.9% 25.2% 24.6% 26.2% 26.0%
Manufacturing 30.9% 27.4% 25.6% 26.7% 27.3% 27.2% 27.1% 27.3% 28.0%
Telecom 12.5% 13.0% 12.5% 11.6% 10.9% 11.0% 10.8% 10.3% 9.1%
Retail 6.6% 7.0% 8.0% 7.5% 8.2% 8.5% 9.1% 8.7% 7.9%
Media and entertainments 5.6% 6.8% 7.2% 7.9% 7.4% 6.9% 6.8% 6.6% 7.1%
Life sciences 6.4% 6.4% 7.2% 7.5% 8.2% 8.4% 8.4% 8.0% 7.9%
Energy, utilities, public sector 7.6% 6.8% 7.3% 7.0% 6.9% 6.8% 7.2% 7.3% 8.3%
Others 5.6% 6.3% 6.1% 6.3% 6.2% 6.0% 5.8% 5.6% 5.7%
Source: Company data, Barclays Capital
8/2/2019 IT Barclays 20111007
33/52
Barclays Capital | Indian Software & IT Services
7 October 2011 33
Valuation
Our 12-month target price of INR485 for HCL Tech is based on a P/E of 11.8x, which we
apply to the average of our EPS estimates for FY2013 and FY2014, which is INR41.30. For
HCL Tech, our target multiple is based on a 30% discount to our target multiple of 17.5x for
Infosys because of the inferior margin profile and smaller scale of business. Our target
multiple for Infosys is in line with Infosyss past five-year average.
For the Indian IT vendors, we believe P/E is the most appropriate valuation method because
earnings best incorporate the two main drivers of the business: revenue growth that is a
result of new contract signings and margin resilience that comes from operational
efficiencies and position in the IT services value chain.
We rate HCL Tech as 1-Overweight because our price target represents 23% potential
upside, which is at the upper end of its peer group. We believe that HCL Tech should be able
to maintain its industry leading-growth rate going forward on the back of the strong
performance of its infrastructure business.
RisksThe key risk that could keep our price target from being achieved, in our view, is the
weakening of the macroeconomic environment that could jeopardize revenue growth or
margins (or both) for the company. Also, HCL Techs margin profile has historically been
inferior to those of Infosys and TCS and, while it has delivered on top-line growth, profit
growth has not been matched. Margin performance and revenue growth are key factors in
stock performance and slip ups here would pose a risk.
8/2/2019 IT Barclays 20111007
34/52
Barclays Capital | Indian Software & IT Services
7 October 2011 34
This page is intentionally left blank
8/2/2019 IT Barclays 20111007
35/52
Barclays Capital | Indian Software & IT Services
7 October 2011 35
TATA CONSULTANCY (2-EW, PT INR1,150, +10%): HEADWINDS AHEAD
We initiate coverage on TCS with a 2-Equal Weight rating and a 12-month price target
of INR1,150, based on a target P/E multiple of 17.5x. Although we like TCS, we find it
difficult to justify its P/E multiple premium of 9.5% to Infosys, and we expect this
premium to correct going forward. We also believe that TCS could now face headwindsin margin expansion (excepted due to rupee depreciation), and hence, operating profit
growth should be largely in line with that of Infosys.
Investment summary
Strong margin performance in past three years: TCSs strong focus on cost control led to a
400bps expansion in margins in the past three years. This has allowed TCS to close its
margin gap with Infosys to only 100bps in the June 2011 quarter. Going forward, we believe
that TCS would maintain its margins at only a 100bps discount to Infosyss margins.
Revenue performance is commendable: For the first time in its listed history, TCS has
outperformed Infosyss revenue growth for five quarters. To some extent, this has been led
by TCSs strong focus on financial services (c.44% of revenues vs Infosyss c.35%);
however, we believe the key reason behind this could be weakness in one of the large
clients of Infosys (British Telecom). Going forward, we believe that revenue growth of the
two companies could be similar, despite Infosys outperforming TCSs revenue growth by a
CAGR of 2.6% over the past decade
Valuations appear fair: TCS is trading at a P/E of 17.2x FY2013E EPS, implying a 10%
premium to the multiple for Infosys. We believe the market is expecting TCSs current
outperformance vs Infosys to continue. We believe that going forward, TCSs operating
profit should grow in line with Infosyss (despite headwinds of higher financial services
exposure) and EPS growth could be slower (largely due to tax and other income). Thus, we
base our price target for TCS on a similar multiple as for Infosys.
Figure 69: Tata Consultancy statistical abstract
Year to Net profit EPS EPS P/E P/B ROE Div. yield
31-March (INR mn) (INR) growth (%) (x) (x) (%) (%)
2011A 86,557 44.2 25.9 23.6 8.1 36.8 1.9
2012E 105,988 54.2 22.4 19.3 6.6 37.2 2.3
2013E 119,005 60.8 12.3 17.2 5.4 34.4 2.2
2014E 143,562 73.3 20.6 14.2 4.4 33.7 2.2
Source: Company data, Barclays Capital estimates
TCS IN / TCS.NS
Stock Rating
2-EQUAL WEIGHTSector View
2-NEUTRAL
Price Target
INR 1150.00
Price (05-Oct-2011)
INR 1043.50
Potential Upside/Downside
+10%
8/2/2019 IT Barclays 20111007
36/52
Barclays Capital | Indian Software & IT Services
7 October 2011 36
COMPANY SNAPSHOT
Tata Consultancy Services Asia ex-Japan Software & IT Services
Income statement (INRmn) 2011A 2012E 2013E 2014E CAGR
Revenue 373,245 476,158 561,405 667,322 21.4% S tock Rating 2-EQUAL WEIGHT
EBITDA 111,894 142,074 162,096 190,548 19.4% S ector View 2-NEUTRAL
EBIT 103,904 132,690 150,653 177,205 19.5% Price (05-Oct-2011) INR 1043.5
Pre-tax income 108,875 138,539 156,573 186,533 19.7% Price Tar get INR 1150
Net income 86,557 105,988 119,005 143,562 18.4% Ticker TCS IN / TCS.NS
EPS (INR) 44.22 54.15 60.80 73.35 18.4%
Diluted shares (mn) 1,957 1,957 1,957 1,957 0.0% Investment case
DPS (INR) 20.00 24.50 22.50 22.50 4.0%
Margin and return data (%) Average
EBITDA margin 30.0 29.8 28.9 28.6 29.3
EBIT margin 27.8 27.9 26.8 26.6 27.3
Pre-tax margin 29.2 29.1 27.9 28.0 28.5
Net margin 23.2 22.3 21.2 21.5 22.0
ROIC 35.5 36.9 36.1 38.7 36.8
ROA 88.2 79.3 62.7 54.8 71.2 Upside case INR 1500ROE 36.8 37.2 34.4 33.7 35.5
Balance sheet and cash flow (INRmn) CAGR
Fixed assets 52,340 61,833 70,391 77,048 13.8%
Cash and equivalents 47,401 63,262 103,522 168,022 52.5%
Total assets 332,608 396,340 477,731 585,327 20.7%
Current liabilities 64,837 72,168 86,056 101,592 16.1%
Long term liabilities 10,678 11,644 11,644 11,644 2.9% Downside case INR 700
Total liabilities 75,555 83,852 97,740 113,276 14.5%
Net debt/(funds) (47,361) (63,222) (103,482) (167,982) NA
Shareholders' equity 252,389 309,214 376,717 468,777 22.9%
Change in work ing capi tal 19 ,2 93 (37,390) (18,686) (20,903) NA
Cash flow from operat ions 113,840 77,982 111,762 136,002 6.1%Capital expenditure (18,624) (18,877) (20,000) (20,000) NA
Free cash flow 95,216 59,105 91,762 116,002 6.8%
Upside/downside scenarios
Valuation and leverage metrics Average
P/E (x) 23.6 19.3 17.2 14.2 18.6
EV/EBITDA (x) 18.4 14.4 12.5 10.4 13.9
FCF yield (%) 4.7 2.9 4.5 5.7 4.4
EV/sales (x) 5.5 4.3 3.6 3.0 4.1
Price/BV (x) 8.1 6.6 5.4 4.4 6.1
Dividend yield (%) 1.9 2.3 2.2 2.2 2.1
Total debt/capital (%) 0.0 0.0 0.0 0.0 0.0
Net debt/EBITDA (x) (0.4) (0.4) (0.6) (0.9) (0.6)
Source: Thomson Reuters Datastream, Barclays Capital est.
Selected operating metrics EPS projections
Total headcount 198,614
Volume growth (%) 31.1 27.0 22.5 19.3
Pricing growth (%) -2.3 -0.1 -1.2 -0.4
Onsite as % of revenues (%) 44.0 44.5 44.4 44.4
Source: Company data, Barclays Capital estimates Note: FY end Mar
W hy a 2-Ne utral? Despite strong fundamental
performance, a 20% P/E premiumto Infosys implies
that valuations could be rich. We value the company
at a similar multiple to Infosys leading to a targetof
Rs1,150.
A strong rebound in discretionary IT spending could
lead to a more positive revenue and margin
scenarios. This would drive both EPS (+15%) and
multiples (to 20x) and hence the share could trade
close to Rs1,500
A signi ficantly weaker macro scenario or a
significant decline in the market could lead to both
EPS downgrades (down 15%) and multiple
compression (to 10x) for a share price of Rs700.
0
2
4
6
8
10
2011A 2012E 2013E 2014E
1.2
1.25
1.3
1.35
1.4
1.45
1.5Line item 1 Line item 2
28
48
68
88
108
25-Oct-10 5-Oct-11
DownsideCase
INR700
(-32.9%) PriceTarget
INR1150
(10.2%)
Upside
Case
INR1500
(43.7%)
350
850
1350
1850
25-Oct-10 5-Oct-11
0
20
40
60
80
2011A 2012E 2013E 2014E
INR
8/2/2019 IT Barclays 20111007
37/52
Barclays Capital | Indian Software & IT Services
7 October 2011 37
Figure 74: TCS Sept 11 quarter estimates
INR mn Sep-11 est. Y/Y Q/Q
Revenue 116,284 17.7% -4.3%
EBITDA 35,393 26.9% 16.8%
EBIT 33,067 27.1% 17