IT Sector Reportbreport.myiris.com/SPASL/INFTECHN_20120903.pdf · years. Wipro though well...

Amit [email protected]

Ph. No. 91 4289 5600 Ext.631

PREPARING FORTHE NEXT

GROWTH WAVE

ITServices

September 3, 2012

SPA Securities Ltd.

1

IT ServicesPREPARING FOR THE NEXT GROWTH WAVE

Information Technology

Weathering the Macro StormWith over 80% of the IT companies revenues linked to the developedworld an economic crisis in that part of the world effect IT companiesadversely. Thus the companies that have diversified their revenueshave been able to stay buoyant. Infosys with highest (c.87% of itsrevenue) exposure to these geographies has suffered the most andTCS with lowest (c.82%) is the least affected.

Growth Verticals - Added ImpetusNasscom has identified certain sectors like Healthcare, Utilities,Retail and services such as IMS etc as the growth sectors whichare expected to grow 2.5 times traditional sectors and exposureto these sectors will not only cushion the blow from the fall indemand from traditional sectors but will provide additionalimpetus of growth. These sectors have already started causing asignificant divergence in growth rates, with HCL and Wipro throughIMS and TCS through Insurance Platform and Retail.

New Service - Sustainable FutureTo ride the next wave of growth IT companies have realized theimportance and are at different stages of capturing market forservices like Cloud, Enterprise Mobility, BI/Analytics etc. TCS hasrecorded initial success in these domains. Inorganic growth haspushed Wipro (Energy & Utilities, Retail-BI) and HCL Tech (IMS) tofuel their diversification strategy. After Infosys's organic growthagenda in PPS not delivering the desired results, causing it to fallbehind its peers in sequential growth numbers, the company islooking at inorganic growth route.

Execution - The USPTraditionally Infosys had been the leader with higher top-of-the-mind-recall from clients. However due to lack of servicesdiversification and rigid rate card it has lost its execution edge toTCS in the past 8 quarters. HCL Tech has won over $1.3bn contractsfrom Fortune 500/Global 2000 clients in the past 9 months with awell diversified services strategy and has improved its clientconversion rate of $1-$5mn clients from 48% to 59% in the last 3

Amit [email protected]. No. 91 4289 5600 Ext.631

September 3, 2012 INDUSTRY REPORT

In this report we analyze the positioning/standing of Top-4 Indian IT companies vis-à-vis traditional and growthverticals. We believe that the IT industry is at the cusp of a change where incremental growth would stemfrom newer verticals and geographies. Thus the companies which have placed themselves well in these segmentswould capture that growth handsomely. We believe the overall sector dynamics look promising and Top-4can deliver revenue CAGR of 13%-16% over FY12-20E. TCS though a top performer has a limited upside hencea HOLD rating. Second position is closely contested by HCL Tech and Wipro, which Wipro losses due to its poorexecution, hence a BUY for HCL Tech and HOLD for Wipro. Infosys is the laggard when it comes to growthsegments diversification and hence finds itself at the bottom with a HOLD rating.

years. Wipro though well diversified has lacked the executionskill which has led to a below par growth rate.

Margins - spike in AMJ'12All companies except Infosys witnessed an improvement inMargins in the Jun'12 quarter on the back of c.10% INRdepreciation. However, we feel this affect to reverse from Dec'12quarter. Wipro was the only company to increase its pricing forall the past three quarters and still has significant margins leversto expand further.

Restructured DealsThough we expect near term growth to continue to remain anemica significant deal flow from restructured deals ($40bn) in Q2CY12will push growth forward for HCL Tech and TCS in ITO and Infosysin BPO.

Protectionist SentimentsWith US elections due in Nov'12 and unemployment rate atstubbornly high levels of 8.2% a lot of protectionist rhetoric iscausing concern to the Indian IT sector. Higher Visa costs andincreased visa rejection rates have led to companies hiring morelocals and subcontractors at higher rates, resulting in increasedemployee costs. We believe these sentiments to die down after theelection but would affect the margins in the near term.

HCL Tech - BUY; TCS, Wipro & Infosys - HOLDTCS has outperformed the sector and is priced to perfection,capping further gains. Wipro has the capacity to surprise on theupside with a well diversified growth portfolio but lacks theexecution skills. However, with the new management philosophytaking shape that could change; making it an ideal candidate fora dark horse in the sector. Infosys's stalled growth engine needsan inorganic push especially in the PPS domain. Thus, werecommend HOLD for Wipro and Infosys and a BUY for HCL Techon the back of its superior growth performance expected tocontinue funded by IMS and restructured deals.

BSE-IT vs Sensex Rebased TCS Infosys Wipro HCL Tech

Reco HOLD HOLD BUY BUY

CMP (INR) 1,333 2,396 370 548

Target (INR) 1,345 2,700 405 648

Upside (%) 0.90 12.69 9.46 18.25

Rev. CAGR(FY12-14E) (%) 13.72 10.97 11.85 19.00

EPS CAGR(FY12-14E) (%) 15.48 14.05 15.12 16.67

1-year Return

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S e n s e x B S E I T

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TCS

Infosys

HCL Tech

Wipro

Contents

Moderation in Growth Rates. 03 - 08Increased Uncertainty 03

Moderation in Valuation Multiples 06

Indian IT Value Proposition Remains Strong 08

Portfolio Benefits 09 - 15Geographical Segmentation 09

Vertical Segmentation 11

Service Segmentation 13

New Opportunities 16 - 19Cloud 16

BI/Analytics 17

Enterprise Mobility/Collaboration 17

Product, Platform and Solutions 18

Restructured Deals 20

Protectionist Sentiments 21

Pricing and Margins 22

Execution 23

Return Parameters 24

Valuation 25

Companies 26 - 35TCS 27 - 28

Infosys 29 - 30

Wipro 31 - 33

HCL Tech. 34 - 35

3


Moderation in Growth Rates.The US economic crisis followed by European Debt crisis has left adent in the growth rates of Indian IT indusrty that gets c.80% of thebusiness from these geographies. Exploring the lower cost advantagethrough offshoring business models has made developed nationcompanies dependent on Indian IT vendors and vice-versa. Thus,the repercussions of turmoil in the developed world can be easilyseen in the growth parameters of Indian IT vendors.

Fig. 1: US & Europe have lion's share in revenue (June, 2012 Quarter)

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Fig. 2: US GDP vs Infosys Revenue Growth (Sequentially)

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Fig. 3: UK GDP vs Infosys Revenue Growth (Sequentially)

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Fig. 4: Eurozone GDP vs Infosys Revenue Growth (Sequentially)

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Increased UncertaintyThe economic turmoil in Europe has affected the IT spendingmarket in two ways (i) Some of the companies are lowering theirIT spends, which in turn means looking for ways to cut costs,offshoring being one of them. Hence, IT companies stand to gain,which we will discuss later on. But on the other hand the troublingpart is that companies have become wary of spending due toincreased uncertainty. Discretionary spends are the ones mostaffected, even the run-the-business (RTB) kind of projects are goingthrough increased screening where only the CIO used to getinvolved CFO's and CEO's also are getting involved. Higher numberof checks and balances and longer processes means delay inproject rampups.

Another major problem caused by uncertainty is that CFO's donot want to tie up large amount of money into one project. Thusthe deal size has shrunk along with the duration of the deals.This is affecting the larger IT vendors as it gives entry to mid-tier players to come to the table and in some cases win dealsdue to their niche expertise or lower rates in case of non-strategic deals.

4


38% up

Fig. 5: Uncertainty, causes rethinking on the part of clients before undertaking huge IT investments, trending down.

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Fig. 6: Steep and continuous decline in the duration of the deals since2007.

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Fig. 7: Increase in duration to 1999-00 levels would increase the deal size by38%

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Fig. 8: Smaller deals TCV has increased by 148% as against 38% for larger dealsover the past 5 years.

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Fig. 9: Tech Pulse Index showing improvement.

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With the uncertainty coming down as reflected in Fig.5 and resultsvisible in Fig.9 and Fig.6 through slightly elongated projectdurations in 2011, we expect that if the uncertainty continues toremain low and macro growth picks up, the deal sizes and durationwill grow with more transformation long term deals helping pushgrowth for the large cap IT vendors.

5


Positive Commentary from International MNC'sSAP • It witnessed a stellar growth of 32% YoY in license sales this quarter and maintains double digit license

growth guidance for 2012. The company has announced this on the back of a "strongest pipeline in a longtime".

• ERP and Mobility saw a strong growth and are expected to grow even faster in 2H

Oracle • License Revenue grew by 7% and 11% in CC terms showing decline in sales growth. Its 5-15% guidance of a YoYSoftware License growth in Q1FY13 hints at better growth pipeline in the coming quarters

IBM • It saw a continuous decline in the outsourcing business (mainly on the back of restructured deals, losing outto India Heritage companies), its high end consulting business showed some improvement reversing thedecline but the growth still in the negative territory indicating doubts in the mind of clients regardingspending.

• However the margins for the company improved adding weight to the offshoring paradigm

Accenture • Outsourcing business grew 16.2% YoY while its Consulting business remained flat with a 0.8% YoY growth.

• It also reflected the same trend in improving margins from 14.1% to 14.8% due to higher outsourcing ledoffshoring growth.

• The company has indicated towards a strong demand from the ERP space with (i) Clients moving to 2nd or 3rdgeneration ERP modules and (ii) global expansion initiatives demanding ERP rollouts on a larger scale. Q4guidance of 6-9% YoY in cc revenue growth with stable pricing.

• New bookings were at $7.29bn with strong consulting growth and lumpy outsourcing.

• It still plans to hire 60,000 this year on an employee base of 2,90,000. The company expects to grow in therange of 10%-12%.

Except SAP, nobody showed exemplary growth, but themanagements were quite upbeat about the 2HCY12 on the back ofincreasing visibility and expanding deal pipeline.

Fig. 10: SAP License - exceptional YoY Growth

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Fig. 11: Oracle License YoY Growth - stable

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Fig. 12: IBM Consulting YoY Growth reviving.

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Fig. 13: Accenture Consulting YoY Growth trending down.

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Fig. 14: IBM Outsourcing YoY Growth in negative territory

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Fig. 15: Accenture Outsourcing YoY Growth positive.

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The reason for upbeat commentary on outsourcing is becauseeven in a high unemployment scenario, the over-25 age groupgraduate supply is restrained in the Developed world. Resultingin no respite from the higher CTC's of local employees vis-à-visoffshored resources.Thus not only the captives but even majorTechnology MNCs (IBM, Google, Yahoo, Accenture, Oracle) continueto expand their footprint in emerging economies to attract talentlocally. IBM has more than 1,50,000 employees based out ofIndia, 2nd largest IT employer after TCS

Fig. 16: Graduate Over-25 unemployment much lower in US vis-a-vis overallunemployment rate.

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Moderation in Valuation MultiplesHaving said that we continue to expect a challenging businessenvironment in FY13/14 and expect mid teen growth rates for theIndian Large Tier IT vendors. We do not expect stellar growthrates of 2000 or 2005 levels to be replicated now and thus expectthe moderation in the valuation multiples to stay.

Fig. 17: Infosys Revenue Growth Trending down due to higher base and macroconcerns.

77%

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Fig. 18: Justifying moderation in multiples below 6 year average 1 year forwardconsensus PE multiple for Infosys.

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Fig. 19: TCS 1-year Forward Consensus PE multiple at its 6-year average, leavingminimum scope of price appreciation.

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Fig. 20: TCS now trades at a PE multiple premium to Infosys, justified by itsexceptional EPS growth

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Fig. 21: Wipro's 1-year forward consensus PE multiple lower than its 6-yearaverage multiple, due to lower growth rate expectations.

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Fig. 22: Wipro trading close to its discounted PE multiple to Infosys.

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Fig. 23: HCL Tech's 1-year forward consensus PE multiple moving close to its 6-year average multiple.

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Fig. 24: HCL Tech's PE Multiple almost at par with Infosys's multiple on the backof good growth numbers.

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8


Indian IT Value Proposition Remains StrongNevertheless, the value proposition of the offshore delivery isonly going to increase over time on the back of (i) Newer businessmodels like pay-per-use or outcome based models (ii) Ease ofscalability for offshore IT companies vis-à-vis international peers(iii) Lack of employable graduates in developed world (iv) NewServices or technology trends and (v) upcoming verticals,geographies or customer segments realizing the need to cut costsand improve efficiency and time-to-market.

As per recent NASSCOM estimates the addressable IT services market(open for outsourcing) will grow 3x in the next 8 years to reach$1.5trn by 2020 on the back of the aforementioned requirements.More than 70% of this incremental growth over the traditionalsectors of BFSI/Manufacturing and geographies of US and Europewould come from newer business paradigms. We expect the IndianIT export sector to grow at 13%-16% CAGR over FY12-20 to capture~200bn (close to $225bn NASSCOM estimates) of this market.

Fig. 25: Estimated addressable IT Services market size by 2020.

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Fig. 26: India Heritage companies improving their market share in capturingGlobal IT spends (TCV>$25mn) from 15% to 22% over CY09 to 1HCY12.

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India Heritage EMEA & Asia Americas MNCs

2007-09 2010-1H12

(Source: ISG, SPA)

9


Portfolio BenefitsWe feel that the growth in IT services in FY13/14 would not besecular as was the case previously but would be limited to a fewpockets as evident from the varied commentary of Indian ITcompanies. Thus only companies which are well placed/diversifiedgeographically, vertically or service wise would be able to capturegreater market share on the behest of other players.

Geographical SegmentationTraditionally Americas especially North America has been a majorgrowth driver for the Indian IT vendors. It continues to be the singlelargest contributor to the global IT spending, closely followed byEurope. Thus, companies with strong presence in these two marketshave traditionally done well. These markets will continue to drivegrowth albeit at a slower pace due to larger base and macrochallenges. However for a company to stay ahead of the curve,geographies like Western Europe, APAC, Latin America would play acrucial role. In Q2CY12 out of the $6.3 bn (TCV>$25mn) Mega Dealsannounced, $2.2bn came out of Brazil Financial Services and $1.2bnfrom India, 3 out of the total 5 deals came out of these two geographies.Thus, companies having presence in these markets will be able tocapture greater market share and get that delta growth.

Fig. 27: Traditionally global IT spends led by US.

US47%

Europe34%

RoW19%

(Source: Gartner, SPA)

Fig. 28: North America continues to drive growth, but APAC and LatAm alsobecoming important destinations for incremental growth CY11-20E.

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Fig. 29: Global IT spends (TCV>$25mn) APAC contribution having higher crestsand higher troughs.

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Fig. 30: TCS and Wipro relatively better diversified.

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Fig. 31: Americas spend (TCV>$25mn) in $Bn down by 27.5% in last 10 years.

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Fig. 32: Mega Deal signings in 2QCY12.

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Fig. 33: US led growth, TCS showing good traction from strong deal wins.

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Infosys TCS Wipro HCL Tech(Source: Company, SPA)

Fig. 34: Europe led growth, TCS and HCL Tech tied with Wipro flat due to theramp-downs.

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Fig. 35: RoW led growth, HCL Tech and Infosys showing strong improvementon a smaller base, inorder to get a foot-hold in this growth geography.

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Fig. 36: Outcome: TCS and HCL Tech have led the USD revenue growth, whereasInfosys and Wipro have fallen behind especially in the past 2 quarters.

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Outcome: Geographically TCS is best placed with c.15% of itsrevenues linked with growth geographies of APAC incl. India, 3%from LatAm and 2% from Middle East. Middle East is a hot bed forgrowth in IT spends from Telecom and Energy & Utilities space buthas been marred by recent events, which is why our second bestdiversified company, Wipro hasn't been able to do so well, eventhough it gets 9% of its revenue from India and Middle East andhas just completed 10 years in Saudi Arabia. However, it has donewell in Europe even after taking into consideration 2 Telecomclient ramp-downs there. On the other hand HCL Tech a close third,on the back of aggressive growth from the RoW and significantdeal wins in Europe, has been the one to be able to match TCS'sgrowth performance in the past 3 years.

11


Vertical SegmentationOver years, traditional sectors like BFSI, Manufacturing andTelecom have been the major IT spenders, improving their ITinfrastructure, client engagement, processes, fraud detection etc.In 2011 out of the total IT spend of $1.6trn Manufacturing ($334bn),BFSI ($322bn) and Telecom ($307bn) together contributed c.60%.The growth in these sectors would continue, especially BFSI (10.6%CAGR over 2011-16E) on the back of new regulations, riskevaluations, retail banking expanding globally and increase inInsurance products, though at a smaller clip because of theirlarger base and macro challenges driving down Investment banksand Telecom sector. However, new growth verticals like Retail &Transportation, Healthcare & Lifesciences and Energy & Utilitieswill see an increasing trend of IT spending to reduce costs, increaseoperational efficiencies, analyse Big Data etc. As per NASSCOM,addressable market in growth vertical is increasing 2.5 timesfaster than traditional verticals and constitute c.33% of the spend.Thus, companies which have strong presence and valueproposition in these growth verticals would take that extra leapgoing forward.

Fig. 37: CY11 IT spending breakup with traditional sectors contributing c.60%and growth verticals (Retail, Healthcare and Energy-Utilities) c.17%.

Energy Utilities4%

Others6%

Manufacturing and Hitech20%

Government18%

BFSI20%

Healthcare and Lifesciences

3%

Retail, CPG and Transportation

10%

Communication, Media and Telecom

19%

(Source: IDC, SPA)

Fig. 38: Revenue Breakup across verticals for Top-4 in AMJ, 2012 quarter.

0%

20%

40%

60%

80%

100%

120%


BFSI Manufacturing and Hitech

Retail, CPG and Transportati on Communicati on, Media and Telecom

Healthcare and Li fesciences Energy Uti liti es

Others


Fig. 39: Global IT Spending growth expectation across various verticals. Retail (11%) and Energy Utilities (10.8%) to grow at a faster pace than industry.

0

500

1000

1500

2000

2500

3000

2011 2012E 2013E 2014E 2015E 2016E

$ Bn

Manufacturing BFSI Communication, Media and Telecom

Government Retail, CPG and Transportation Energy Utilities

Healthcare and Lifesciences Others


12


If we analyse the growth rates of the Top-4 against each other, acommon trend appears. Three of the top 4 companies, with Wiprobeing the exception have done well in the traditional verticals ofBFSI and Manufacturing showing significant growth, except in thepast 2 quarters for Infosys where one of its top Investment Bankingclients has ramped-down significantly. Telecom, anothertraditional sector has been under pressure across the world andthus reflects across all IT companies. The magnitude of downsideis different given the dependence upon Telecom OEM's and ServiceProviders, with SP's coming under pressure with reduced call rates,VOIP's etc. Infosys has been at the receiving end from this sectoralbeit the de-growth has slowed down in the past few quarters.

These three traditional sectors have contributed 60%-80% to thesecompanies topline, but the real difference between a leader and amediocre growth is decided by growth in the newer sectors likeRetail, Health and Lifesciences and Energy and Utilities. Retail andTransportation is the one sector where all top-4 have performedwell. HCL Tech has led growth in Retail and Healthcare, these twobeing the management's focus areas, a large number of deals havebeen won by the company in these two sectors in the past 18 months.Energy & Utilities growth has seen a two-way tie between TCS (onthe back of India based APDRP project wins) and Wipro (SAICacquisition bringing in domain knowledge and client base). Wiprois expected to pick up pace in Retail sector after its recent acquisitionof Promax which has 25 strong retail client presence across US andEurope with revenues of AUD15-16mn in CY11.

Special Mention: One of the reasons for Infosys’s dismal growthin the past 2 years is evident from the fact that it did not havefocus on these verticals (contributing 28.3% to the topline and11.4% excl. Retail vis-a-vis Wipro's 39.3% and HCL Tech's 33.3%}and thus hasn't been able to feature as an outperformer in any ofthese growth verticals. To be fair, the company has only recentlystarted reporting its Healthcare and Lifesciences revenues.

Fig. 40: Manufacturing growth in the past 3 years led by TCS

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Fig. 41: Telecom is a distressed sector for the Industry, Infosys falling off.

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Fig. 42: BFSI all companies performed well until last 2 quarters, TCS leads

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Fig. 43: Retail contribution to HCL grown from 6% to 9% of the topline

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2Infosys TCS Wipro HCL Tech


Fig. 44: HCL tech in a different orbit with Healthcare growth in past 3 yrs

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Fig. 45: TCS and Wipro winning deals in Energy & Utilities sector.

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Fig. 46: S&P Listed Banking Sector cumulative performance (Bn $)

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2002 Q3 2004 Q1 2005 Q3 2007 Q1 2008 Q3 2010 Q1 2011 Q3 -60

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0

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60

Net Revenue (LHS) Net Income

(Source: Bloomberg, SPA

Outcome: Again the best performer in this sector is TCS with

outperformance in all the three traditional sectors especially

BFSI where the company has shown a 5% CQGR for the past 20

quarters on the back of Retail Banks and Insurance platform

(Diligenta). Even in the growth sectors the company has shown

good growth increasing their contribution to the topline from

24% to 26% over the past three years which is huge given the

larger base. The next best performer is HCL Tech's management,

which has chosen its battleground well, increasing its market

share in the newer verticals rather than trying to fight in vain

over traditional markets. It has increased its topline contribution

from these 3 new sectors from 21% to 27% in the past 3 years.

Even in the traditional sectors, it has been able to win a large

number of restructured deals keeping pace with the bread and

butter traditional segments as well.

Service SegmentationThis is the most important aspect from an operational standpointof an IT company, as it reflects what the company actually doesfor its clients across geographies and verticals and how well itdoes it, to command a premium to its competitors on the ratecard. Except Consulting, Product development and to some extentBPO, which requires considerable exposure to a particular domainbefore approaching a client, rest of the services are easilyreplicable across verticals. Thus the value proposition as to whatelse a vendor can do for the client and how big can the clientbecome is especially important in accessing these services.

Traditionally, Indian IT companies have excelled in the field ofADM, BPO, Testing and Engineering Service. These are the cost-efficient models for the client, which means these are not strategicneeds of the client and thus have been outsourced in-order toreduce costs. They will continue to be the bread and butterbusiness for Indian IT vendors. However, over a period of time,clients have come to question the "what else?", part and so hasthe Indian vendors who have realized the need to move intodifferent business models and services given considerable domainknowledge they have imbibed working for different clients acrossgeographies. Some companies went ahead by converting thatdomain knowledge into products and services, TCS and Infosysmade banking products B@ncs and Finacle respectively whichnow contributes 2%-5% of their revenue. Infosys went ahead andstarted a Consulting practice which now contributes 30% to thetopline. Similarly other services like IMS, started by HCL Tech sawtremendous growth after Axon acquisition by the company, haveprovided a necessary growth push. Similarly a number of otherservices like Enterprise Application, Cloud, Virtualization, BI/Analytics, Mobility etc. will change the demography of Indian ITvendors over time and thus exposure to these sectors is crucial.

Fig.47: IMS and BPO provide better growth opportunity than ADM due tounder-penetration.

Growth Opportunities Market Size (USD Bn) Present Market Share (%)

Custom Application 37 40%

Maintenance 48 12%

Total 85 24%

BPO 153 12%

IMS 150 4%-6%

(Source: NASSCOM, SPA)

14


BPO has been a traditional service mainly through its Voicesegment, Data and Platform businesses have largely been under-penetrated by Indian IT companies. TCS has achieved some successin forming platforms which caters to different segments in theBPO market but it still has not caught up with internationalcompetitors, which gives it a significant headroom to grow. HCLTech has recently revamped its BPO practice to cater Data. Infosyswas the last to start a BPO practice, but has done well in keepingit profitable and growing at the same time.

IMS is a newer service line which has recently been put in practiceby HCL Tech and Wipro. HCL Tech has taken this to a new level afterthe acquisition of Axon in Europe. But IMS is a huge market andIndian IT vendors haven't even scratched the surface as yet. IMSglobally is $524Bn industry, but most of it is done in-house, whichwould undergo a change. However, addressable market size ofIMS at present is $150bn, 80% of which is Outsourcable i.e.$120bn. Of this 40%-60% is offshorable which means a offshoremarket size of $60bn of which India based Offshoring could be50% i.e. $30bn is the IMS market available to be captured byIndian IT vendors. At present Indian IT is just capturing only 4%-6% of this business as against a market opportunity 10 times thissize, thus a huge growth push if focused correctly could comefrom this segment. IMS contributes 25% to HCL, 23% to Wipro andhigh single digit percentage to Infy and TCS's toplines..

Consulting is an aspirational service for some of the IT vendorsin India as it is not only at the pinnacle of services hierarchy butalso pushes the margins up tremendously. It is divided into 2types mainly IT and management consulting. IT consulting marketsaw a -9% decline in 2009 after the US economic crisis. It hassince recovered handsomely but underlines its sensitivity toGlobal economic uncertainties and hence its discretionarynature. Top 4 IT Consultants: Deloitte, IBM, PWC and Accenturecaptures 20% of the market. Indian IT vendors have a long wayto go. Except Infosys none of the others have any significantpresence in this segment.

Fig. 48: Top Service Providers in BPO Market (TCV>$10mn). (Market size in$ Mn, YoY growth rate). TCS has significant presence across verticals.

0%

20%

40%

60%

80%

100%

120%

F&A FSO ContactCenter

HRO Industry Procurement

India Heritage Global MNC Function-Specific

(Source: ISG, SPA)

Fig. 49: Market Growth expectations in BPO, Consulting and EAS provide highgrowth opportunities to Indian IT vendors if they focus on these.

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2008 2009 2010 2011 2012E 2013E 2014E 2015E

$ Bn

Consulting BPO EAS S/w(Source: Gartner, SPA)

Fig. 50: Top-4, services split (AMJ, 2012 quarter). HCL most balanced portfolio.Wipro and HCL good EAS and IMS exposure.

0%

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BPO Consulting

Enterprise Application Services Others


Accenture

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TCS

Wipro

WNS

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BONYMellon

Capita

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State Street

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Xerox

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EXL Services

Genpact

Global eProcure

IBM

Infosys

Procurian

TCS

Xchanging

15


Fig. 51: EAS owns a big chunk of the software market and provides various opportunities to grow. EAS S/w is expected to be a $143bn opportunity by 2015 as against$107bn in 2011 growing at a CAGR of 7.5% and Indian IT companies haven't even scratched the surface of providing services to this segment.

(Source: Forrester, SPA)

Fig.52: ADM continues to be the mainstay for Indian IT vendors contributionvarying from 30%-45%. HCL in the lower percentile showed good growth.

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Fig. 53: IMS growth puts HCL in solid footing

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Fig. 54: EAS, TCS get 11% from this sector as against 31% for Wipro and 21% forHCL Tech.

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Fig. 55: TCS taking the BPO growth cake due to diversified presence.

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Fig. 56: TCS expanding in Consulting over a lower base, else the segment is introuble due to its discretionary nature.

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Infosys TCS Wipro(Source: Company, SPA)

Outcome: This time HCL Tech beats TCS to the top spot, the companyhas not only grown tremendously well in traditional ADM typesbusiness but also its growth in the IMS is commendable. Its BPObusiness is in dire-straits but is coming on track. TCS on the otherhand is expanding fast in the newer business lines like IMS,Consulting with a strong food hold in ADM and BPO market. Wiprohas good presence in the growth sectors just like HCL tech but isnot able to execute the way it should have, thus placing it in adistant third.

SCM2%

Product LifeCycle Mgmt

2%

CRM3%

Financial Mgmt. System

4%

BI3%

Content Collaboration & Others

3%

Destop Application

6%

Security and Storage

3%

SaaS4%

ERP9%Operating System

12%

Others22%

RDBMS10%

Enterprise Infrasructure Software

15%

HR Management2%

Other41%

16


New OpportunitiesAs discussed briefly in the last segment that with the evolution of IT spending a number of new opportunities have surfaced like changingbusiness models (i) Outcome based or (ii) Transaction based. With Indian IT coming of age they are now venturing into high growth non-linear new services like (i) Cloud (ii) BI/Analytics (iii) Mobility and (iv) Products/Platforms etc.

Fig. 57: Growth Curve - Top 4 Indian IT companies cumulative QoQ USD Revenue Growth

82

1,324

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958

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552560

743850

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370

992891

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914782

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CloudIt is a changing business paradigm which IT vendors offer to theirclients to convert their capex into opex and gain from volumes. Insimple language they ask the clients not to own their owninfrastructure but to use IT vendors infrastructure and pay on a pertransaction basis. This reduces (i) Overheads for the client tomanage his/her IT resources which is not its core competency and(ii) Costs of setting up business (iii) Overall cost because now he ispaying for a piece of infrastructure/software only when he/she isusing it. But there are some riders to this technology, as customer isnot the owner of the public cloud, he is wary about handing over hissensitive information to the cloud provider (ii) Network Bandwidthsand downtime ownership also is an issue and (iii) power outages inhis vendors datacenter can bring his/her business to a standstill(As seen recently with Amazon cloud users).

Cloud comes in various variations depending on the needs of theclient (i) Public - IT vendor owned, shared by multiple corporate(ii) Private - Owned by the corporate but managed by the IT vendor(iii) Mixed - A part is private not accessible to anyone else and theother is public and (iv) Sector - This types of clouds generallycater to companies in a particular sector. Ex. Government cloudwould cater to government departments across the state. Thereare also various level of functionalities provided through a cloud(i) IaaS - Infrastructure as a Service (ii) PaaS - Platform as a Service(iii) SaaS - Software as a Service (iv) BPaaS - Business Process asa Service and (v) TaaS - Testing as a Service etc.

As with every new technology/business model there is a learningcurve (Hockey stick curve) so is true with Cloud which presently isseeing increased pickup from the clients. As per Forrester, World

Golden Period of Outsourcing andOffshoringCost Efficiencies deriving growth

Pent Up demand fundinggrowth mainly from BFSI,Retail & Manufacturing

Next Growth Cycle will be fueled by:Cloud, Mobility, BI/Analytics, Collaboration,Virtualization, IMS and First time offshorersfrom New Geo's

Cloud market is expected to grow at 19.5% CAGR from 2010-2020Eto $241bn.

Fig. 58: Cloud market growth Expectations (USD Bn).

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20

30

40

50

60

2011 2012E 2013E 2014E 2015E0

35

70

105

140

IaaS PaaS SaaS Advertisement (RHS)(Source: Gartner, SPA)

Indian Mid Tier IT players like Hexaware, Patni and Persistent etc.have made some headway into this domain with services likeevaluating various clouds based on customers' needs, helpingmove their legacy systems onto the cloud and data porting etc.Amongst the large Tier players, TCS has started its own IaaS/SaaSin collaboration with Tata Communication and HP targeted tocater to the IT needs of SMEs across India. They currently havemore than 400 SME's already using their cloud, but the revenuesare still not significant. Similarly Wipro started its TaaS which isstill in its early stage. Infosys started an app Store Flypp in a B2Cmodel but are now moving it towards a B2B model offeringapplications that would be useful for companies when hosted ontheir clouds. Its early stage but a step in the right direction showsmanagement's intent and dynamism.

17


BI/AnalyticsWe are approaching 6Bn electronic devices which can communicateover a network. This is huge considering that the Network address(IPv4) which can support 4.3bn devices, once thought more thanenough, has exhausted all its addresses and needsto be replacedwith IPv6 which can support 3.4X1038 unique addresses. This isthe speed with which we are consuming electronic devices andhence generating 1000 petabytes of data each day (1018 bytes).40% of this data is generated by the corporates and thus it becomesimportant for companies to use this huge data and convert it intomeaningful information. With the help of BI/Analytical tools andservices generating patterns and hence meaningful informationhelping the management take effective decisions to increase theirsales. Ex. Meru cab records data about pickup time, place and dateand feeds into central repository. With BI/Analytics one cangenerate pattern to know which location receives heaviest rush ofpassengers and at what time, thus positioning more cabs thereinorder to garner higher revenues.

BI/Analytics is finding its use in various streams Corporates, WebAnalytics, Target Ad spend, BIG DATA, MIS, business performancemanagement (BPM), predictive analysis etc. Some of the toolsavailable in the market are COGNOS (IBM), TIBCO, BusinessObjects (SAP), Hyperion (ORACLE), BI (MICROSOFT), Netweaver(SAP), Informatica, SpotFire (Tibco) etc. A number of acquisitionshave changed and will continue to change the shape of the BImarket giving relevance to the point of how important this spacehas become. Gartner's CIO survey has shown BI to be the toppriority of CIO spending in 2012.

Fig. 59: BI companies in huge demand.

Acquiree Acquired

IBM COGNOS, SPSS, Varicent, Tealeaf, Vivisimo, i2, Netezza

SAP Business Objects

Oracle Hyperion

TIBCO Spotfire

(Source: SPA)

Fig. 60: BI market growth Expectations (USD Bn).

10

12

14

16

18

20

2011 2012E 2013E 2014E 2015E

BI Software (USD Bn)(Source: Gartner, SPA)

Several Indian IT vendors have started a business unit in this domainbut few have tasted success. TCS has a BI service line where-in theyuse their expertise on BI tools to derive meaningful data for theclients and also customize the output for them. It contributes c.4%to the topline and has grown at 1.4% CQGR over the past 12 quarters.Infosys has a BPM practice which presently contributes 1.4% tothe topline but has grown at 15% CQGR over the past 6 quarters.Wipro has acquired Promax an Australian BI/Analytics servicecompany focusing on the retail sector in US and Europe with AUD15-16mn yearly revenue run-rate (c.0.3% Wipro's IT topline).

Enterprise Mobility/CollaborationThis is a service segment which has not yet been extensively workedupon, except for small projects handled by Infosys and TCS, we feelit is a very important growth area for the whole sector going forward.With the advancement in technology, social networking, beingconnected and checking mail/updates on the go etc. have becomethe need of the hour, thus accessing your office network fromanywhere through virtualization or smartphones or BYOD (BringYour Own Device) is becoming a new business paradigm and toservice these networks, servers, security issues etc is a bigopportunity. Ex. Infosys has recently signed a deal with a US basedaerospace company to provide detailed product information to itssales team on the go, thus giving a better visual experience to itsperspective clients.

Fig. 61: Enterprise Mobility expected CAGR of 7.5% over 2011-15

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2011 2012E 2013E 2014E 2015E

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Enterprise Mobility (USD Bn) Apps Download (Bn) - RHS

(Source: Deloitte, SPA)

CAGR 11.4%

18

Product, Platform and SolutionsIndia churns ~600,000 engineering students each year, of whichonly 25% are employable after training. The industry needs 2,40,000employees each year so they are forced to look for non-engineeringstudent who (math graduates, BCom etc.) together with engineersmake a comfortable pool of 3,00,000 employable students eachyear. This is sufficient for now, but the IT companies linear modelsmeans that to grow they have to increase hiring in which case theywill have to compete with other sectors and raise remunerations,which might not be feasible business model in the long run. Thus ITcompanies are increasingly looking towards non-linear sources ofrevenues like IMS, Consulting and Products business.

Product and Consulting businesses gives the per employeeproductivity a huge boost and is a great margin kicker in the long run.

Fig. 62: Productivity Gains estimationTTM Revene Headcount Revenue/ Productivity Discounting Achievable

(Bn $) Empl. Gain Productivity GainTCS 10.49 243,545 43,072IBM (Consulting) 14.90 98,000 152,041 253.0% 0.8 50.6%SAP 5.48 60,972 89,877 108.7% 0.5 54.3%

* Discounting is done in Consulting because of the larger size of the practice developed over time, thusreusable case experiences

** Discounting in Products is done to factor in the risk to launch a new product and developed portfolio ofproducts and brand image of SAP, which the Indian vendor will have to start afresh

(Source: SPA Research)

Products Platforms SolutionsDefinition It is a Software code that you sell to a client in It is a complete ecosystem including the It is an application that you develop to meet a

the form of a license and does implementation product IP which you host for a client. particular need of a client. Over time,and maintenance/customization. depending on the reusability and acceptability

by other clients it can take a shape of a productor a platform.

Issues It is a smaller engagement with license sales It is a long duration sticky business, They can be of two types: Proactive and Reactive.and implementation. But if it finds acceptability where concentration is more towards Proactive Solutions are undertaken by a vendorin the market, it achieves breakeven faster. services rather than the product itself. company in-order to resolve any issue faced by

the industry, this a risky bet subject to acceptability.The amount of functionality a vendor wants to Also, as you have setup a team the Reactive Solutions are developed in collaborationput-in in the standard license model and the breakeven for that team and the with a client with the end user in mind toamount it wants to keep for later customizations ecosystem (each engagement) is much resolve its problem. The risk of breakeven isdepends upon different kind of needs of different larger than a normal product because null in this case.clients. the engagement itself is spread over a

longer duration. Ownership: Since the solution is developed forAlignment of the sales team as selling products one client he owns the IP to it, thus the vendoris different from selling just services. holds no right to it after completion. But if the

product has resonance in other clients, than the vendor can benefit from the solution.There are ways to resolve ownership issues: (i)Co-develop, here the vendor charges the clientless for a particular product and in-turndevelops the app. using his live data and thenmake a sale on a license/platform basis (ii) Ifthe vendor has lesser visibility of the generalapplicability of the solution, it can develop thesolution and then pay the client royalties whilemaking the sale of the same to others.

Example GE order's a SAP-on-demand. It will get a Whereas in case of BPaaS buy, GE will SATS wants to resolve its airport terminalproduct license and that's it. GE will not only get the software but also a team management and wants NIIT Tech to resolve it.then employ its own HR guys who will use (ODC) who will cater to GE's employees HR NIIT develops solutions, implements it and itthat system and look after the payrolls, needs. It frees GE from having its own HR works exceedingly well. Then it gets a requestseparation, onboarding etc. process of all team. As GE pays with either outcome of similar kind from Beijing and Bangaloreemployees. based model or transaction based model, airport, with SATS permission it sells the same

it is not worried about the number of hours solution to these clients and pays royalty toeach vendor's employee clock until and SATS.unless all its HR grievances are handledin a professional and timely manner

Infosys has already set out for the journey of transforming thecompany from a traditional IT services base into a balancedbusiness with 1/3rd revenues each from traditional, Consultingand Products Platform and Solutions (PPS). It already has 30%revenues from Consulting, although PPS has a long way to go atjust 2% of the topline, the productivity improvement is visible inthe per employee revenue for the company vis-à-vis its peers.

Fig. 63: Per Employee revenue higher in Infosys (Consulting) and HCL (IMS)

38,000

40,000

42,000

44,000

46,000

48,000

50,000

52,000

FY10 FY11 FY12

USD



19


Taking a leap from a services DNA company to a product businessneeds additional care. The success, in PPS depends on four things:

(i) Cost efficiencies it can bring on the table (ii) Reduced Cycletime, throughput (iii) Simplifying the process or restructuring theexisting system and/or (iv) Open new markets/segments. Thiswould in-turn require (i) Thorough and deep understanding of thesystems and their inter-linkages (ii) Efficient delivery models (iii)Highly qualified sales team and most of all (iv) Deep pockets tosustain through long product gestation periods. Indian companieshave cost advantage in building products but lags internationalplayers in expertise and sales presence to beat them to the market,given that they have started focusing on this segment only recently.Thus, success in this segment of business organically is atleast 3-5 years away, but a step in this direction is the right way to goforward if they plan to grow sustainably in the future.

Realistic vs Optimistic viewAs we have mentioned that organically significant traction in PPSis atleast 3-5 years away, realizing this some companies havepursued in-organic routes to hasten this process ex. TCS acquisitionof Diligenta (Insurance Platform) and now Infosys managementannouncing a need to grow through inorganic route. Secondly, IndianIT companies would be better off building platform at the peripherals(BI/Analytics platforms as companies have significant DataManagement knowledge, ex. Wipro - Promax deal)as the core productmarket is already saturated with international product companies.Thirdly, a new product or an idea takes some time to grow in amarket (S-curve). One must be able to sustain through that periodwhich would be atleast 3-4 years and Finally at any point in time ina diversified portfolio there would be a number of products/ideasbeing nurtured at one time, thus success of one product might notbe able to move the margin needle up as it would be used to fundother developing products. In GM there are more than 300 versionsof cars undergoing R&D, thus success of one car does notnecessarily move the margins higher.

Special Note: We find Infosys's target of achieving 33:33:33business from Traditional: Consulting: PPS a bit farfetched(organically or inorganically). Though the company hasn't givenany timeline but we think it would take them more than 10 yearsatleast to achieve that foot in terms of PPS contributing 33% to thetopline. Firstly, given the company's long running aspiration of40:40:20 contribution from US:Europe:RoW they have still reachednowhere close to it as US continues to contribute more than 60%to the overall business. Secondly, PPS constitutes only 5% to thetopline as of now and there is a 3-5 year gestation period forproducts to find relevance and company to find its niche in the

product/platforms. Thus, to grow at such a fast pace is verydifficult. It took SAP 40 years to reach $17bn revenue runrate andmost of the growth is back ended, thus for a startup business likePPS to grow from $350mn to 10 times its size in less than 10 yearsis a bit stretching it too far. Including in-organic route we expectthe company to reach 17% of the topline by 2020. ($1 bn investmentin a growing, promising product company would only be able tobuy them revenues of $400-$500mn, at a 2.5x-2x Mcap/Salesmultiple, which would be 6% of topline).

Fig. 64: Infosys Productivity Gains Expectations, a step in the right directionRevenue Productivity Productivity GainContribution Gains Contribution

Existing ModelTraditional Business 67.0% 0.0% 0.0%Consulting 31.0% 50.6% 15.7%Products 2.0% 54.3% 1.1%Total 16.8%

Aspiring ModelTraditional Business 34.0% 0.0% 0.0%Consulting 33.0% 50.6% 16.7%Products 33.0% 54.3% 17.9%Total 34.6%

Realistic ModelTraditional Business 50.0% 0.0% 0.0%Consulting 33.0% 50.6% 16.7%Products 17.0% 54.3% 9.2%Total 25.9%

(Source: SPA)

20


Restructured DealsIn the medium term a major growth opportunity has presenteditself in the form of restructured deals. A number of deals havecome for re-bidding in the market in the past 2 years and is expectedto be even higher in 2HCY12. ITO deals have benefited Indian ITvendors especially HCL which has won a larger amount of churnwinning deals from incumbent players like IBM, Accenture,Capgemini etc. In the economic distressed conditions where thereis procrastination in the New scope deals, restructured deals havecome to the rescue of some of the Indian IT vendors. This market isexpected to be higher in 2012 with 690 deals coming for renewal,against 570 in 2011, with a total TCV of $40bn. Last year Indianvendors were able to capture 30% of this market, if the same feetis repeated this year, it would mean a market potential of $12bn,which is a huge opportunity coming in the 2HCY12.

Fig. 65: New Scope Deals (TCV>$25mn) lower than 5 year average

-10

10

30

50

70

90

110

130

150

2007 2008 2009 2010 2011 2012

$ Bn

1H 2H 1H Average

(Source: ISG, SPA)

Fig. 66: Restructured Deals (TCV>$25mn) higher than 5 year average

0

10

20

30

40

50

60

70

80

2007 2008 2009 2010 2011 2012

$ Bn

1H 2H 1H Average

(Source: ISG, SPA)

Though the international MNC's have established significancepresence across emerging economies to reduce their cost of service(Accenture - 60% of employees based in emerging economies,IBM India based headcount c.150,000), still India Heritagebusinesses were able to win market share over them due to higheroperating leverage, with revenue per employee at 60% discountto MNC's but cost per employee at 65% discount. Also, loweroffshore employee cost allows India Heritage businesses maintainlower utilization rates, which translates into ease of scalabilityand faster ramp-ups for clients.

Fig. 67: Revenue to cost per India based employee comparison for Accentureand Infosys.

33%

34%

35%

36%

37%

38%

39%

40%

41%

Revenue per employee Cost per Employee


Fig. 68: Utilization rates - Accenture vs Infosys

60%68%76%84%92%

100%

S-O

-N 0

9

D-J

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M-A

-M 1

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2Accenture Infosys


21

Protectionist SentimentsThis is an election year in US and thus a lot of political rhetoric isfloating around especially against India and China:

(i) Mitt Romney expressing his will to declare China a currencymanipulator on the very first day in office.

(ii) Raising Taxes against companies who do offshoring.

(iii) GM, a recently bailed out by US government for $50bn, hasits CIO Randy Mott commenting about slashing all itsoffshoring spend, constituting 90% of its IT spend, and bringit in-house in 3 years.

(iv) US border security bill which contains provision of fundsthrough raising H-1B, L1 visas.

(v) Senator Charles Schumer tagging Indian IT companies aschop-shops.

Though some of these rhetoric might not even see the light of day,but in the short run it has been taking its toll on the Indian ITvendors with (i) Increasing Visa costs causing IT companies tohire costlier resources in host nations impacting their margins(ii) Subcontracting costs going up across the sector and (iii) Visarejection rates at an all time high.

Fig. 69: Visa Rejection rates at an all time high.

0%

5%

10%

15%

20%

25%30%

35%

40%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

H1B Refusal Rate L1 Refusal Rate

(Source: ISG, SPA)

Fig. 70: Subcontracting costs (Infosys) as a % of Revenue at record levels.

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

FY06 FY07 FY08 FY09 FY10 FY11 FY12 Q1FY13



22

Pricing and MarginsExcept for the visa issues and subcontracting costs puttingpressure on the Margins there are concerns on the pricing frontas well. Due to economic uncertainty (i) a lot of projects haveeither been delayed or are coming at lower price points (ii) becauseof large transitional projects drying up, the revenue mix has shiftedmore towards traditional commoditized rate card businessaffecting the blended pricing (iii) even the existing clients areputting projects up for rebidding at the end of contract period toattract lower price vendor bids ex BT rebidding its projects affectingInfosys and Tech Mahindra and (iv) if the INR depreciationcontinues/stays clients might ask Indian heritage companies topass on INR depreciated margin gains to the clients in the form ofprice reversals. Except Wipro the other three companies are belowtheir Q1FY12 blended pricing levels.

Fig. 71: Fixed Bid contracts growing for HCL Tech.

35%

38%

41%

44%

47%

50%

53%

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Fig. 72: EBITDA Margin gap between Infosys and TCS reduced to 100bps.

15%

20%

25%

30%

35%

40%

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Fig. 73: TCS using Offshoring as a margin lever.

35%38%

41%

44%

47%50%

53%

56%

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Fig. 74: EPS growth in HCL Tech in AMJ,12 fuelled by INR depreciation.

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23

ExecutionAll strategy and planning to capture a market counts for nothing

if the company isn't able to garner a particular clients’ spend

and extract higher share of its IT spending pie. This is an

important criteria from both volume growth perspective as well

as margin improvement as lesser sales people would be required

to generate the same amount of revenue if the company can

successfully farm into existing clients IT spend. We find Infosys

to be the leader in this category until now, but in the past few

quarters TCS has dethrone Infosys from per client revenue

generation and is fast catching up in client conversion rate

(Converting a $5mn+ client into a $10mn+ client or so on). HCL is

also the one to look out for.

Fig. 75: Revenue per client - TCS dethroning Infosys

1.20

1.55

1.90

2.25

2.60

2.95

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Fig. 76: Conversion Rate - Bulk Category $50 - $10mn, TCS overtakes Infy

0%

15%

30%

45%

60%

75%

$1-$5 mnClients

$5-$10 mnClients

$10-$50 mnClients

$50-$100 mnClients



Fig. 77: $10mn to $50mn client-conversion rate, Infosys client mining better

0%

5%

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25%30%

35%

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Fig. 78: $50mn to $100mn client conversion - HCL on a high.

0%

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102

40

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2315

4

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158 6

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215 4

0

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40

60

80

100

120

140

Active Clients >$20mn >$50mn >$100mn

TCS Infosys Wipro HCL Tech

Highest Number of ActiveClient additions in thepast 2 years

Fig. 79: Incremental Client additions - HCL Tech increasing the client base.


HCL needs to improve itsconversion rates furtherespecially in the $50mn

24

Return ParametersTCS has the highest RoE, however HCL Tech is fast catching up.Infosys continues its top position with highest RoIC but RoE lagsshowcasing a less than optimum use of cash, even the re-investmentrate has come down for the company. HCL Tech on the other handcontinues to have the highest re-investment rate and with a secondbest RoE it has the maximum Economic Value Addition (EVA)benefitting the shareholders.

Fig. 80: RoE

0%

9%

18%

27%

36%

45%

FY09 FY10 FY11 FY12



Fig. 81: FCF / EBITDA

0%

15%

30%

45%

60%

75%

90%

FY09 FY10 FY11 FY12



Fig. 82: RoIC

0%

9%

18%

27%

36%

45%

54%

63%

72%

FY09 FY10 FY11 FY12



Fig. 83: OCF / EBITDA

0%

20%

40%

60%

80%

100%

FY09 FY10 FY11 FY12



Fig. 84: Acceleration in TCS and HCL Tech USD QoQ Revenues

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Second derivative of growth represented by the slope of the USDrevenue change QoQ is showing positive movement for TCS andHCL Tech, meaning a significant momentum behind these twocompanies to keep growing on the back of deals won by these 2 ITvendors. Infosys revenue growth has also reversed its direction,representing positive deal flow, Wipro on the other hand continueswith a negative slope or significant deceleration in USD Revenuegrowth in its IT services business.

25


ValuationGiven that the top 4 companies are almost identical in terms oftheir businesses and service offerings, we have used 2methodologies to identify the relatively cheaper businessesamongst them.

(i) EV/IC to ROIC/WACC - is a measure between ratio of Marketvalue of capital (EV) to Book value of capital (IC) and EconomicReturn of the firm (ROIC/WACC). It determines what the marketis willing to pay in excess of book value for the given economicreturn of the company

(ii) EV/GCI to CROCI/WACC - is a measure between ratio of Marketvalue of capital (EV) to Gross Capital Invested (GCI) and CashEconomic Return of the firm (CROCI/WACC). It is a better metricto determine the premium market is willing to pay on the bookvalue of capital given the Cash Economic Returns of thecompany.

Fig. 85: EV/IC to ROIC/WACC

Infosys

TCS

WiproHCL Tech

1

2

3

4

5

6

7

2 4 6 8 10 12 14

EV / IC

ROIC

/ W

ACC


Fig. 86: EV/GCI to CROCI/WACC

Infosys

TCS

Wipro

HCL Tech

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2 3 4 5 6 7 8

EV / GCI

CRO

CI /

WA

CC


We consider a multiple of 2% to be a right priced multiple to valuethe company at its current market price. Thus, the combination oftwo metrics clearly suggests that HCL Tech is trading at a discount,whereas TCS is at right price with a positive bias and Wipro isalso rightly prices though with a negative bias. Infosys in both themetrics is trading at a premium because of the acquisition buzz.Thus, we recommend a BUY for HCL Tech. We consider WIPRO tobe a dark horse as it is rightly placed in the growth businesssegments but lacks execution. We expect that the recent changesin the management strategy would improve execution once thenew strategy gets ingrained into the company. However, until wesee signs of any improvement we recommend HOLD for Wipro.

Companies Section

27

TCS


TCS has outperformed its peers in almost all the growth rate and execution metrics. On the back of a strongdeal pipeline and sufficient exposure to the growth segments, we expect this outperformance to continue andthe company would be able to meet our expectations of 13.7% USD revenue CAGR over FY12-14E. We expectthe company to continue to garner premium valuation at 19x FY14E earnings, with a Target Price of INR 1,345.Since there is not much upside left we recommend HOLD on the stock.

Strong growth to continue

TCS has shown USD Revenue CAGR of 19.1% over FY09-12 much

ahead of its peers on a much larger base. With the Q1FY13

commentary the company has allayed concerns about the project

delays and BFSI vertical which constitutes 43% to the topline and

is much more diversified than its peers. It has shown 5% volume

growth in BFSI for 20 consecutive quarters and Q1FY13 was no

different. On the basis of strong execution skills and a stong deal

pipeline, we are sure that the company will be able to meet/exceed

our USD revenue growth guidance of 13.7% CAGR for FY14E.

New services/sectors yielding results

TCS has not only been investing in growth verticals like Healthcare,

Media, Retail and services like IMS, but it has been investing

heavily in newer geographies. It was the first IT company to enter

China. It has a JV with Mitsubishi in Japan, BPO in Philipines and

similar engagements across APAC and Latin America. This has

started yielding results for the company. In APAC itself it has

revenue CAGR of 52% over FY10-12, growing its share in business

from 4% to 7%. We consider these segments to continue adding to

the delta growth of the company going forward.


Shareholding (%) Jun-12

Promoters 73.98

FIIs 14.63

DIIS 6.71

Others 4.68

Relative Price Performance

Key Data

BSE Code 532540

NSE Code TCS

Bloomberg Code TCS IN

Reuters Code TCS.NS

Shares Outstanding (mn) 1,957

Face Value 1.0

Mcap (INR bn) 2,672

52 Week H/L 1378.5/970.0

2W Avg. Qty, NSE 1,777,000

Free Float (%) 30.0%

Beta 0.88

Y/E March (INR mn) FY11 FY12 FY13E FY14E

Net Sales 373,245 488,938 588,081 623,851

Growth (%) 35.46% 13.99% 21.07% 23.76%

EBIDTAM (%) 29.95% 29.52% 30.82% 29.31%

Adj. PAT 90,680 104,135 131,281 138,821

Growth (%) 29.53% 14.84% 26.07% 5.74%

Adj. EPS (INR) 46.27 53.07 67.00 70.77

P/E (x) 25.56 22.01 20.37 19.29

EV/EBIDTA 16.02 14.91 12.90 12.54

Net Debt/Equity (0.30) (0.20) (0.20) (0.28)

RoCE (%) 39.57% 36.60% 38.91% 33.03%

RoE (%) 42.77% 38.92% 40.58% 36.18%

Margin expansion limited

The company operates at 81% utilization levels' nearing its all

time high of 83%, even its offshoring at 50.5% is near its peak of

51.4%. The only significant margin lever available with the

company is pyramid expansion. It's less than 3 year profile has

dropped from 43% to 38% due to lateral hires last year. We also

expect INR appreciation in remaining FY13/14E to take a bite off

the margins. We have estimated EBITDA margins to stabilize at

29.3% for FY14E.

Pricing

The company has witnessed a dip in pricing in the last two

quarters. We expect pricing to remain under pressure due to

changing business mix and competitive pressure.

Outlook and Valuation

We have followed DCF, PE (empirical), PE (theoretical) and all of

them have converged towards a price in the same range. With a

superior growth rates and higher RoE we expect the company to

continue trading at a premium. We have valued the stock at 19x

FY14E earnings with a 2 year target price of INR 1,345. Thus, due to

limited upside potential for the stock price we recommend HOLD.

8090

100110

120130140150

Aug-

11

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TCS Sensex

Sensex: 17,380.7 CMP: INR 1,341.1 Target: INR 1,345

September 3, 2012

28

FinancialsIncome statement

YE Mar (INR Mn) FY11 FY12 FY13E FY14E

Net Sales 373,245 488,938 588,081 623,851

Growth (%) 35.46% 13.99% 21.07% 23.76%

Employee Cost 137,261 185,719 219,541 241,345

Development and Bought Out 124,201 158,866 187,304 199,632

Total Optg. Exps. 261,462 344,585 406,845 440,977

EBIDTA (excl OI) 111,784 144,353 181,236 182,874

EBIDTA Margin (%) 29.95% 29.52% 30.82% 29.31%

EBIDTA Growth (%) 28.57% 29.14% 25.55% 0.90%

Dep./Amortization 7,353 9,179 10,028 11,608

EBIT 104,431 135,174 171,208 171,266

EBIT Margins (%) 27.98% 27.65% 29.11% 27.45%

Interest Expense 265 222 196 104

Other Income 6,040 4,282 1,049 10,717

PBT 110,206 139,233 172,061 181,880

Tax Expenses 18,308 33,999 39,574 41,832

PAT 91,898 105,235 132,487 140,047

PAT Margins (%) 24.62% 21.52% 22.53% 22.45%

PAT Growth (%) 29.57% 14.51% 25.90% 5.71%

Minority Interest 1,218 1,100 1,206 1,226

APAT 90,680 104,135 131,281 138,821

APAT Margins (%) 24.30% 21.30% 22.32% 22.25%

APAT Growth (%) 29.53% 14.84% 26.07% 5.74%

Balance Sheet


Share Capital 2,957 2,957 2,957 2,957

Reserves and Surplus 242,091 292,835 354,241 413,982

Total Networth 245,048 295,792 357,199 416,939

Minority Interest 4,582 5,588 6,300 6,300

Unsecured Loans 364 28 28 28

Secured Loans 384 1,126 1,126 1,126

Total Debt 748 1,154 1,154 1,154

Non Current Liabilities - 5,027 5,027 5,027

Source of Funds 250,378 307,560 369,679 429,419

Net Block 42,471 51,186 57,880 66,286

CWIP 14,692 14,464 13,559 6,431

Goodwill 32,320 35,435 35,434 35,434

Non Current Assets 17,627 40,100 55,597 71,597

Current Assets 218,807 270,200 321,778 386,347

Current Liabilities 76,046 104,650 114,946 137,232

Net Current Assets 142,762 165,550 206,832 249,116

Deferred Tax Assets 507 826 378 557

Application of Funds 250,378 307,560 369,679 429,420

Cash Flow


EBT 110,206 139,233 172,061 181,880

Less: Other Income/Excp. 13 212 200 200

Add: Depreciation 7,353 9,179 10,028 11,608

Add: Interest Paid (983) (183) - -

Less: Taxes Paid (22,770) (40,684) (49,629) (53,613)

Change in Working Capital (21,277) (30,200) (54,713) (42,264)

Others (6,162) (7,476) (5,915) (7,210)

CFs from Operations (a) 66,381 70,082 72,032 90,601

Change in Fixed Assets (18,322) (19,874) (16,722) (20,013)

Change in Investments (6,357) (11,756) (15,497) (16,000)

Others 9,367 4,257 4,811 6,434

CFs from Investments (b) (15,313) (27,373) (27,408) (29,579)

Change in Equity 7 97 - -

Change in Debt (244) (342) - -

Dividend Paid (46,087) (39,083) (46,976) (53,001)

Interest Paid (265) (224) (196) (104)

CFs from Financing (c) (46,589) (39,551) (47,172) (53,105)

Change in Cash (a+b+c) 4,479 3,158 (2,548) 7,916

Opening Cash 10,244 15,486 19,835 19,087

Exchange Difference 303 1,191 1,800 1,280

Closing Cash 15,026 19,835 19,087 28,283

FCF 25 26 28 36

Key Ratios

YE Mar FY11 FY12 FY13E FY14EPer Share Data (INR)Reported EPS 46.27 53.07 67.00 70.77Adj. EPS 46.27 53.07 67.00 70.77Growth (%) 29.72% 14.70% 26.25% 5.64%CEPS 48.81 63.04 79.14 79.86DPS 14.06 25.11 30.22 35.41BVPS 109.78 138.17 166.82 197.76FCFPS 24.55 25.65 28.26 36.07EVAPS 30.43 34.35 45.68 41.81Return Ratios (%)RoCE 39.57 36.60 38.91 33.03RoNW 42.77 38.92 40.58 36.18RoIC 50.74 43.21 46.07 43.77CRoIC 33.10 32.23 34.64 29.06Du Pont AnalysisTax Burden 0.83 0.76 0.77 0.77Interest Burden 1.06 1.03 1.00 1.06Sales Turnover 0.28 0.28 0.29 0.27Asset Turnover 1.48 1.58 1.58 1.45Leverage Ratio 1.17 1.14 1.14 1.11RoE 42.77% 38.92% 40.58% 36.18%Valuation RatiosP/E (x) 25.56 22.01 20.37 19.29P/BV (x) 10.77 8.45 8.18 6.90PEG (x) 0.86 1.50 0.78 3.42MCap/ Sales (x) 4.98 4.51 4.09 3.85EV/EBIDTA (x) 16.02 14.91 12.90 12.54Payout Ratio (%) 30.38% 47.30% 45.11% 50.03%


29

Infosys


Infosys has missed its quarterly revenue guidance two quarters in a row. Its lack of exposure to growth verticalsand its over dependence (40% of revenue) on discretionary linked spend has failed it. We expect its aim ofexpanding into PPS business is still some years away unless it receives a significant Inorganic push. Howeverwe forecast earnings CAGR of 14% over FY12-14E. We value Infosys at 13x FY14E earnings plus INR 234 of freecash/share. Thus we recommend HOLD with a Target Price of INR 2,700.

Revenue Growth - Challenging

As a strategy the company decided to focus on non-linear consulting

and PPS business. Though the step was in the right direction the

timing was not. With 40% of company's topline linked to

discretionary spend the company did not have a fall back plan

during economic turmoil, the result of which is a sub-par USD

revenue growth at 14.4% CAGR over FY09-12. However, the company

reported a 2.7% volume growth in Q1FY13. Based on a healthy deal

pipeline we estimate USD revenue CAGR of 10.9% over FY12-14E.

Margins Levers available.

Though pricing continues to be a concern (-3.7% QoQ) because of

changing business mix, we can comprehend a number of margin

levers the company has its disposal. Infosy's utilization rates have

come down a long way to 71% from its peak of 81%, its offshoring

is also much lower at 50% than 54% where it used to be. Also the

employee pyramid has taken a hit due to excessive lateral hires.

Thus, we expect a significant scope of improvement for the company

on the margin front going forward. We have estimated EBITDA

Margins to the tune of 32.8%/32.4% for FY13E/14E.



Promoters 16.04

FIIs 37.89

DIIS 18.29

Others 27.78


Key Data

BSE Code 500209

NSE Code INFOSYSTCH

Bloomberg Code INFO IN

Reuters Code INFY.NS

Shares Outstanding (mn) 574.2

Face Value 5.0

Mcap (INR bn) 1,373.0

52 Week H/L 2994.0/2101.7

2W Avg. Qty, NSE 1,181,000


Beta 0.97


Net Sales 275,010 337,340 384,162 408,688

Growth (%) 20.93% 22.66% 13.88% 6.38%

EBIDTAM (%) 32.61% 31.79% 32.75% 32.37%

Adj. PAT 68,350 83,320 95,480 108,391

Growth (%) 9.08% 21.90% 14.59% 13.52%

Adj. EPS (INR) 119.63 145.82 167.10 189.69

P/E (x) 27.06 19.65 14.27 12.60

EV/EBIDTA 17.15 12.75 8.87 7.81

Net Debt/Equity (0.58) (0.65) (0.68) (0.73)

RoCE (%) 24.26% 24.28% 24.03% 20.81%

RoE (%) 27.88% 29.08% 27.46% 25.41%

Growth Verticals - Absent

Infosys not only suffered because of de-growth in BFSI(contributing 34% to the topline, degrew by -3% CQGR over thelast two quarters) and Europe (contributing 21%, degrew by -4.3%CQGR over the last two quarters) but also because it didn't havethe cushioning of growth services like IMS or verticals likeHealthcare or geographies like APAC.

Inorganic PPS business

Due to its conservative nature the company let go of Axon, whichboosted HCL growth tremendously. However, for its PPS businessthe management has indicated towards an acquisition to the tuneof $1bn. This could be a shot in the arm for the company as it willhelp Infosys establish a base and build upon it, its PPS business.

Outlook and Valuation

With a large chunk of revenue linked to discretionary spend weremain apprehensive about the revenue outperformance by thecompany until economy shows signs of improvement. Until then,we recommend a discounted PE multiple of 13x to our FY14E ofINR 189.7 plus INR 234 of free cash/share (after acquisition andworking capital requirement), resulting in a 2 year target price ofINR 2,700 with a HOLD rating.

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INFY Sensex

Sensex: 17,380.7 CMP: INR 2,368.0 Target: INR 2,700

September 3, 2012

30



Net Sales 275,010 337,340 384,162 408,688

Growth (%) 20.93% 22.66% 13.88% 6.38%

Employee Cost 150,540 188,640 211,050 224,465

Sales and Marketing 15,190 17,570 19,976 23,704

General and Administrative 19,600 23,900 27,314 28,240

Total Optg. Exps. 185,330 230,110 258,340 276,409

EBIDTA (excl OI) 89,680 107,230 125,822 132,279

EBIDTA Margin (%) 32.61% 31.79% 32.75% 32.37%

EBIDTA Growth (%) 14.08% 19.57% 17.34% 5.13%

Dep./Amortization 8,540 9,280 9,350 10,418

EBIT 81,140 97,950 116,472 121,861

EBIT Margins (%) 29.50% 29.04% 30.32% 29.82%

Other Income 12,110 19,040 16,140 26,620

PBT 93,250 116,990 132,612 148,481

Tax Expenses 24,900 33,670 37,131 40,090

PAT 68,350 83,320 95,480 108,391

PAT Margins (%) 24.85% 24.70% 24.85% 26.52%

PAT Growth (%) 9.08% 21.90% 14.59% 13.52%

APAT 68,350 83,320 95,480 108,391

APAT Margins (%) 24.85% 24.70% 24.85% 26.52%

APAT Growth (%) 9.08% 21.90% 14.59% 13.52%

Balance Sheet


Share Capital 2,861 2,861 2,861 2,861


Total Networth 259,760 313,320 381,971 471,029

Minority Interest - 1,230 1,230 610

Unsecured Loans - - - -

Secured Loans - - - -

Total Debt - - - -

Non Current Liabilities - 230 - -

Source of Funds 259,760 314,780 383,201 471,639

Net Block 52,350 55,550 58,010 61,766

CWIP 5,250 5,900 7,800 5,443

Goodwill


Current Assets 250,680 309,300 374,084 464,449



Deferred Tax Assets 3,210 2,650 3,086 2,655


Cash Flow


EBT 93,250 116,990 132,612 148,481


Add: Interest & Dividend Paid (11,540) (18,340) (19,597) (22,690)

Less: Taxes Paid (28,460) (31,170) (40,725) (43,684)


Others (530) 510 (540) 350



Change in Investments 35,550 - (1,932) (1,311)

Others 11,480 13,840 13,097 34,358

CFs from Investments (b) 33,980 (1,470) (645) 18,873

Change in Equity - - - -

Change in Debt 240 70 15 -

Dividend Paid (36,640) (23,280) (24,736) (24,736)

Interest Paid - - - -


Change in Cash (a+b+c) 45,100 38,400 53,720 83,593

Opening Cash 121,110 166,660 205,910 259,630

Exchange Difference 450 850 - -

Closing Cash 166,660 205,910 259,630 343,223

FCF 60 84 118 132

Key Ratios

YE Mar FY11 FY12 FY13E FY14EPer Share Data (INR)Reported EPS 119.63 145.82 167.10 189.69Adj. EPS 119.63 145.82 167.10 189.69Growth (%) 9.09% 21.91% 14.88% 13.33%CEPS 139.36 166.62 195.51 205.55DPS 70.23 54.90 43.29 43.29BVPS 426.93 499.00 605.40 742.72FCFPS 60.33 83.60 117.74 131.75EVAPS 48.02 56.38 66.94 58.03Return Ratios (%)RoCE 24.26 24.28 24.03 20.81RoNW 27.88 29.08 27.46 25.41RoIC 54.66 64.95 68.55 69.60CRoIC 23.82 23.73 23.23 20.19Du Pont AnalysisTax Burden 0.73 0.71 0.72 0.73Interest Burden 1.15 1.19 1.14 1.22Sales Turnover 0.30 0.29 0.30 0.30Asset Turnover 1.06 1.07 1.00 0.87Leverage Ratio 1.06 1.10 1.10 1.11RoE 27.88% 29.08% 27.46% 25.41%Valuation RatiosP/E (x) 27.06 19.65 14.27 12.60P/BV (x) 7.58 5.74 3.95 3.22PEG (x) 2.98 0.90 0.96 0.95MCap/ Sales (x) 6.15 4.67 3.59 3.37EV/EBIDTA (x) 17.15 12.75 8.87 7.81Payout Ratio (%) 58.71% 37.65% 25.91% 22.82%


31

Wipro


Wipro has everything in the making of a dark horse. The company has presence in all the growth segmentsIMS, EAS, Healthcare, Retail, India, Middles East etc. The only thing that has eluded the company till now is theexecution success. We feel the new strategy to be a step in the right direction. As the strategy gets ingrainedinto the DNA of the company we would witness a rebound in its USD revenue growth rates. We have estimateda 15% EPS CAGR over FY12-14E and recommend BUY with a target price of INR 405.0 at 13.5x FY14E earnings.

Revenue Growth - Gradual RecoveryWe consider that the restructuring is largely over, but the new

strategy will take some time to get the desired results. This is evident

from the -1.4% decline in the QoQ USD IT revenues and a weak 2Q

guidance of 0.3%-2.3% sequential growth. We agree with the

company's policy to continue investment in the weaker segments

so as to yield benefits during an upturn. We have forecasted 11.9%

CAGR USD overall revenue growth.

Margins Up - Pricing GrowthWipro is the only company to show a pricing uptick in each of the

past 3 quarters and it still has significant margin levers at its

disposal. Utilization at 75.5% has come down from 80.7%.

Offshoring at 46% against a peak of 50.6%. Subcontracting costs

have also started trending down. We expect the company to expand

its margins offsetting INR appreciation in to record EBITDA Margins

of 21.3%/19.7% in FY13E/FY14E.

Inorganic GrowthWipro's acquisition strategy has borne good results for the

company with 2.2% CAGR growth contribution and 20% of current

revenues. The company continues its inorganic growth route

through acquisitions of Promax and Yardley.



Promoters 78.37

FIIs 6.59

DIIS 3.47

Others 11.57


Key Data

BSE Code 507685

NSE Code WIPRO

Bloomberg Code WPRO IN

Reuters Code WIPR.NS

Shares Outstanding (mn) 2,458.8

Face Value 2.0

Mcap (INR bn) 907.5

52 Week H/L 452.5/310.2

2W Avg. Qty, NSE 2,566,000


Beta 0.76


Net Sales 310,385 371,878 430,356 473,763

Growth (%) 14.06% 19.81% 15.73% 10.09%

EBIDTAM (%) 20.77% 18.91% 21.27% 19.67%

Adj. PAT 52,924 56,046 67,558 73,971

Growth (%) 14.28% 5.90% 20.54% 9.49%

Adj. EPS (INR) 21.61 22.70 27.48 30.08

P/E (x) 22.13 19.34 13.43 12.27

EV/EBIDTA 16.94 14.62 10.91 10.70

Net Debt/Equity (0.05) (0.07) (0.10) (0.15)

RoCE (%) 12.98% 11.23% 13.68% 12.33%

RoE (%) 25.85% 22.61% 23.85% 23.12%

Fig87. Subcontracting Costs Trending down

5.8%

7.9%7.8%8.5%

8.5%6.9%

6.3%5.5%

4.6% 4.9%5.2%

5.4%

8.7%8.6% 9.4%9.6% 9.7%

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Outlook and ValuationWe consider Wipro having all the ingredients to be a dark horse

and surprise with a revenue growth on the upside due to long

standing exposure to growth verticals and now a stable strategy.

We have estimated an EPS CAGR of 15% over FY12-14E and

recommend BUY for the stock with a 2 year target price of INR

405.0 based on 13.5x FY14E earnings of INR 30.1.

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Subcontracting cost down to 8.5% from a peak of 9.7%.

Sensex: 17,381 CMP: INR 362.6 Target: INR 405.0

September 3, 2012

32

Fig. 88: M&A Deals by Wipro

S.No. Effective Date Acquired Country % Stake acquired Deal Size (Mn) Sector

1 Jul, 2012 Yardley UK 100 Undisclosed Cosmetics and Personal Care

2 May, 2012 Promax Australia 100 AUD 15.0 BI/Analytics (Retail)

3 Jun, 2011 RKM Equipamentos Hidraulicos Brazil Undisclosed Diverse Manufacturing

4 Jun, 2011 SAIC Inc US 100 USD 150.0 Consulting Services

5 Dec, 2009 Yardley Europe 100 USD 45.5 Cosmetics and Personal Care

6 Mar, 2009 3D Networks India USD 30.0 Computer Services

7 Jan, 2009 Citi Technology Services India 100 USD 127.0 Enterprise S/w & Services

8 Jul, 2008 Gallagher Financial Systems US 100 Undisclosed Commercial Services (Finance)

9 Jun, 2008 WM NetServ UK 50 Undisclosed Telecom Services

10 Oct, 2007 Oki Electric Ind. Singapore 100 Undisclosed Telecom OEM

11 Sep, 2007 Infocrossing Inc. US 100 USD 547.9 Data Processing / Management

12 Jul, 2007 Unza Holdings Pte Singapore 100 INR 10,102.0 Cosmetics and Personal Care

13 Mar, 2007 Enabler Portugal 100 EUR 41.0 Consulting Services

14 Jan, 2007 Hydrauto Group AB Sweden 100 USD 31.0 Auto Med and Heavy Duty Trucks

15 Nov, 2006 3D Network and Planet PSG Singapore 100 SGD 23.0 Telecom Services

16 Jul, 2006 Quantech Global Services LLC US 100 Undisclosed Engineering and R&D Services

17 Jun, 2006 Saraware Oy Finland 100 EUR 25.0 Application Services

18 May, 2006 North-West SwitchGear Ltd. India 100 INR 1,022.0 Electric Equipment

19 Apr, 2006 cMango Inc US 100 USD 20.0 Consulting Services

20 Dec, 2005 Mpower Inc US 100 USD 28.0 Financial Services

21 Dec, 2005 NewLogic Technologies Austria 100 EUR 47.0 Electronics Component-Semiconductor

22 May, 2003 Wipro NerveWire Inc US 100 USD 18.7 Consulting Services

23 Apr, 2003 Glucose Drink Band India 100 Undisclosed Non Alcoholic - Beverages

24 Jan, 2003 Spectramind eServices India 8 USD 14.0 Telecom Services

25 Jan, 2003 Telefonnaktiebolaget LM Ericsson India 100 Undisclosed Application Software

26 Nov, 2002 CGI Technologies & Solutions US 100 USD 26.0 Data Processing / Management

27 Sep, 2002 Spectramind eServices India 2 USD 3.5 Telecom Services

28 Aug, 2002 Spectramind eServices India 66 INR 4,069.0 Telecom Services

29 Jul, 2002 GE Medical Systems IT India 100 USD 5.7 Application Software

30 Aug, 2002 Spectramind eServices India 17 INR 480.0 Telecom Services

31 Dec, 2000 Wipro Net Ltd US 47 EUR 25.6

32 Feb, 2000 Wipro Acer Ltd India 100 Undisclosed



33



Net Sales 310,385 371,878 430,356 473,763

Growth (%) 14.06% 19.81% 15.73% 10.09%

Employee Cost 205,412 253,493 282,221 315,185

S&M 22,172 27,777 33,137 37,427

G&A 18,339 20,285 23,479 27,952

Total Optg. Exps. 245,923 301,555 338,837 380,564

EBIDTA (excl OI) 64,462 70,323 91,519 93,200

EBIDTA Margin (%) 20.77% 18.91% 21.27% 19.67%

EBIDTA Growth (%) 8.35% 9.09% 30.14% 1.84%

Dep./Amortization (7,891) (9,754) (10,640) (11,118)

EBIT 56,571 60,569 80,879 82,082

EBIT Margins (%) 18.23% 16.29% 18.79% 17.33%

Interest Expense 1,932 3,439 1,174 1,204

Other Income 7,709 12,685 6,229 13,825

PBT 62,348 69,815 85,935 94,703

Tax Expenses 9,695 13,845 17,997 20,333

PAT 52,653 55,970 67,938 74,369

PAT Margins (%) 16.96% 15.05% 15.79% 15.70%

PAT Growth (%) 14.63% 6.30% 21.38% 9.47%

Minority Interest 344 257 380 398

APAT 52,924 56,046 67,558 73,971

APAT Margins (%) 17.05% 15.07% 15.70% 15.61%

APAT Growth (%) 14.28% 5.90% 20.54% 9.49%

Balance Sheet


Share Capital 4,906 4,916 4,918 4,918


Total Networth 224,870 270,174 299,582 343,782


Long Term Debt 19,759 22,510 21,372 20,208

Short Term Debt 31,166 35,480 37,306 39,980

Total Debt 50,925 57,990 58,678 60,188

Non Current Liabilities 5,373 3,885 4,335 4,582

Source of Funds 281,859 332,898 363,444 409,401

Net Block 50,618 56,394 63,733 69,564

CWIP 5,034 3,466 5,907 4,584

Goodwill 54,266 67,961 67,961 67,961


Current Assets 226,918 269,027 291,322 339,298



Deferred Tax Assets 38 165 185 176


Cash Flow


EBT 62,348 69,815 85,935 94,703

Less: Other Income/Excp. (6,460) (8,708) (8,364) (9,975)


Add: Interest Paid 776 1,025 1,174 1,204

Less: Taxes Paid (9,293) (16,105) (17,997) (20,333)


Others 6,321 2,112 (1,938) 3,384



Change in Investments (32,012) 324,356 (7,614) (6,172)

Others 6,363 8,010 8,364 9,975


Change in Equity (11) - - -

Change in Debt (11,202) 934 688 1,510

Dividend Paid (15,585) (17,229) (34,521) (34,521)

Interest Paid (696) (902) (1,174) (1,204)


Change in Cash (a+b+c) (4,260) 14,843 14,203 23,497

Opening Cash 64,878 61,141 77,666 87,337

Exchange Difference 523 1,682 (4,532) 2,300

Closing Cash 61,141 77,666 87,337 113,134

FCF 28,747 27,884 48,460 53,908

Key Ratios

YE Mar FY11 FY12 FY13E FY14EPer Share Data (INR)Reported EPS 21.61 22.70 27.48 30.08Adj. EPS 21.57 22.70 27.48 30.08Growth (%) 90.74% 5.23% 21.04% 9.49%CEPS 23.18 25.25 32.86 33.46DPS 6 6 12 12BVPS 82.98 100.67 115.86 130.83FCFPS 11.71 11.34 19.71 21.93EVAPS 3.27 (1.29) 6.40 2.34Return Ratios (%)RoCE 12.98 11.23 13.68 12.33RoNW 25.85 22.61 23.85 23.12RoIC 22.26 19.38 23.60 22.16CRoIC 13.35 11.88 13.90 12.53Du Pont AnalysisTax Burden 0.84 0.80 0.79 0.79Interest Burden 1.10 1.15 1.06 1.15Sales Turnover 0.18 0.16 0.19 0.17Asset Turnover 0.84 0.86 0.92 0.91Leverage Ratio 1.81 1.75 1.64 1.63RoE 25.85% 22.61% 23.85% 23.12%Valuation RatiosP/E (x) 22.13 19.34 13.43 12.27P/BV (x) 5.76 4.36 3.19 2.82PEG (x) 0.24 3.70 0.64 1.29MCap/ Sales (x) 3.38 2.66 2.22 2.02EV/EBIDTA (x) 16.94 14.62 10.91 10.70Payout Ratio (%) 27.82% 26.32% 43.67% 39.89%


34

HCL Tech


HCL Tech is the blue eyed boy of the Indian IT industry, check marking all the boxes of growth and executionmetrics. The company has especially made hay in the restructuring deal sun, identifying the market andcapturing a major chunk of the churn. We consider FY13 to be no different and have estimated an EPS CAGR of16.7%, highest amongst its peers over FY12-14E. However due to its low margin profile and smaller size weexpect the company to trade at a 30% discount to TCS's PE multiple. Thus, we recommend BUY with a TargetPrice of INR 650.0 at 13x FY14E earnings.

Strong Topline Growth

The company has shown a 23.3% CAGR USD revenue growth over

FY09-12 highest amongst its large cap peers. We expect that

outperformance to continue with a 19% CAGR USD revenue growth

over FY12-14E. Our forecast is based on a strong deal wining

appetite company has shown in FY12 from restructured deals

which we expect will continue with a strong restructuring deal

flow expected in 2HCY12. IMS deals on the back of Axon

acquisitions also add to that confidence.

Margins Spike

We consider Q4FY12 EBITDA margins of 22% to be a spike from

INR depreciation and expect it to wear off as the company gives

wage hikes and bonuses in Q1FY13E. After two successive quarters

of pricing decline it improved in the Q4 which we expect to remain

stable. Due to higher number of Axon employees we expect

offshoring as a margin lever to be capped. Thus with limited margin

levers at disposal and INR depreciation tailwind wearing off, we

expect the margins to come down. We have estimated EBITDA

Margins of 18.7%/18.2% for FY13E/14E.



Promoters 62.24

FIIs 19.97

DIIS 9.51

Others 8.28


Key Data

BSE Code 532281

NSE Code HCLTECH

Bloomberg Code HCLT IN

Reuters Code HCLT.NS

Shares Outstanding (mn) 700.7

Face Value 2.0

Mcap (INR bn) 347.4

52 Week H/L 562.1/373.0

2W Avg. Qty, NSE 1,881,000


Beta 1.00


Net Sales 157,304 210,311 247,651 278,921

Growth (%) 29.61% 33.70% 17.75% 12.63%

EBIDTAM (%) 15.61% 19.14% 18.67% 18.18%

Adj. PAT 16,465 25,260 30,001 34,905

Growth (%) 30.76% 53.42% 18.77% 16.35%

Adj. EPS (INR) 24.09 36.60 42.82 49.82

P/E (x) 19.78 13.18 12.76 10.97

EV/EBIDTA 11.56 7.64 7.32 6.47

Net Debt/Equity 0.06 0.01 (0.06) (0.14)

RoCE (%) 15.65% 23.35% 24.94% 25.20%

RoE (%) 23.63% 30.10% 31.04% 32.35%

Growth AvenuesIn FY12 HCL Tech won 52 transformational deals. Most of them

were from traditional sources but a substantive chunk was from

growth segments like Energy Utilities (Consumer Energy, Statoil),

Healthcare (UHG), IMS (AstraZeneca) etc. Another heartening thing

for the company was it won deals against incumbent international

MNC's showcasing similar execution skills on a cheaper rate card.

Execution Skill - Scope of improvementThe company acquired 128 new customers in FY12 (highest

amongst its peers), it would help the company broaden its client

pyramid base, but extracting revenues and growth out of them

needs to be improved. Its client conversion rate for $1-$5mn at

41% and $5-$10mn at 58% is one of the lowest among its peers

median at 49% and 66% respectively.

Outlook and ValuationOn the back of highest growth rate among its peers and slightly

lower margins we expect an EPS CAGR of 16.7% over FY12-14E. We

expect the stock to trade at a 30% discount to TCS's PE multiple

due to its smaller size and margin profile. Thus, we recommend

BUY with a 2 year target price of INR 650.0 based on 13x FY14E

earnings of INR 49.8.

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Sensex: 17,380.7 CMP: INR 544.0 Target: INR 650.0

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Net Sales 157,304 210,311 247,651 278,921

Growth (%) 29.61% 33.70% 17.75% 12.63%

Employee Cost 5,221 6,329 8,185 7,762

Development and Bought Out 85,896 108,105 124,379 145,702

G&A 41,632 55,627 68,847 74,751

Total Optg. Exps. 132,749 170,061 201,411 228,215

EBIDTA (excl OI) 24,555 40,250 46,240 50,706

EBIDTA Margin (%) 15.61% 19.14% 18.67% 18.18%

EBIDTA Growth (%) 26.54% 63.92% 14.88% 9.66%

Dep./Amortization (4,597) (5,641) (6,381) (6,779)

EBIT 19,958 34,609 39,859 43,927

EBIT Margins (%) 12.69% 16.46% 16.09% 15.75%

Interest Expense 1,604 1,501 1,194 982

Other Income 2,997 331 1,791 4,688

PBT 21,351 33,439 40,456 47,633

Tax Expenses 4,885 8,180 10,457 12,728

PAT 16,466 25,259 30,000 34,904

PAT Margins (%) 10.47% 12.01% 12.11% 12.51%

PAT Growth (%) 30.79% 53.40% 18.77% 16.35%

Minority Interest (1) 1 1 1

APAT 16,465 25,260 30,001 34,905

APAT Margins (%) 10.47% 12.01% 12.11% 12.51%

APAT Growth (%) 30.76% 53.42% 18.77% 16.35%

Balance Sheet


Share Capital 1,316 1,401 1,401 1,401


Total Networth 76,459 91,350 101,958 113,834


Secured 21,434 19,222 15,725 13,854

Unsecured 439 1,335 1,330 1,250

Total Debt 21,873 20,557 17,055 15,104

Deferred Tax Liability - - - -

Source of Funds 98,369 111,940 119,049 128,975

Net Block 52,387 54,854 58,656 60,911

CWIP 6,094 5,860 4,980 5,509

Goodwill - - - -

Investments 7,375 11,795 15,240 19,430

Current Assets 69,447 87,990 98,995 111,682



Deferred Tax Assets 3,633 3,543 3,235 3,102


Cash Flow


EBT 21,351 33,439 40,456 47,633

Less: Other Income/Excp. (2,034) (1,940) (2,364) (2,314)


Add: Interest Paid 1,254 1,501 1,194 982

Less: Taxes Paid (3,285) (8,180) (10,457) (12,728)


Others 1,266 - - -



Change in Investments (72,298) (6,140) (5,920) (10,232)

Others 1,302 2,162 2,662 2,660


Change in Equity 896 1,800 800 650

Change in Debt (4,990) (1,446) (3,632) (2,081)

Dividend Paid (5,179) (4,837) (11,477) (13,116)

Interest Paid (1,269) (1,501) (1,194) (982)


Change in Cash (a+b+c) 181 1,744 3,741 8,178

Opening Cash 4,833 17,296 19,516 23,022

Exchange Difference 336 476 (235) 380

Closing Cash 5,349 19,516 23,022 31,580

FCF 9,808 11,706 22,501 31,280

Key Ratios

YE Mar FY11 FY12 FY13E FY14EPer Share Data (INR)Reported EPS 24.09 36.60 42.82 49.82Adj. EPS 24.09 37.24 43.56 50.68Growth (%) 33.78% 54.57% 16.99% 16.35%CEPS 33.06 53.26 61.18 67.09DPS 7 12 14 16BVPS 101.17 119.75 137.95 153.99FCFPS 14.24 16.71 32.11 44.64EVAPS 4.17 17.46 21.36 23.63Return Ratios (%)RoCE 15.65 23.35 24.94 25.20RoNW 23.63 30.10 31.04 32.35RoIC 18.99 28.30 30.94 33.39CRoIC 16.10 22.16 22.99 22.63Du Pont AnalysisTax Burden 0.77 0.76 0.74 0.73Interest Burden 1.07 0.97 1.01 1.08Sales Turnover 0.13 0.16 0.16 0.16Asset Turnover 1.60 1.88 2.08 2.16Leverage Ratio 1.41 1.33 1.23 1.20RoE 23.63% 30.10% 31.04% 32.35%Valuation RatiosP/E (x) 19.78 13.18 12.76 10.97P/BV (x) 4.71 4.03 3.96 3.55PEG (x) 0.59 0.24 0.75 0.67MCap/ Sales (x) 1.80 1.48 1.40 1.25EV/EBIDTA (x) 11.56 7.64 7.32 6.47Payout Ratio (%) 31.25% 33.29% 32.70% 32.12%


36

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