Slow US recovery to hit IT firms

Analysts see problem continuing as over 60% of revenue comes from North America
The sluggish demand from the US market will continue to hurt the business prospects of Indian IT outsourcing services providers even as the industry expects to see stability in the overall business environment in the second quarter of financial year 2010.

The delay in recovery of US economy, according to analysts and companies, will eat into the top- and bottom-lines of most Indian IT firms, even as they see a surge in demand from some European countries, including the UK and France, along with emerging geographies like Australia and West Asia. The reason is simple — most of the Indian IT services firms derive over 60 per cent of their revenues from the North Americas, including the US.

“There is no doubt that there is some comfort building in the environment. We are seeing some demand from emerging markets and Europe, but it is small in terms of overall exposure. The US has to recover for the world to stabilise, and growth in the US will happen only when consumers start spending there,” explains V Balakrishnan, CFO of India’s second-largest IT firm Infosys Technologies.

Amid the global financial uncertainties in the first quarter of the financial year 2009-10, Indian companies showed some resilience by posting almost flat to slightly negative growth in their top-lines. One of the real concerns for the industry was, however, the decline in volumes.

Even though, India’s largest IT services provider, Tata Consultancy Services (TCS), showed a volume growth of about 3.5 per cent, the volume for Infosys and Wipro declined by about 1 per cent and 1.5 per cent respectively. Thus reflecting the state of the affairs in the supply environment.

In the current quarter, while most of the companies are seeing a much better demand than the previous quarter, they are still maintaining a cautious approach owing to the US market, which is yet to come out of the downturn.

“We are not in a downturn now, even though we are not in a recovery phase. We have now come to a stable phase. The recovery will be late by the US market, and we will have to wait and see when this happens,” says S Mahalingam, chief financial officer of TCS.

The silver lining to the cloud is that some of the deals announced recently, including the estimated $1.5-billion BP outsourcing contract to three Indian IT vendors, reveal that clients are now opening up their purse strings to accommodate discretionary spending. In the current environment, according to analysts, clients may be ready to spend as many of them may want to exhaust their existing IT budgets before the year ends. The second reason is that they may be perceiving a better outlook for the overall economy.

“New projects or new business spending by companies had increased in the July-August-September quarter, which will definitely have a positive impact. But there’s no correlation as yet whether this will result in better margins and higher revenue,” cautions Sabyasachi Satpathy, partner, Tholons Advisory.

“The worst is getting over and we are currently moving from a stable to positive territory even though we are maintaining a cautious approach. Our funnel has gone up from the end of the first quarter to now,” says Suresh Senapaty, chief financial officer of Wipro Ltd. Wipro had given a cautious revenue guidance of 0.2 to 2 per cent for the second quarter of the current fiscal.

Outsourcing and offshoring are very critical for companies to become more operationally efficient and agile. But when recovery happens and the economy bounces back, the year-on-year growth rates of 30-40 per cent which IT firms enjoyed will be a thing of the past, since the base is very high.

“It might be around 20 per cent or so,” concludes Mahalingam of TCS.