Technology IT services

Transcription

1 Technology IT services Yogesh Aggarwal* Analyst HSBC Securities and Capital Markets (India) Private Limited *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations 1

2 2 Sector structure IT Serices IT services BPO S Software and R&D Asia-Pacific Equity Research Heritage Indian IT Service providers Multi-national Corporations Multi-national Corporations Multi-national Corporations Large Caps TCS Infosys Wipro HCL Technologies Mid Caps Tech Mahindra Hexaware Technologies Mphasis KPIT Cummins Mindtree Persistent Technologies Polaris Financial Tech E-Clerx Services ITC Infotech IBM Accenture Cognizant HP Capgemini Logica CSC AtosOrigin Dell igate Genpact WNS Global Services Aegis Limited Firstsource Solutions IBM Daksh Convergys Indian BPO TCS BPO Wipro BPO Infosys BPO HCL BPO SAP Oracle Microsoft Cisco Intel Dell GE Honeywell Technologies Geometric Solutions Source: HSBC

3 Apr-12 Feb-12 Dec-11 Oct-11 Aug-11 Sector price history Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Jun-11 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 IT companies undeperformed due to strengthening of currency Source: S&P, Thomson Reuters Datastream, HSBC Large number of restructuring deals S&P CNX 500 S&P CNX IT Index S&P downgrade of US credit rating 3

4 4 EBIT margin asset turnover ( ) High asset turn efficient MindTree Ltd volume driven strategies 1.4 Neowiz Games % High asset turn and high margins; profitable industry leaders strategies Asia-Pacific Equity Research Polaris Financial Technol MphasiS TCS Asset Turnover (x) Persistent Systems Ltd HCL Technologies Tech Mahindra Wipro NHN Corp Infosys Technologies Daum Communications Corp 0.94x NCsoft 0.5 Gamevil Inc 0.4 Com2us Corporation Low ROA companies. Business restructuriung may be required High margins; niche players or brands with strong pricing power - 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% EBIT Margin (%) Source: Thomson Reuters Datastream, HSBC

5 Sector description Information Technology (IT) plays a critical role in enhancing the efficiency and productivity of businesses by automating processes and processing large amounts of information. It enables clients to focus on their core business by handling their IT needs, often at a lower cost than would possible if the work was done in-house. India has emerged as the most attractive offshore outsourcing market. It has cost advantages and an ample supply of the qualified staff who speak English. In the last decade India s IT exports have grown 16 times to reach an annual value of USD68bn. Yogesh Aggarwal* Analyst HSBC Securities and Capital Markets (India) Private Limited yogeshaggarwal@hsbc.co.in *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Tata Consultancy Services (TCS), Infosys, Wipro and HCL Technologies are the four largest Indian IT players. They generate a high percentage of revenues from overseas clients by offering services ranging from managing complex computer networks and call centres to software coding and maintaining technology operations. Tata has emerged as the biggest player in software for financial institutions, Infosys has a strong presence in banking and also retail, Wipro focuses on R&D and engineering and HCL on infrastructure services. Most of the major multinational IT service providers have also set up operations in India to capitalise on the low-cost talent pool. We estimate that Indian IT companies have expanded their market share of global IT services from 4% in 2007 to 8% in We expect this growth to continue. The global market for IT services, estimated to be a USD600bn industry (source: Nasscom), has gone through various growth phases. The 1990s saw unprecedented growth for the IT industry worldwide. IT spending in the US grew from 3% of GDP in the early 1980s to 9% by 2000, creating demand that could not be met in-house. This led to outsourcing to other US-based vendors but an acute shortage of talent during the Y2K period led to work being done off-shore in emerging countries, especially India. We believe Europe is today where the US was in early 2000, with a lot of work still being done in-house, leaving huge potential for outsourcing. Another phase of growth came after the dot com bust of 2002, when companies started engaging in large and complex application development and maintenance (ADM). We believe the current growth phase will depend on factors such as cloud, mobility, analytics and big memory. Hence, we believe that even after 20 years of strong expansion there is still huge potential for the IT services and software business. New business opportunities and greater in-roads into Europe will fuel the next phase of growth in India. Key themes IT and information technology enabled service (ITES) companies have both cyclical (software licensing, consulting, system integration, R&D, restructuring) and non-cyclical (ADM, infrastructure services, testing services) business components. 5

6 Cloud, mobility, analytics and big memory Cloud, mobility, analytics and big memory are new areas of growth. Cloud eliminates the need for clients to invest in installing servers and customising solutions. The advent of devices like the ipad and smartphones has increased the need for mobility, allowing employees direct access to business applications. Companies are investing in analytics and big memory to analyse sales pattern in real time. M&A As clients increasingly want a complete range of services, cash rich IT companies regularly acquire small niche players to ramp up their technology offering. Establishing a presence in different regions is also a major reason for M&A and we expect further industry consolidation. New geographies In terms of outsourcing IT services, the US is the world s biggest market followed by Europe. The Asia Pacific and the Middle East are small but fast-growing markets. Europe has traditionally been conservative in adopting IT outsourcing/offshoring but recent contract wins suggest a huge growth opportunity is emerging. Sector drivers The large Indian companies have built their success on application development, maintenance and enterprise resource planning (ERP) implementation. The first growth phase (FY04-06, earnings CAGR 36%) took place in the early years of offshore outsourcing; the second cycle (FY06-08, CAGR 40%) was the golden era of outsourcing/offshoring. Some parts of the industry grew faster than others; banking, financial services and insurance (BFSI), ERP, retail and telecom were the growth accelerators during this period. The latest growth phase following the sub-prime crisis (FY10-12, CAGR 22%) was driven by banks looking to improve their financial performance by enhancing IT systems. In particular, M&A integration and regulatory and compliance requirements led to strong revenue growth from the banking sector. IT services companies The revenue model of IT services companies is based on the ratio of employees who are earning (i.e. the work they are doing is billed to clients). Hiring at the right time is critical. Delays can slow up billable projects, while hiring too many people in advance hurts the bottom line. It is also important to get the balance right between offshore and onshore projects. IT software companies Acquiring new customers is the key to growth as it provides opportunities to cross-sell products. New licences are a key growth barometer for software companies as this leads to revenues from maintenance and professional services. As costs do not increase in proportion to revenue, these companies generally have high margins. Companies need to invest in R&D to develop new products or improve their services. Key segments There are four major sub-segments software and software related services, IT services, engineering services and business process outsourcing (BPO). 6

7 Software and software related services Companies like SAP and Oracle develop enterprise-based solutions to integrate information flow across an entire organisation. This software is very complex and difficult to implement across the whole structure of the enterprise. IT services IT service providers help companies manage their IT infrastructure (maintaining their hardware and software), implementing complex software across the business, integrating the information exchange across the whole value chain and develop custom solutions/applications to make the system more efficient. Engineering services In order to be agile and innovative, engineering firms (excluding automotive, aerospace companies) outsource a range of upstream and downstream services that are not core to the firm. These upstream services include concept design, simulation and design engineering. The downstream engineering services include computer aided design and manufacturing, embedded software and localisation. BPO Companies outsource their non-core business operations such as maintaining customer service representatives, process management and data management functions which can be remotely managed by a third party at a lower cost. Retail banking, insurance, travel/hospitality and telecoms form the major customer industry segments. Voice and data are the major revenue earners for traditional BPO companies but recently knowledge process outsourcing (KPO) and legal process outsourcing (LPO) have been catching up. Valuation The traditional valuation metrics are forward-looking PE ratios. The Indian IT sector revenues rose at a CAGR of near 20% over FY10-12 (22% for the top four Indian companies). Large cap companies tend to trade at 12-month forward PE multiples of between 16x and 18x. The mid-caps historically trade at an average PE of 12x Asia IT (Software): Growth and profitability (calendarised data) e 2012e Growth Sales 19.3% -0.4% 25.3% 23.3% 7.4% EBITDA 21.1% 7.1% 27.0% 20.2% 6.5% EBIT 21.1% 7.1% 28.3% 21.0% 5.7% Net profits 8.8% 7.8% 25.6% 16.8% 5.2% Margins EBITDA 26.5% 28.5% 28.8% 28.1% 27.9% EBIT 23.9% 25.7% 26.3% 25.8% 25.3% Net profit 20.6% 22.3% 22.3% 21.1% 20.7% Productivity Capex/sales 5% 4% 4% 4% 5% Asset turnover (x) 1.5x 1.0x 1.0x 1.0x 1.0x Net debt/equity -0.4x -0.4x -0.4x -0.4x -0.4x ROE 49% 31% 29% 28% 27% Note: based on all HSBC coverage of IT (software) companies across Asia. All data is market cap weighted Source: company estimates, HSBC estimates 7

8 Sector snapshot Key sector stats IT (Software) 3% of MSCI Asia ex-jp Trading data ADTV (USDm) n/a Aggregated market cap (USDm) 79,694 Performance since 1 Jan 2000 Absolute 135% Relative to MSCI Asia 0.9x 3 largest stocks TENCENT, INFOSYS, TATA CONSULTANCY SERVICES Correlations (5-year) with MSCI Asia 0.85 Source: MSCI, Thomson Reuters Datastream, Bloomberg, HSBC Top 10 stocks Stock rank Stocks Index weight 1 TENCENT HOLDINGS 36.5% 2 INFOSYS 24.4% 3 TATA CONSULTANCY SERVICES 13.7% 4 NHN CORPORATION 10.4% 5 WIPRO 4.7% 6 NCSOFT CORP 4.0% 7 * 2.8% 8 SK C&C 1.5% 9 SATYAM COMPUTER 1.1% 10 HCL TECHNOLOGIES 1.0% *Removed for compliance reasons Source: MSCI, Thomson Reuters Datastream, HSBC Core industry driver: Enterprise software sales are a leading indicator of downstream IT service revenues 40% 30% 20% 10% 0% -10% -20% -30% -40% 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 Source: SAP, Oracle, HSBC PE band chart Price level SAP License y -o-y in cc Oracle DataBase & Middleware (y -o-y ) 25x 20x 15x 10x Country breakdown Country Weights (%) 100 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 India 44.8 China 39.3 Korea 15.9 Source: MSCI, Thomson Reuters Datastream, HSBC Source: MSCI, Thomson Reuters Datastream, HSBC PB vs ROE (12-month forward) Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Fwd ROE % (LHS) Fw d PB (x ) Source: MSCI, Thomson Reuters Datastream, HSBC 8