Indian IT Services - PL INDIA IT Services Global IT stocks Leap ahead; Time to Reboot for Indian IT...

March 09, 2017

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Indian IT Services

Global IT stocks Leap ahead; Time to Reboot for Indian IT

Sector Update Madhu Babu

[email protected] +91‐22‐66322300

Rating and Target price

Rating TP

Infosys BUY 1230

TCS Accumulate 2600

Wipro Reduce 500

HCL Tech BUY 990

Source: PL Research

Three year stock return of Global IT Stocks

58%

47%

43%

48%

40%

45%

50%

55%

60%

Atos

Accenture

CGI G

roup

Capgemini

Source: PL Research

Three year stock return of Indian IT stocks

9% 8%

‐18%

8%

‐20%‐15%‐10%‐5%0%5%

10%15%

TCS

Infosys

Wipro

HCL Tech

Source: PL Research

Indian IT services stocks have stagnated with tepid absolute returns over the past

three years, while global IT services stocks are on a roll. While Global IT services

vendors have delivered stable EBIT margin with a steady upward bias, Indian IT

vendors struggled to defend the forte on the margins. Acquisition strategy of

Global IT vendors has been tactical which included driving growth in Digital/ Cyber

Security, expanding geographic footprint and gaining scale. However, lacklustre

acquisition strategy has led Indian IT vendors fall behind the curve. We believe that

defending the margins could remain tough for Tier 1 IT vendors over FY18‐FY20E.

We believe that a good capital allocation could help companies in this phase of

transition. Our view is that Tier 1 vendors should have a consistent and steady

buyback plan. We believe that cash rich Tier 1 IT vendors should aim to trim their

sharecount by 10‐12% over a three‐four year period which could help boost the

earnings and drive re‐rating. Infosys and HCL Tech are our preferred large cap

picks. Hexaware and Persistent Systems are our midcaps. In this theme report we

analyse the impact of convergence in the IT services space.

Growth moderation at Indian IT: Accenture’s local currency revenue growth

guidance for FY17E is at 5‐8% local currency revenue growth which is almost

similar to revenue growth of Indian Tier 1 Vendors (TCS/Infosys set to report ~8‐

8.5% CC revenue growth for FY17E). This despite Accenture’s annual revenues at

~US$33bn almost twice the scale of TCS. We believe Indian IT sector is poised

for 7‐9% constant currency growth over FY18‐FY20E. With growth differential of

Indian IT narrowing v/s global peers ( Accenture), Indian IT stocks have seen a

reduction of growth premium in their P/E multiples. Hence, TCS/Infosys

currently trades at 15/25% discount to Accenture.

Acquisition strategy aided Global IT: Accenture’s growth outperformance is

being driven by robust traction in Digital, Cloud and Cyber Security which

accounts for 40% of Accenture revenues for FY16. Accenture spent over

US$2.4bn over three‐year period for ~50 acquisitions to boost Digital, Cyber

Security capabilities. Atos has scaled up over the past five years through strong

M&A strategy. Most recently, HP and CSC are merging the IT services business,

to transform into a much larger play. When compared to these, Indian IT

vendor’s acquisition strategies have remained tepid and company specific. Top

four companies (TCS/Infy/Wipro/HCL Tech) together spent USD2.6bn over FY14‐

9MFY17 for acquisitions. Indian IT vendors could have desisted from acquisition

in Digital owing to fear of margin dilution as well as cultural challenges in

integration. However, with Enterprise IT spend seeing a shift towards Digital; we

believe that a stronger consulting capability could remain key.

Margin differential narrowing: On a low base (8‐16% EBIT margin), global IT

services vendors have been showing gradual margin expansion. However Tier 1

Indian IT vendors (EBIT margin of 20‐26%) are struggling to defend margins.

While we expect global IT services companies to improve margins over FY18‐

FY20E, we see scope for margin challenges for Tier 1 IT. We believe that

Management and Investors are yet to realign expectations for a possible margin

correction over FY18‐FY20E.

March 09, 2017 2

Indian IT Services

Global IT services stocks hit Bulls eye, while Indian IT remain wayward

Exhibit 1: Stock price returns of Global and Indian IT companies

Company Brief Description Absolute stock price return in

three years

Absolute one year Stock price Return

Atos French IT services Major 58% 64%

Accenture Global IT services Major 47% 20%

CGI Group Canada Based IT Service Major 43% 9%

IBM Global IT major ( Services +Products) ‐4% 30%

CSC Global IT major based in USA 115% 125%

Capgemini French IT services Major 48% 9.2%

HP Enterprises Carved out separately one year ago NA 50%

EPAM Systems Belarus based IT vendor 100% 3%

TCS Indian IT major 9% 5%

Infosys Indian IT major 8% ‐12%

Wipro Indian IT major ‐18% ‐8%

HCL Tech Indian IT major 8% 2%

Source: Company Data

Over the last three years, TCS/Infosys/HCL Tech generated 9/8/8% absolute stock

price returns respectively, while Wipro declined by 18% on an absolute basis. In

sharp contrast, Global IT vendors delivered much better

returns. Accenture/Atos/CGI group/Capgemini delivered 47/ 58/43/48% return over

a three‐year period. Even, considering a one‐year stock return, major Global IT

services stocks trumped the Indian IT stocks by a wide margin. Our inference is that

FII’s would have suffered a huge opportunity cost by investing in Indian IT (v/s Global

IT) .What has led to this wide divergence?

We measure three factors which led to higher returns of Global IT vendors as compared to their Indian IT counterparts.

Margin Expansion by Global IT vendors v/s Stable to downward bias of Indian IT

vendors (despite Rupee depreciation)

Solid M&A strategy by Global IT vendors v/s lacklustre acquisition strategy by

Indian IT

Aggressive Dividend and Buyback policy of Global IT vendors

In this report, we analyze each of these factors in detail. Global vendors discussed in

this report include Accenture, Atos, Capgemini, HP Enterprises and CGI group.

March 09, 2017 3

Indian IT Services

Margin Trajectory: Global IT v/s Indian IT vendors

Global IT services vendors have been showing a steady margin improvement,

albeit on a low base. For example, HP enterprise EBIT margin came at 10.7% for

Q4FY16 v/s 5.1% in Q1FY16 (October year ending). Steady margin expansion has

helped in stock generating solid returns (up 50% in past one year). However, HP

Enterprises has showed some moderation in margin performance in recently

announced 1QFY17 results. Atos EBIT margin came at 9.4% for CY16 v/s 6.5%

in CY12. Margin improvement has aided in higher earnings growth for the

Global IT companies over CY13‐CY16. Most importantly, select companies within

global IT continue to guide for further margin expansion in CY17E/CY18E.

Exhibit 2: EBIT margin of Global IT vendors

EBIT Margin (%) CY13 CY14 CY15 CY16

IBM (Services Margin) 17.4 16.5 17.2 NA

Accenture* 15.2 14.3 14.5 14.6

HP Enterprises* 2.9 3.6 5.3 7.7

Capgemini 8.5 9.2 10.6 11.5

Atos 7.5 7.8 8.3 9.4

CGI Group * 10.7 12.9 14.2 14.6

Source: Company Data, PL Research *Note: Accenture has August 31st as year ending , HP Enterprises has October 31 st as year ending, CGI group has September year ending

On the contrary, Indian IT vendors are struggling to defend their already high

EBIT margins. The margin trajectory for Indian IT companies remains tepid

despite tailwinds from INR depreciation over the past six consecutive years.

Over FY14‐FY17E, Infosys EBIT margins remained relatively stable, while the

other three Tier 1 IT vendors showed erosion.

Exhibit 3: EBIT Margins of Indian IT Vendors v/s Average Exchange rate

FY11 FY12 FY13 FY14 FY15 FY16 FY17E

Average Rate (USD v/s INR) 45.5 48.1 54.5 60.7 61.2 65.6 67.1

EBIT margin (%)

Infosys 29.5 29.0 25.8 24.5 25.9 25.0 24.7

TCS 28.0 27.6 26.9 29.1 26.9 26.5 25.8

Wipro (IT services EBIT margin) 22.7 20.8 20.7 22.6 22.2 20.5 18.0

HCL Tech 14.0 16.3 20.1 24.1 22.2 20.4 20.3

Cognizant (Non GAAP) 20.3 20.2 20.6 20.2 19.7 19.5 NA

Source: Company Data, PL Research, * Cognizant is a CY ending company

Despite steep Rupee depreciation, Indian IT

vendors struggled to defend their EBIT

margins. However, Global vendors have

been showing steady EBIT margin

expansion albeit on a lower base

March 09, 2017 4

Indian IT Services

What’s aiding margin expansion at Global IT vendors?

Global IT vendors have focused on driving more work offshore as well as cost

rationalization. They have also focused on other restructuring initiatives which

include pruning high cost resource base, facility consolidation and mix shift in

business. We present the percentage of headcount in global delivery centres of

Accenture and Capgemini over the past few years.

Exhibit 4: Accenture’s % of headcount located in Global Delivery

41.6%45.8%

59.6%

66.2%71.7%

75%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

1QFY17

Source: Company Data, PL Research

Exhibit 5: Capgemini’s % of headcount located in Global Delivery

32.7%35.8%

38.7%41.6%

50.7%

56%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

55.0%

60.0%

CY11

CY12

CY13

CY14

CY15

CY16


Accenture has almost reached the effort mix which is similar to Indian IT vendors.

Accenture currently has 75% of its headcount in Global Delivery locations

(predominantly India and Philippines). Accenture has 295,381 employees in Global

Delivery centres. This is more than the absolute headcount of most of the Indian IT

vendors.

Exhibit 6: Accenture Total Headcount and Net additions

3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17

Total Headcount 293,529 305,882 318,700 323,278 336,092 358,458 372,507 372,579 375,490 383,735 394,083

Net addition 4,689 12,353 12,818 4,578 12,814 22,366 14,049 72 2,911 8,245 10,348

Global Delivery Headcount 194,502 205,235 218,188 225,878 237,149 256,846 270,271 272,745 276,363 285,240 295,381

GDM as a % of Total Headcount 66.3% 67.1% 68.5% 69.9% 70.6% 71.7% 72.6% 73.2% 73.6% 74.3% 75.0%

Source: Company Data, PL Research, Accenture has August 31 st as year ending

March 09, 2017 5

Indian IT Services

Capgemini has also been substantially boosting its base in India over the past few

years. I‐Gate acquisition has acted as a catalyst for further ramping‐up headcount in

India. As on CY16, Capgemini has a total headcount of 190,000 employees, of which,

56% are in Global delivery locations (vs. 13% as on CY06).

Capgemini also focused on hiring younger graduates and correcting the pyramid

structure. Capgemini’s guided that during CY15; ~42% of its gross additions were

young graduates.

“We have today more than 3,900 automation experts worldwide and we have done

automation work for more than 200 customer’s year‐to‐date. For example,

automating the monitoring of part of SAP managed service for a big client, we have

achieved 80% productivity improvement and we believe this part is scalable across

our entire SAP managed service landscape. We’re also leveraging our global

production centre, representing now 55% of our workforce to accelerate our growth

in Europe, with higher offshore adoption in France and the Netherlands. Our large

Indian platform is instrumental to our competitiveness.”

“Strong growth in offshore service in Nordic and Germany and we now think there is

more openness and appetite for equivalent service in Benelux and France. To the

example of the large deals signed which now starting to production. And for the first

time in France offshore leverage is exceeding 30%”. Extracts from Capgemini Concall

Transcripts on key levers which are driving margins

“Operating profit (for Enterprise services business) improved 250 basis points year

over year, to 10.7% in Q4FY16, the highest since Q4’09, team continues to execute on

productivity improvements in delivery and sales. For the full year, we delivered

operating margins of 7.7%, well above our original guidance of 6‐7%. We continue to

track against our longer‐term goal of 60% headcount in low cost locations and

completed the quarter with 51% of our headcount in low cost locations” extracts

from HP Enterprises Q4FY16 concall

Our inference is that similar strategies (operational efficiencies, pruning low margin

deals, automation, higher offshoring, restructuring high cost resources and facility

consolidation) have aided margin expansion for global IT services companies. Our

view is that margin expansion could continue over next two years for global IT

service companies. This would be driven by pruning high cost resource base, higher

market share in Digital, Cloud, Cyber security, improving efficiency in execution and

higher offshoring.

HP Enterprises has seen a strong

improvement in margin trajectory in CY16

which aided in solid stock price returns.

Post its merger with CSC, the combined

entity continues to aim at further margin

expansion

March 09, 2017 6

Indian IT Services

Indian IT vendors facing multiple margin headwinds

Select Indian IT vendors (TCS/Infosys) operate at 2x the EBIT margin profile of global

IT vendors. Over the past few years, Indian IT vendors had increased onsite

Investments, expanded onsite delivery centres, and took over onsite headcount as

part of deals. Apart from this, IT companies (Wipro,Tech M, Mindtree) have also

acquired onsite centric companies. These factors, coupled with other operational

headwinds (pricing pressure, subcontracting expenses), led to Indian IT vendors

struggle on margin front despite steep currency tailwinds ( INR depreciated by over

45% vs USD in a span of six years). Key headwinds for margins for Indian IT vendors

include:

Pricing pressure in traditional services (which accounts for 50‐60% of total

revenues)

Taking over deals which involve rebadging of onsite employees (HCL Tech

margins suffered led by deals which had onsite rebadging).

Onsite centric acquisitions (Tech M /Mindtree’s margins tumbled led by onsite

acquisitions)

Constrains on visas leading to increasing subcontracting costs.

We elaborate few of these margin headwinds in detail.

Pricing Pressure hurting traditional IT services

Offshore pricing is under tremendous pressure which is leading to revenue leakage.

Infosys/Mindtree are the only vendors which report realisations separately

(Onsite/Offshore realisations). As on Q3FY17, Infosys offshore realisations stood at

US$22.2 per hour (v/s US$25.6per hour in Q1FY15). This represents a 14% drop in

offshore pricing in a period of 11 quarters. This clearly indicates the quantum of

pressure in offshore revenues led by pricing pressure. Over the same period, delivery

costs continued to increase owing to regular salary hikes and wage inflation. Even on

a constant currency Index pricing, Infosys offshore realisation is down 7.7% as on

Q3FY17 (v/s Q1FY15 offshore realisation). Mindtree’s offshore realisation stood at

US$17 per hour as on Q3FY17 (v/s US$19.8 per hour as on Q1FY15). This represents

a 15% drop in offshore realisation over 11 quarters. Hence, offshore volume growth

has not translated to commensurate revenue growth.

Infosys offshore pricing as on Q3FY17 has

dropped by 8% compared to Q1FY15.

Hence, offshore volume growth has not

been able to translate to commensurate

revenue growth

March 09, 2017 7

Indian IT Services

Exhibit 7: Infosys Offshore realisation per employee per month

4516 4317

4047

4024

3948 3906

3600

3800

4000

4200

4400

4600

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17

(US$)


Exhibit 8: Mindtree Offshore realisation per employee per month

3498

3528

32893264

2993

3007

2600

2800

3000

3200

3400

3600

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17

(US$)


Exhibit 9: Infosys realisation per employee in CC ( QoQ)

‐0.6%

0.4%

‐2.4%‐2.0%

‐2.3%

3.2%

‐2.4%

‐0.8%‐1.4%

0.2%0.3%

‐3.0%

‐2.0%

‐1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17


Exhibit 10: Mindtree realisation per employee in USD (QoQ)

‐0.5%

‐1.5%

2.4%

‐3.9%‐3.0%

‐1.4%

0.6%

‐4.0%‐4.5%

0.5%

‐0.1%

‐5.0%

‐4.0%

‐3.0%

‐2.0%

‐1.0%

0.0%

1.0%

2.0%

3.0%

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17


Uptick in subcontracting expenses also weighed on margins

Owing to limited H1B visas and high demand, Indian IT vendors have faced a

shortage of visas and hence had to rely on onsite subcontractors. This has also been

a margin headwind for Indian IT over FY13‐FY16.

Subcontractors are usually more expensive compared to employees sent on H1B

visas. Indian IT vendors might hire subcontractors directly or through agencies

and staffing companies which present additional costs. Subcontractors also

charge on an hourly basis and costs of subcontractors are 15‐20% more

expensive. For Infosys, Subcontracting expenses as a percentage of sales stood

at 6.8% for FY16 (v/s 3.7% as on FY12).

March 09, 2017 8

Indian IT Services

Exhibit 11: Infosys v/s TCS subcontracting costs (as a % of sales)

5.1% 5.3%

3.8%

5.5%

6.3%

7.5%

6.4%6.6%

6.2% 6.4% 6.6%7.2% 7.2%

7.7% 7.8%7.5%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

Q1FY14

Q2FY14

Q3FY14

Q4FY14

Q1FY15

Q2FY15

Q3FY15

Q4FY15

Q1FY16

Q2FY16

Q3FY16

4QFY16

1QFY17

2QFY17

3QFY17

Infosys TCS


Deals involving Re‐badging of Onsite Employees: Indian IT vendors took over

deals which involved re‐badging onsite employees. This has also been a major

margin headwind for select vendors. With an aim to expand service footprint,

vendors focused on onsite acquisitions. While this has boosted competencies, it

weighed on margin trajectory. Midsized IT vendors like Mindtree suffered as its

margins tumbled post onsite acquisitions (Bluefin and Magnet).

Despite a 44% drop in INR v/s USD over the past six years, Indian IT vendors

EBIDTA margins remained static with a downward bias. We believe margin

challenges are likely to remain over FY18‐FY20E predominantly led by scope for

increased onsite intensity in the business.

Margin headwinds remain an overhang for Indian IT over FY18‐FY20E

Much of the noise in the sector over the past four months has been the possible

restrain on H1B visas on Indian IT companies. We analyze the same in detail.

While there are limited H1B visas (65,000 per year+ additional 20,000 visas for

Masters Degree), the demand has far outstripped supply. This leads the USCIS to

rely on random lottery system for visa allocation. For FY17, USCIS received over

236,000 applications for H1B visas (v/s 65,000 available visas).

March 09, 2017 9

Indian IT Services

Exhibit 12: Number of days taken to reach Visa cap limit

301

236

72

5 5 50

50

100

150

200

250

300

350

FY12

FY13

FY14

FY15

FY16

FY17

Number of days taken to reach Cap


High demand for H1B visas led to the cap being reached within the first week of

opening of the H1B window (April 1 st of every year). Indian IT vendors have been

one of the major users of H1B visas over the past several years. We present the data

of new H1B visas given in 2015 for various corporations. For FY16, Indians got ~70%

of the total H1B visas issued by North America. TCS, Cognizant, Accenture Wipro,

Infosys were the top five users of new H1B visas in 2015.

March 09, 2017 10

Indian IT Services

Exhibit 13: New H1B Visa issued in 2015 for different corporations

New H1B visas issued in 2015

TCS 4,674

Cognizant 3,812

Accenture 3,385

Wipro 3,079

Infosys 2,830

IBM 1,919

Tech Mahindra 1,576

HCL America 1,339

Deloitte 1,203

Amazon 1,058

Syntel 1,050

Microsoft 961

Google 833

Ernst & Young 663

Larsen & Toubro Infotech 649

PricewaterhouseCoopers 647

Intel 628

Capgemini 548

Apple 532

I Gate 532

Oracle 493

Mindtree 464

Facebook 408

JPMorgan Chase 295

UST Global 287

Mphasis 274

Cisco 267

Yahoo! 251

Goldman Sachs 243

NTT Data 220

Source: Company Data, PL Research, U.S. Citizenship and Immigration Services; National Foundation for American Policy.

A part for new H1B visas, companies also file for extension of H1B visas (The

H1B visa is issued for three years and gets an additional three year extension).

Cost of H1B visa has increased over the years: The cost of H1B visa has steadily

increased over the years owing to various additional levies by the US

government. We note that cost of H1B visa is now at ~US$6325 to US$8000 per

person for a new initiation for most of the Indian IT companies. The break‐up of

the H1B visa cost is shown below.

March 09, 2017 11

Indian IT Services

Exhibit 14: Various costs included for H1B Visa

Fee type Fee in USD Details

Base filing fee $325 For every petition

AICWA Fee (American Competitiveness and Workforce Improvement Act of 1998)

$750 or $1,500 $750 – for employers with 1 to 25 full time employees. $1500 – for employers with 26 or more full time equivalent employee )

Fraud prevent & detection fee $500 Only applies to New H1Bs and Change of employer’s petitions only. Does not apply to Chile and Singapore based H1B1 petitions

Fee based on Public Law 114‐113 $4,000 Applicable, if 50 or more employees and more than 50% of employees are on H1B or L1 Visa status, required for new H1B filing and change of employers.

Premium processing fee (Optional) $1,225 For faster adjudication within 15 calendar days. As per this year’s press release, USCIS will consider the 15 day clock from starting from no later than May 16th.

Immigration Attorney Fee Varies from $500 to $3000

This varies depending on the attorney. This fee applies to companies that work with third party immigration attorneys for filing the H1B Visa petitions. Some large organizations have in‐house attorneys. If the employer does not have any in‐house attorney, it would cost them anywhere from $500 to $3000.


There is a scope for Trump administration to further increase H1B visa fees for

H1B dependent companies. This could be an additional cost headwind for the

sector.

H1B visas are crucial for Indian IT companies as a part of the business model.

Infosys has 14,659 employees on H1B visas and 1364 employees in L1 visa (Data

from Infosys annual report) as on FY16.

Onsite effort for IT services is ~20‐25% for Indian IT vendors (rest is offshore).

Onsite effort per project can vary based on the service line of the project, client

requirements etc. Any restrictions on issuing fresh H1B visas or renewals of

existing H1B visas, increase in H1B visa fees, and increase in minimum wage

requirement for H1B visa employees could be a cost headwind for the sector.

The H1 window for FY18 would open on April 2017 and we see continued strong

demand this season as well. However, companies have already stepped up

initiatives on local hiring. We believe increased onsite hiring would be a margin

headwind for the sector over FY18‐FY20E. This is because onsite effort has lower

gross margins (vs. offshore). We also see scope for negative impact on onsite

utilisation owing to increased local hiring which would also be a margin

headwind. We believe that Indian IT vendors might aggressively focus on other

counter levers to negate the headwinds from onsite hiring. This would include

aggressive pyramid correction in offshore, rationalizing mid and upper end of

the management and further enhancing focus on automation initiatives.

March 09, 2017 12

Indian IT Services

Deals with Rebadging could also increase: There has been constant rhetoric in

the American media that Americans have lost jobs and wages are depressed for

Tech employees owing to cheaper staff coming from India on H1B visas. We

note the media rhetoric on layoffs at Disney and Southern Edison in which local

employees were replaced by H1B visa holders from Indian IT vendors has got

wide attention. We believe that corporations would be careful under

the Trump administration to avoid such situations as it could result in a major

backlash. Hence, we believe that Indian IT vendors would have to re‐badge

onsite employees as a part of deals. This could also remain a margin headwind.

Ceteris paribus, a 1% effort mix shift towards onsite hits gross margin by ~40‐

50bps. We also note that any restriction on H1B visas might heat up of the US

Tech job market which could put upward pressure on onsite salaries and hence

increase onsite salary costs for Indian IT vendors. Considering the strong

competitive intensity in the sector, Indian IT vendors might not be able to pass

these cost headwinds to clients in terms of higher billing rates

We note sector already has been suffering from margin challenges over the

past three years. However, steep rupee depreciation has been enabling

companies report a decent margin print.

Exhibit 15: Infosys and TCS EBITDA Margins (%)

24.0%

26.0%

28.0%

30.0%

32.0%

34.0%

1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17

Infosys TCS


March 09, 2017 13

Indian IT Services

Exhibit 16: Wipro (Consol) and HCL Tech EBITDA Margins

18.0%

20.0%

22.0%

24.0%

26.0%

28.0%

1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17

Wipro ( Consolidated) HCL Tech

Source: Company Data, PL Research * Wipro EBIDTA margin show in the above exhibit is the consolidated EBIDTA margin ( Includes IT products business).

Exhibit 17: USD v/s INR Average rate over the past few quarters

56.6

62.8

62.0

61.5

59.9

60.662.2

62.163.6

65.4

66.1

67.7

67.1

66.9

67.7

51.0

54.0

57.0

60.0

63.0

66.0

69.0

1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17


March 09, 2017 14

Indian IT Services

How would market react if TCS resets the margin band to lower levels?

TCS currently has a stated EBIT margin guidance band of 26‐28% and company has

been operating in this EBIT margin guidance band for over the past six years. With

softening USD revenue growth trajectory (~8.5% cc growth for FY17E), we believe

company is now in the growth‐margin trade‐off zone. TCS has the option to lower

the EBIT margin guidance band to 24‐26% and drive incremental investments to

chase growth. Incremental growth drivers could be further chasing emerging market

deals (especially in India, Latin America, Middle East where the margins could be

lower), increasing investments in Digital initiatives either organically or through

acquisitions. We believe that lowering margin guidance would not be a bad idea if it

can provide incremental impetus to the growth trajectory of the company and retain

absolute PAT growth CAGR over FY18‐FY20E. However, recent management

commentary post 3QFY17 results suggest that it would to continue to focus on

operating at the 26‐28% EBIT margin guidance band.

Exhibit 18: TCS Consolidated financial model

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E

USD Revenues (USD mn) 6,339 8,186 10,171 11,568 13,443 15,454 16,544 17,620 19,302 21,223

Growth (%) 5.4% 29.1% 24.2% 13.7% 16.2% 15.0% 7.1% 6.5% 9.5% 10.0%

Average Exchange Rate(USD/INR) 47.4 45.6 48.0 54.5 60.8 61.2 65.6 67.4 67.0 66.0

Revenues (Rs bn) 300 373 489 630 818 947 1087 1187 1293 1401

Growth (%) 8.0% 24.3% 31.0% 28.8% 29.9% 15.7% 14.8% 9.2% 9.0% 8.3%

EBIT (Rs bn) 80 104 135 170 238 254 288 306 336 364

EBIT margin (%) 26.8% 28.0% 27.6% 26.9% 29.1% 26.9% 26.5% 25.8% 26.0% 26.0%

PAT (Rs bn) 70 91 104 139 192 217 242 264 286 311

PAT Growth 33.2% 29.5% 14.8% 33.6% 37.6% 13.3% 11.6% 8.9% 8.6% 8.6%

EPS 35.7 46.3 53.2 71.1 97.8 108.8 123.2 133.8 145.4 157.9

EPS Growth (%) 32.8% 29.9% 14.8% 33.6% 37.5% 11.2% 13.2% 8.7% 8.6% 8.6%


“As I always said, the philosophy has been to go for growth but not at the cost of

margin. We believe that compromising on either one of those, thinking that the

other one will come, will result in us end up losing both.” TCS Board chairman N

Chandra in 3QFY17 concall.

March 09, 2017 15

Indian IT Services

Non‐linearity yet to show up in a big way

While Automation has been the focus area over the past two years, we believe that

focus should further intensify on this front. Hiring trends remain company specific.

As on 9MFY17, net employee addition of top 5 IT companies combined stood at

69,986 (v/s 58,190 employees in 9MFY16). However, most of the net addition for

9MFY17 was driven by hiring at Cognizant. Cognizant hired 27,200 employees for

9MFY17 (v/s 4,000 employees in 9MFY16).

Exhibit 19: Total combined Headcount of Top 5 vendors and Headcount growth YoY (%)

832 846 855 876 893 929

957 976 990 1,017 1,034

1,059 1,085

1,111 1,129

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

700

800

900

1,000

1,100

1,200

1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17

'000s

Total Headcount (Top Five IT combined) YoY growth (%) (RHS)


Exhibit 20: Headcount of Top 5 Indian IT Vendors

Headcount FY12 FY13 FY14 FY15 FY16 9MFY17

Infosys 149,994 156,688 160,405 176,187 194,044 199,763

TCS 238,583 276,196 300,464 319,656 353,843 378,497

Wipro 135,920 145,812 146,053 158,217 172,912 179,129

HCL Tech 82,464 84,403 90,190 104,184 104,896 111,092

Cognizant 140,500 162,700 178,600 217,700 233,000 260,200

Total Headcount 747,461 825,799 875,712 975,944 1,058,695 1,128,681


Among Tier 1 peers, Infosys has shown the strongest efficiencies on automation.

Infosys net addition stood at 5,719 employees for 9MFY17 (v/s 17,196

employees added in 9MFY16). This represents a 66% drop in net addition for

9MFY17. For the 9MFY17, Infosys USD revenues grew by 8.2% YoY.

March 09, 2017 16

Indian IT Services

Exhibit 21: Net additions of Indian IT vendors

FY12 FY13 FY14 FY15 FY16 9MFY17

Infosys 19,174 6,694 3,717 15,782 17,857 5,719

TCS 39,969 37,613 24,268 19,192 34,187 24,654

Wipro 13,535 9,892 241 12,164 14,695 6,217

HCL Tech 9,044 1,939 5,787 13,994 712 6,196

Cognizant 29,300 22,200 15,900 39,100 15,300 27,200

Total Net additions 111,022 78,338 49,913 100,232 82,751 69,986


Exhibit 22: Combined USD Revenue Growth YoY (%) Vs Headcount growth (YoY%)

5.0%

7.0%

9.0%

11.0%

13.0%

15.0%

17.0%1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17

Revenue growth (%) Headcount Growth (%)


Over the past few quarters, both Revenue and Headcount growth has been

moderating in the sector. For Q3FY17, combined revenues of Top 5 IT companies

(TCS/Cognizant/Infosys/Wipro/HCL Tech) stood at US$14.04bn, up 6.5% YoY.

Assuming a cross‐currency headwind of ~200bps, we can assume that revenues for

the top five IT companies combined would have grow by ~8.5% YoY. The Headcount

for the top five IT companies combined stood at 1.12mn up 9% YoY.

We believe vendors have to focus on further moving utilisation rates upwards and

drive a lean operating model. Vendors are also aggressively deploying bots and other

automation tools to drive productivity. Hence, net addition in the sector could

continue to moderate over FY18‐FY20E.

March 09, 2017 17

Indian IT Services

Solid M&A strategy by Global IT vendors

Global IT vendors have been tactical in capital allocation which has also contributed

to their outperformance v/s Indian IT counterparts. While some Global IT vendors

chose to invest in acquisitions targeted at growth segment (Digital, Analytics, and

Cloud Implementation), few others (Atos, Capgemini CGI) used capital allocation to

gain scale and expand geographic reach.

Apart from acquisitions, select vendors have also hived off and sold commoditized

offerings (IBM exited BPO operations as well as sold some of its commoditized

Hardware Businesses). We present the revenue growth performance of global IT

vendors. Atos and Capgemini have also done strategic acquisitions which aided

higher revenue growth and achieved scale. While organic growth for both these

companies was in the range of 0‐2% over CY15/CY16, acquisition aided these

companies to report higher overall revenue growth.

Exhibit 23: Revenue growth for Global IT vendors

Revenues (USD bn) CY13 CY14 CY15 CY16

Global IT vendors

IBM Global Services 56.9 54.9 49.1 NA

Growth (%) (3.1) (3.6) (10.4) NA

IBM Total revenues 99.6 92.7 81.7 79.9

Growth (%) (4.7) (7.0) (11.9) (2.2)

Accenture* 28.6 30.0 31.0 32.9

Growth (%) 2.5 5.1 3.4 5.9

Local Currency growth (%) 4.0 5.0 11.0 10.5

HP Enterprises (Services Revenues only) 23.6 22.3 19.8 18.8

Growth (%) (5.5) (11.2) (4.7)

Capgemini 11.1 11.6 13.1 13.8

Growth (%) (1.7) 4.8 12.7 5.5

Atos 9.5 10.0 11.8 12.9

Growth (%) (2.6) 5.1 18.1 9.7

CGI Group 7.76* 8.08 7.91 8.2

Growth (%) 111.3 4.1 (2) 3.9

Source: Company Data, PL Research * Accenture follows August 31st year ending, Atos and Capgemini revenues are converted to USD at rate of (Euro to USD @1.1 uniformly across all years). Logica acquisition aided higher growth in CGI group revenues in CY13. Acquisitions also contributed to revenue growth at Accenture, Atos, CGI and Capgemini

March 09, 2017 18

Indian IT Services

Exhibit 24: YoY Revenue Growth of Global IT vendors (%)

CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14 CY15 CY16

IBM* 11.9 9.0 (6.4) 3.2 6.8 (2.1) (3.1) (3.5) (10.3) NA

Accenture 13.0 11.0 0.0 (2.0) 15.0 11.0 4.0 5.0 11.0 10.5

Capgemini 13.0 0.0 (3.8) 3.9 11.5 5.9 (1.7) 4.8 12.7 5.2

Atos Orgin 8.5 (4.0) (8.8) (2.1) 35.7 29.8 (2.6) 5.1 18.1* 9.5*

Source: Company Data, PL Research * For IBM, we have presented the services business only, Acquisitions contributed to higher growth in Atos Origin in CY11/CY12/CY15/CY16. For CY16, Atos Origin, organic growth is 1.8%.

Accenture: Accenture spent US$2.45bn in the past three years to acquire over

50 companies. Accenture indicated that 70% of the investments in acquisitions

were in boosting the new service offerings. The acquisitions aimed to

strengthen growth segments which include Cloud, Cyber Security, Analytics, and

UX Design etc. The M&A strategy has clearly yielded results with Accenture

growth over the last two years predominantly being driven by the Consulting.

Exhibit 25: Accenture acquisitions in the last few years

Company acquired

Period of acquisition

Rationale

Javelin group

May‐15 Expand footprint in Retail Industry (Strategic Consulting and Digital Transformation)

BrightStep Jun‐15 Digital Consulting company based on Digital Content

Tquila May‐15 Sales force Implementation capabilities Europe

Gapso Mar‐15 Advanced Analytics Capabilities in Brazil

Reactive Media

Dec‐14 Expand Digital Design capabilities in Australia and New Zealand

Axia Apr‐15

Strengthen expertise in cost management capabilities


With Digital being one of the incremental growth drivers, Accenture has been

able to garner substantial mindshare from clients with robust offerings in these

areas. Hence, Accenture appears to better mine the accounts which is leading to

steady downstream revenues in outsourcing segment as well.

“Approximately 70% of these investments (acquisition related) were in “the

New.” Key examples in fiscal 2016 included Cloud Sherpas, a leading cloud

advisory and services provider; IMJ Corporation, one of Japan’s largest digital

marketing agencies and several European digital services companies, including

MOBGEN in the Netherlands, Tecnilógica in Spain and dgroup in Germany. We

are also investing to enhance our expertise in key industries through

acquisitions such as Sagacious Consultants in Health, Beacon Consulting and

Formicary in Capital Markets and Schlumberger Business Consulting and

Cimation in Energy” Extracts from Accenture Annual Report.

We note that 70% of Accenture’s

acquisitions are focused on “New

Technologies” which include Cloud, Digital

and Cyber Security

March 09, 2017 19

Indian IT Services

Exhibit 26: Consulting revenues and consulting as a % of revenues for Accenture (USD bn)

50.0%

52.0%

54.0%

56.0%

3.0

3.5

4.0

4.5

5.0

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

(US$ bn)

Consulting revenues As a % of Total Revenues (RHS)


Exhibit 27: Consulting Growth of Accenture in Local currency

0%

5%4%

7%

11% 11%

14%15%

18%16%

13%

7%

0%

5%

10%

15%

20%

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17


Accenture has launched “Accenture Digital” by combining capabilities in

Accenture Interactive, Accenture Analytics and Accenture Mobility. Revenues

from Digital, Cloud and CyberSecurity contributed US$13.5bn annually

representing 40% of total revenues and are showing robust traction growing

30% YoY.

Exhibit 28: Similar acquisition strategies done by other MNC vendors

Year Company Acquired Amount Spent Rationale

Atos Dec‐10 Siemens IT US$1.1bn Increase Scale and Expand in Germany and Eastern Europe

Atos May‐14 Bull US$844mn Expand in Cloud and Cyber Security

Atos Nov‐15 Unify US$373mn Strengthening Collaboration business

Atos Jul‐15 Xerox ITO US$966mn expand into American Market

IBM Mar‐16 Bluewolf US$200mn Design and Cloud Services ( Sales force market)

IBM Jan‐17 Agile 3 NA Cyber security

IBM Truven Health US$2.6bn Patient Data and analytics

IBM Oct‐15 CleverSafe US$1.3bn Hybrid Cloud Competency

Capgemini Apr‐15 Igate US$4bn Expand into North American clients and boost Global Delivery

Capgemini June‐11 Praxis Technology NA Expansion into Chinese market

Capgemini Sep‐10 CPM Braxis, Expansion into Brazil

CGI Smith May 12 Logica US$2.8bn Expand presence in Europe


Most of the acquisition strategies of Global IT vendors were focused on Digital,

Cyber security and Cloud. This has led to Global IT vendors gain a higher client mind

share on the Digital Consulting Business. Global IT services companies also pursued

tactical acquisitions to expand into geographies and gain scale (M&A strategy of Atos

and CGI).

March 09, 2017 20

Indian IT Services

Exhibit 29: Rating of Digital Strategy Consulting by a Leading Consulting


As per the IDC report, leaders in Digital Consulting include IBM, McKinsey,

Accenture, Deloitte and Globant. Most of the players in Digital Consulting remain

dominated by Global IT companies. We believe that a strong acquisition strategy

has favoured Global IT vendors.

HP+CSC = Scale and Cost Synergies

While Accenture’s acquisition strategy was focused on boosting Digital, select other

global vendors focused on merger to drive scale and provide cost synergies. In May

2016, HP Enterprises and CSC announced a merger to create a global IT services

conglomerate. The Combined entity would have revenues of US$26bn annually (HP

Enterprises annual revenues at US$18bn for FY16 and CSC had annual revenue of

US$7.1bn for FY16 (April year ending). HP Enterprises and CSC have a headcount of

~1,30,000 employees and 59,000employees respectively. The combined headcount

of the merged entity would be ~190,000 (Of this ~45,000‐50000 would be in India).

While the deal is expected to close in March 2017, the combined entity would have

cost synergies of ~US$1bn per year. Both the stocks generated strong returns in

CY16 aided by this consolidation move.

“We will be able to consolidate delivery centres and leverage our position in India

and China and Costa Rica and other places” HP Enterprises CEO comments on the

deal with CSC.

Digital Strategy Consulting space continues

to be dominated by Global vendors which

include Accenture, IBM, Globant, Deloitte

and McKinsey

March 09, 2017 21

Indian IT Services

On the contrary, Capital allocation of Indian IT companies has remained company‐

specific. While Wipro has been most aggressive in acquisitions, TCS has been the

least. Tech M was also aggressive on M&A strategy but had some disappointments

on this front led by weak performance in LCC acquisition which dragged the

profitability of the company. HCL Tech’s partnership with IBM for the IP products

appears expensive in our view. HCL Tech guided that it would derive US$160mn in

annual revenues from IBM IP and spent US$550mn for acquiring the same. This

implies that the acquisition of IBM IP revenues was done at a P/S of 3.3x. Infosys’

major acquisitions over the past two years include Panaya, Skava and Noah

Consulting.

Exhibit 30: Acquisitions done by Indian IT companies

Vendor Year Company Acquired Amount Spent Rationale

Tech Nov‐14 LCC USD240mn Strengthen Network practice for the Telecom Vertical

Tech M Dec ‐15 Pininfinarina USD28mn Automotive design capabilities

Tech M May 16 Target USD164mn Platform offering in BFSI, Strengthen Tech M Positioning in UK Banking

Tech M Jan‐15 Softgen USD40mn Delivering Solutions in and around Core Banking

Wipro Jun‐15 Designit USD95mn Digital Design ( User Experience, Interactive Design)

Wipro Feb‐16 Healthnet USD460mn Business platform as a service for Healthcare

Wipro Oct‐16 Appirio USD500mn Implementing Cloud Services with competency in SalesForce

Infosys Feb‐15 Panaya USD200mn Strengthen Automation and Platform Initiatives

Infosys April‐15 Skava USD120mn Strengthen Platforms business of Infosys

Infosys Oct‐15 Noah USD70mn Strengthen Consulting Capabilities for the Oil and Gas Industry

Source: Company Data, PL Research * For Pininfarina, we note Tech would spent US$28mn for 76% stake and has also infused money into it

On the Digital front, we believe that Wipro is the only vendor which has done

sizeable acquisitions to boost capabilities on this front (Designit and Appirio). Select

other acquisitions of Indian IT vendors were aimed at boosting as As a Service

offerings (Health Net, Target etc).

Global IT companies have shown a clear edge over Indian IT counterparts on the

acquisition strategy. In our view, one limitation of Indian IT companies to

aggressively chase acquisition could be the possible dilution of margins as well as

cultural challenges which could lead to turbulence post acquisition.

March 09, 2017 22

Indian IT Services

Focus shifts on Capital Allocation Strategy

With growth moderating in the sector, focus has shifted to capital allocation

strategy. During the phase when USD revenue growth remained strong, investors

have not complained much on the high cash component on balance sheets.

However, growth slowdown over the past two years has led the focus to shift on

capital allocation. With strong demand from investors, sector has seen a slew of

companies doing tender offer based buybacks

(TCS/Wipro/Hexaware/Eclerx/Mphasis).

Exhibit 31: Total revenues of top‐5 Indian IT vendors (USD bn) v/s Revenue growth

7.9 8.6 8.9

9.5 10.1

10.9 11.5

12.2 12.7

13.2 13.9 14.0

4.0%

9.0%

14.0%

19.0%

24.0%

29.0%

34.0%

7.0

8.0

9.0

10.0

11.0

12.0

13.0

14.0

1QFY12

2QFY12

3QFY12

4QFY12

1QFY13

2QFY13

3QFY13

4QFY13

1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17

(US$ bn)

Total Revenues YoY gr. (RHS)


Exhibit 32: Combined USD Revenue growth of top‐5 Indian IT vendors (YoY growth)

28.1%

22.9%

18.4%

15.7%

11.7%10.2%

11.1%12.2%

14.3%15.4%

14.2%13.6%13.4%12.3%11.8%

10.2%10.6%10.0%8.3% 8.9% 9.0%

7.2% 6.5%

6.0%

11.0%

16.0%

21.0%

26.0%

31.0%

1QFY12

2QFY12

3QFY12

4QFY12

1QFY13

2QFY13

3QFY13

4QFY13

1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17


March 09, 2017 23

Indian IT Services

Exhibit 33: Revenue and revenue growth of top vendors

Fig in USD mn 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17

Infosys 2,133 2,201 2,218 2,159 2,256 2,392 2,407 2,446 2,501 2,587 2,551

QoQ Growth (%) 2 3.2 0.8 (2.7) 4.5 6 0.6 1.6 2.2 3.4 (1.4)

TCS 3,694 3,929 3,931 3,900 4,036 4,156 4,145 4,207 4,362 4,374 4,387

QoQ Growth (%) 5.5 6.4 0.1 (0.8) 3.5 3 (0.3) 1.5 3.7 0.3 0.3

Wipro 1,740 1,771 1,795 1,774 1,794 1,832 1,838 1,882 1,931 1,916 1,903

QoQ Growth (%) 1.2 1.8 1.4 (1.2) 1.1 2.1 0.3 2.4 2.6 (0.8) (0.7)

HCL Tech 1,407 1,433 1,491 1,491 1,538 1,545 1,566 1,587 1,691 1,722 1,745

QoQ Growth (%) 3.4 1.8 4 ‐ 3.2 0.5 1.4 1.3 6.6 1.8 1.3

Cognizant 2,517 2,581 2,742 2,911 3,085 3,186 3,232 3,202 3,370 3,450 3,462

QoQ Growth (%) 3.9 2.5 6.2 6.2 6 3.3 1.4 (0.9) 5.2 2.4 0.3

Total Revenues 11,491 11,915 12,177 12,235 12,709 13,111 13,188 13,324 13,855 14,049 14,048

QoQ Growth (%) 3.5 3.7 2.2 0.5 3.9 3.2 0.6 1 4 1.4 ‐

YoY Growth (%) 13.4 12.3 11.8 10.2 10.6 10 8.3 8.9 9 7.2 6.5


Capital allocation strategy of Accenture and Infosys

Accenture’s high ROE led by superior capital allocation

We have analysed key metrics in Accenture’s cash flows over the past four years. We

note that Accenture has been spending more than what it generates from FCF for

buybacks and dividends. This superior capital allocation has helped Accenture in

enjoying superior ROE of 60% for FY16. Accenture has been seeing a net reduction in

cash on balance sheet over the past few years. As on FY16, Accenture Cash on

balance sheet stands at US$4.9bn (v/s US$6.6bn cash as on FY12).

Exhibit 34: Key items in Accenture consolidated cash flows

Fig in USD mn FY13 FY14 FY15 FY16

Net cash provided by operating activities 3303 3486 4092 4575

Purchases of property and equipment (Capex) (370) (322) (395) (496)

Free Cash Flow from Operations 2,934 3,164 3,697 4079

Amount spent for Acquisitions (804) (740) (792) (932)

Free Cash Flow post acquisitions 2,130 2,424 2,905 3147

Share buyback (a) (2,544) (2,559) (2,453) (2,604)

Cash dividends paid (b) (1,122) (1,255) (1,353) (1,438)

Amount Spent on Buyback and Dividend (3,666) (3,814) (3,806) (4,042)


However,Accenture’s absolute share count has not seen major reduction over the

years as Buyback strategy helped absorbed the dilution impact which has been

created from ESOPs. We present sharecount of Accenture and Cognizant.

March 09, 2017 24

Indian IT Services

Exhibit 35: Share Count of Accenture and Cognizant (mn)

Accenture (mn) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Basic 610 623 639 647 643 645.5 634.2 626.7 624.7

Diluted 823 785 766 738 726 712.7 692.3 678.7 667.7

Cognizant (mn) CY08 CY09 CY10 CY11 CY12 CY13 CY14 CY15 CY16

Basic 580.2 586.6 601.4 606.6 602.6 604 608.1 609.1 607

Diluted 597.8 602.2 618.26 620.7 611.7 609.7 612.5 613.3 610


On the contrary, despite already having a strong net cash position, Infosys continues

to see further cash accretion to its balance sheet which is dragging ROE. Despite

Infosys indicating 50% dividend payout ratio guidance, this translates to only 70‐80%

of free cash flows being paid in the form of dividend. We believe that Infosys should

start paying 100% FCF generated from here‐on as dividend. This would aid an

improvement in the return ratios.

Exhibit 36: Key metrics of Infosys

(Rs mn) FY10 FY11 FY12 FY13 FY14 FY15 FY16

FCF generated 60,430 46,040 65,710 62,310 94,420 72,230 87,730

Dividend Paid (Including Dividend Tax) 16,740 40,130 31,370 28,150 42,330 61,450 67,040

Dividend paid/FCF generated 27.7% 87.2% 47.7% 45.2% 44.8% 85.1% 76.3%

Net Cash on Balance Sheet 133,010 167,890 209,360 235,710 290,060 312,410 327,720

ROE (%) 30.1 26.6 27.4 25.7 24.9 24.1 23.2


Net cash on balance sheet is Rs357bn as on Q3FY17. Our view is that Infosys can

return the cash on balance sheet to shareholders by doing a tender offer based

buyback in phased manner over a three year period. This would also aid in boosting

the ROE for the company as well as increase EPS over FY18‐FY20E predominantly led

by reduction sharecount.

March 09, 2017 25

Indian IT Services

Infosys: Aggressive share buyback scenario

Infosys’ current model is to distribute ~50% of PAT as dividends (including dividend

tax). However, this strategy has led to Infosys ending up further accumulating cash

on to balance sheet which continue to drag ROE (%)

Exhibit 37: Base Case Estimates for Infosys

FY15 FY16 FY17E FY18E FY19E FY20E

PAT (Rs mn) 123,328 134,900 143,541 156,930 170,241 188,951

EPS 53.9 59.0 62.8 68.7 74.5 82.7

Dividend Payout Ratio 50% 50% 50% 50% 50% 50%

Dividend Yield (%) 2.2% 2.4% 2.6% 2.8% 3.0% 3.4%

Net Cash on Balance Sheet ( Rs mn) 312,410 327,720 373,079 430,303 490,577 559,625

ROE 24% 23% 22% 22% 21% 21%


Case Study 1: Aggressive Capital allocation model

Assuming, Infosys does a tender offer based buyback of ~Rs120bn every year over

the next three years (FY18/FY19/FY20E), it would help investors get a steady stream

of returns. Assuming the Buyback price at 1200/1250/1300/Share in

FY18/FY19/FY20E, Infosys will be able to reduce its share count by 12.5% by FY20E

(assuming no major dilution from ESOP’s). Over this period, we also assume Infosys

will continue its 50% dividend payout ratio. Hence, net cash on balance sheet will

reduce from Rs373bn in FY17 to Rs179bn by FY20E. However, Infosys ROE will surge

to 29% by FY20E (vs 22% as on FY17). We see EPS being upgraded by 1.3/3/4.5% for

FY18/FY19E/FY20E. Current regulations in India allow tender offer buyback to be

done only after a one year period post exhaustion of existing buyback plan. Hence,

an exact replica as discussed in this model might not be feasible. However, Infosys

should commit a strong policy to reduce share count.

Exhibit 38: Model Assuming a very aggressive Capital allocation by Infosys (Involves returning significant component of Cash)

Aggressive Capital Allocation Assumptions FY15 FY16 FY17E FY18E FY19E FY20E

PAT (Rs mn) 123,328 134,900 143,541 152,058 160,343 172,549

EPS 53.9 59.0 62.8 69.5 76.7 86.3

Dividend Payout Ratio (%) 50% 50% 50% 50% 50% 50%

Net Cash on Balance Sheet (Rs mn) 312,410 327,720 373,079 306,498 240,417 179,518

ROE(%) 24.1% 23.2% 22.0% 22.8% 25.6% 29.3%

Share count (mn) 2286 2286 2286 2186 2090 1997

Number shares bought through Tender 100 96 92.3

Price at which Tender offer is done ( Assumption) 1200 1250 1300

% Of Equity capital bought through tender 4.4% 4.4% 4.4%


March 09, 2017 26

Indian IT Services

Indian IT vendors have de‐rated led by growth moderation

While select Global IT vendors (Accenture) have seen a steady re‐rating led by strong

growth and aggressive capital allocation strategy, the Indian IT vendors are

struggling due to slowdown in revenue growth trajectory. While valuations remain

attractive for Indian IT vendors, a strong capital allocation policy would be the key

over FY18‐FY20E shareholder returns as well as any re rating. We believe companies

with high margins and high free cash flows would be better positioned to return

higher quantum of cash to shareholders or do tender offer based buybacks. Infosys

and HCL Tech remain our preferred large cap picks. Hexaware and Persistent

Systems are our midcap picks. NIIT Tech is positioned as our value pick.

Exhibit 39: Valuation of Global IT vendors

Company Name Mcap (US$bn) P/E EV/EBITDA ROE (%)

CY16 CY17E CY18E CY16 CY17E CY18E CY16 CY17E CY18E

Atos 12.2 18.3 13.9 12.8 8.1 7.4 6.9 14.2 16.6 16.3

IBM 170 12.0 13.1 12.7 12.8 10.4 10.5 73.0 62.4 59.7

Accenture* 77.0 21.6 20.9 19.4 12.7 13.2 12.3 60.0 46.1 43.6

Capgemini 14.8 14.7 14.1 12.9 10.4 8.8 8.3 13.0 12.6 12.6

Source: Company Data, PL Research* Accenture follows 31st August Year ending . Hence , Accenture metrics are for FY16/FY17E/FY18E

Exhibit 40: Comparative Valuation of Indian IT Vendors

Adj. EPS dil. (Rs) P/E (x) ROE (%)

CMP Mcap (Rs bn) FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E

TCS 2,505 4937 133.8 145.3 157.8 18.7 17.2 15.9 31.4 27.8 26.0

Infosys 1,020 2342 62.8 68.7 74.5 16.2 14.8 13.7 21.9 21.5 20.9

Wipro 492 1203 34.3 36.9 40.5 14.3 13.3 12.2 17.1 16.3 16.1

HCL Tech 855 1205 58.0 63.6 69.6 14.7 13.4 12.3 26.8 25.0 23.5

Tech M 498 484 33.9 39.4 43.9 14.7 12.6 11.3 19.6 20.1 19.6


March 09, 2017 27

Indian IT Services

Valuations

Exhibit 41: Infosys one‐year forward P/E Chart


Exhibit 42: TCS one‐year forward P/E Chart


Exhibit 43: Wipro one‐year forward P/E Chart


Exhibit 44: HCL Tech one‐year forward P/E Chart


8

13

18

23

Mar‐13

Jun‐13

Sep‐13

Dec‐13

Mar‐14

Jun‐14

Sep‐14

Dec‐14

Mar‐15

Jun‐15

Sep‐15

Dec‐15

Mar‐16

Jun‐16

Sep‐16

Dec‐16

Mar‐17

P/E Mean

Mean + Std Dev Mean ‐ Std Dev

10

13

16

19

22

25

Mar‐13

Jun‐13

Sep‐13

Dec‐13

Mar‐14

Jun‐14

Sep‐14

Dec‐14

Mar‐15

Jun‐15

Sep‐15

Dec‐15

Mar‐16

Jun‐16

Sep‐16

Dec‐16

Mar‐17

P/E Mean


10

12

14

16

18

20

Mar

-14

May

-14

Jul-

14

Sep

-14

No

v-14

Jan

-15

Mar

-15

May

-15

Jul-

15

Sep

-15

No

v-15

Jan

-16

Mar

-16

May

-16

Jul-

16

Sep

-16

No

v-16

Jan

-17

Mar

-17

P/E Mean Mean + Std Dev Mean - Std Dev

4

8

12

16

20

Mar‐13

Jun‐13

Sep‐13

Dec‐13

Mar‐14

Jun‐14

Sep‐14

Dec‐14

Mar‐15

Jun‐15

Sep‐15

Dec‐15

Mar‐16

Jun‐16

Sep‐16

Dec‐16

Mar‐17

P/E Mean


March 09, 2017 28

Indian IT Services

Exhibit 45: Accenture one‐year forward P/E Chart


Exhibit 46: Capgemini one‐year forward P/E Chart


Exhibit 47: IBM one‐year forward P/E Chart


Exhibit 48: Atos one‐year forward P/E Chart

8

9

10

11

12

13

14

15 Feb‐15

Apr‐15

Jun‐15

Aug

‐15

Oct‐15

Dec‐15

Feb‐16

Apr‐16

Jun‐16

Aug

‐16

Oct‐16

Dec‐16

Feb‐17

P/E Mean



10

13

16

19

22

25

Feb‐14

May‐14

Aug‐14

Nov‐14

Feb‐15

May‐15

Aug‐15

Nov‐15

Feb‐16

May‐16

Aug‐16

Nov‐16

Feb‐17

P/E Mean


5

8

11

14

17

20

Feb‐14

May‐14

Aug

‐14

Nov‐14

Feb‐15

May‐15

Aug

‐15

Nov‐15

Feb‐16

May‐16

Aug

‐16

Nov‐16

Feb‐17

P/E Mean


8

9

10

11

12

13

14

15

Feb‐15

Apr‐15

Jun‐15

Aug‐15

Oct‐15

Dec‐15

Feb‐16

Apr‐16

Jun‐16

Aug‐16

Oct‐16

Dec‐16

Feb‐17

P/E Mean


March 09, 2017 29

Indian IT Services

Prabhudas Lilladher Pvt. Ltd.

3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai‐400 018, India

Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209

Rating Distribution of Research Coverage PL’s Recommendation Nomenclature

32.2%

51.7%

16.1%

0.0%0%

10%

20%

30%

40%

50%

60%

BUY Accumulate Reduce Sell

% of Total Coverage

BUY : Over 15% Outperformance to Sensex over 12‐months

Accumulate : Outperformance to Sensex over 12‐months

Reduce : Underperformance to Sensex over 12‐months

Sell : Over 15% underperformance to Sensex over 12‐months

Trading Buy : Over 10% absolute upside in 1‐month

Trading Sell : Over 10% absolute decline in 1‐month

Not Rated (NR) : No specific call on the stock

Under Review (UR) : Rating likely to change shortly

DISCLAIMER/DISCLOSURES

ANALYST CERTIFICATION

We/I, Mr. Madhu Babu, BTech & PG MBA, Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report.

Terms & conditions and other disclosures:

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This document has been prepared by the Research Division of PL and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of PL. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security.

The information contained in this report has been obtained from sources that are considered to be reliable. However, PL has not independently verified the accuracy or completeness of the same. Neither PL nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein.

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PL or its research analysts or its associates or his relatives do not have actual/beneficial ownership of one per cent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report.

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