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The Changing Landscape

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DQI Bureau
New Update

The information technology sector has been the

breeding ground of garage outfits both in India and the rest of the world. Many of today's

IT giants were once small teams of highly innovative people set up with little or no

investments. India too has a long list of start-ups which have been built literally from

scratch. Beginning with HCL, Infosys, MicroLand, IIS Infotech, and Mastek, to more recent

ones like Leading Edge, Cybertech, and Sierra Optima, it is these units today which lead

the IT world in India. Presently too, hundreds of small units survive across the country

which are emulating the examples of their older cousins. But as we move on to the next

millennium, will start-ups continue to become tomorrow's leaders? Will they be able to

beat their larger competitors in India and ones from abroad? In spite of open

technologies, is the IT sector still as open as it used to be 10 or 20 years ago? While we

still cannot say that the days of start-ups are over, we can say that it is a lot harder,

the Internet notwithstanding, than it was a few years ago. The primary reason for this

change is the overwhelming presence of big companies in leading technology and usage

areas. From chips, operating systems, databases, networking to ERP, all markets are

polarized. Even on the Net-the ISPs, the search engines, the electronic stores, or the

utilities-polarization is the name of the game with mergers, buyouts, and takeovers going

on at a frantic pace. AOL-Compuline, Microsoft-Hotmail, and the list goes on. In India

too, size is becoming important. Offshore units have to have a minimum critical size to

succeed while body shopping too is becoming cash-flow sensitive-a lot harder if you don't

have a US office. Today's PC assemblers can never hope to become a Shiva and, in fact,

majority of them have been forced to join the GID bandwagon. Equality is no longer a

hallmark of the IT sector.

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Net Advantage



The net could, however, be the great

equalizer, being a market where size is irrelevant, where the tiny rub shoulders with the

giants. The net, as we all know, does not differentiate on the basis of physical or

financial size. However, Net presence is not a full substitute for physical presence and

financial muscle. If you have products which you sell on the net, you still need people

and offices to support them and money to advertise your site both on the net and outside

it to avoid the clutter. The net itself, however, continues to remain a place for new

ventures. These may not be strictly IT businesses, but businesses which are born out it.

This world still mimics the IT world of a few decades ago when business followed

innovation. In IT today, while innovation continues, big business controls most of it.

face="Arial" size="3" color="#FFFFFF">Overall Ranking
COMPANY RANK
Wipro Ltd 1
Cybertech Systems & Software Ltd 2
Pentafour Software & Exports Ltd 3
Infosys Technologies Ltd 4
NIIT Ltd 5
Satyam Computer Services Ltd 6
Unicorp Industries Ltd 7
Orient Information Technology Ltd 8
Eurolink Systems Ltd 9
Leading Edge Systems Ltd 10
Altos India Ltd 11
Aptech Ltd 12
Rolta India Ltd 13
Sierra Optima Ltd 14
HCL Infosystems Ltd 15
Digital Equipment (India) Ltd 16
Binary Semantics 17
Citicorp Information Technology Industries Ltd 18
Tata Infotech Ltd 19
Moser Baer (India) Ltd 20
SRA Systems 21
Software Solution Integrated Ltd 22
Dixit Marketing Private Ltd 23
Nucleus Software Exports Ltd 24
Kale Consultants Ltd 25
Silverline Industries Ltd 26
Adam Comsof Ltd 27
IIS Infotech Ltd 28
Spectra Innovations (India) Pvt. Ltd 29
DSQ Software Ltd 30

The dynamics of IT products and, perhaps, services

sector as well have started looking like the consumer durable market-the importance of

investments, processes, global presence, and finally size are becoming critical. This is

not to say that the days of garage outfits are over. What it means is that while many such

outfits continue to do well, few will grow into independent companies, and most of such

units, even if they are successful, will merge or be bought out by some larger companies.

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Whether this phenomenon is a permanent one or just a

passing phase, before the next round of technological innovation creates many more Bill

Gates out of college dropouts, is a million dollar question. In the meanwhile, it would be

worth looking at the consolidation taking place in the Indian IT firmament as we move on

to the new century. While we know and accept that size is important, DATAQUEST looks at

some of the financial performance figures available from Indian companies to seek some

patterns of evolution of the sector.

One last caution before we move on. While we maintain that

the data used here are based on audited accounts and are therefore reasonably objective,

like many other things in our markets, accounting standards in India are weak when

compared to the West. Consequently, managements can use their creative minds to window

dress their numbers. Unfortunately, in spite of the best efforts of some accounting firms

such window dressing usually gets away. Generally, this creative accounting has only one

casualty-the investor. The investor in India not only needs to take care of creative

accounting but also face the problems of heavy speculation in the market which largely

remains unchecked.

In India, we have to deal with more than just the

fundamentals of the companies and the sentiments of the market. Speculation is largely

unchecked in an emerging market like India. Consequently, a few brokers can form a cartel

and rig up share prices of any stock. The public seeing the stock price rise jumps for it.

As the public enters the scrip, the brokers quietly exit the scene, leaving gullible

investors with dirt stocks. This has happened over and over again in India, leaving a

whole lot of sorry investors stuck with stocks which are not worth the paper they are

written on. Software has taken the fancy of some of the speculators in the market and this

has led to many dirt stocks becoming shooting stars of the market. Many of these shares

belonged to companies which were fundamentally weak, and some hardly have any IT-related

operations. In India the accounting standards are poor, marketing regulation is weak, and

brokers continue to have insider knowledge about companies. In this scenario, investors

need to be doubly sure about the credentials of a company and sometimes even its audited

figures before they buy the stock. People in the industry would have a natural advantage

here and should surely check with their colleagues in the company where they wish to

invest.

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Methodology



DATAQUEST
sent a mailer to Top 200 companies

as per the DQ Top 20 survey of 1996-97 as well as collected the annual reports of a

majority of IT companies which are listed on Indian bourses. Being the first of its kind

exercise, success in getting annual reports of privately-held companies has been, to put

it mildly, not an easy task. We hope that with the beginning made with this issue and

increasing transparency in Indian corporate life, next year's efforts will be more

successful.

In all, there are 61 companies in our sample who together

have a turnover which is around 36.2 percent of the DATAQUEST estimates of the total

turnover of the industry. The data used for this study is strictly based on the latest

audited figures available for companies. Consequently, many companies whose fiscal year

ends on March 31, 1998 could not provide audited reports. Also, there are companies whose

latest annual report available is 1995 vintage. Nevertheless, we expect that the data used

reflects more of calendar 1997 than of the current year. While the data may not be the

latest, its authenticity is assured to some extent due to the fact that all figures are

audited. However, given the fact that they pertain to different years, inter-company data

is not strictly comparable nor do they reflect the current performance of a company. The

analysis also does not take into account the associated or group companies as there are no

clear norms for consolidating accounts in the Indian context. This too would affect the

overall objectivity of the exercise, especially in cases of companies who have large

subsidiaries.

Finally, numbers by themselves do not tell a complete

story. Only an analysis of the 'real' company behind these numbers could complete the

picture. Consequently, there are companies in the lists whose performance in the past or

even in the current year has been excellent in terms of numbers but which do not qualify

for a full-throated round of applause. These are, of course, the quirks of any analysis

that is purely based on numbers.

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The first step was to rank companies based on certain known

parameters as a starter and we hope to bring in newer facets of the financial position of

Indian IT sector as we move on from this issue. Finding one parameter to rank all

companies of different sizes, ages, and segments is a difficult task. Therefore, we have

used a set of static and dynamic parameters to define our concept of performance. These

include sales, profit after tax, gross fixed assets, and return on capital employed as our

static criterion. Dynamic parameters include growth in sales, profits, and assets of a

company.

To evaluate and rank a company's performance based on all

the parameters a final ranking has been presented. Starting with sales, most of the

figures reveal a high degree of skewness. This means that a few companies at the top have

very high profits and sales while a vast majority have very low figures. When ranking such

a sample, variances in the data makes simple ranking difficult, and even unfair. To avoid

the problems of simple ranking when the data is skewed, as is the case of IT companies, we

have used proportional ranking for the overall evaluation. This means that the top ranking

company in any parameter, say sales, gets 100 points and the following companies are given

points in proportion to their sales achievement vis-…-vis the first company. Thus a

company which may be second in line but has only half the sales of the first company is

given only 50 points. Similarly, companies which are at the bottom of the list would get

only very few points. This, in overall terms, gives importance to size in ranking rather

than just a position in the list.

Also, while all parameters are not equal in importance, we

have chosen to give equal to avoide any subjectivety in the analysis. Over a period of

time, we would fine-tune this evaluation mechanism.

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SALES: Sales is perhaps the most important

criterion for determining the strength of a company as we move into a polarized IT world

where marketshares are supreme. A proof of this polarization is that the top 10 companies

have almost 70 percent of the total revenues while the bottom 10 constitutes less than 1

percent of revenues. Also, we see that very few companies have been able to change their

ranking in a significant way over the previous period. This also reiterates the importance

of size in the Indian IT sector. The importance of software companies in sales turnover

ratings also outlines their growing dominance in Indian IT sector.

PROFITS: While sales may be the most

important factor in the marketplace, in terms of meeting the objectives of the

shareholders, profits are a sacred figure. Here too, the skewness of the distribution

provides a picture of increasing consolidation in the sector. The Top 10 companies have

contributed 70 percent to the total net profits of the sample. At the same time, the

bottom 10 have a negative contribution of almost 2 percent of the net profit. The profit

of the sector is primarily divided across hardware and software (the top 3 companies in

our sample are from the software sector). Indeed considering that hardware companies have

been around for far longer than most of the software companies, this shows the terrible

times the hardware sector has gone through in the recent years.

ASSETS: The Indian IT industry has been a

resource-starved sector and serious investment in fixed assets such as infrastructure has

been made only in recent years. This too has largely been funded by retained profits. More

recently, some companies, most of them in software services, have grown by tapping the

capital markets. Consequently, the skewness of assets is less than that of sales or

profits. Here the Top 10 companies constitute only 64 percent of the total fixed assets of

the sample, whereas in terms of sales or profits the number is over 70 percent. It also

hints at the fact that mere investment into assets does not transform into sales and

profits. The level of investment in the bottom 10 companies is, however, limited to just 1

percent of the sector, pointing to the limited investments made by the smaller companies

due to lack of funding.

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SALES GROWTH: In an industry where growth

is the key to survival and prosperity, we see that sales growth too is skewed across our

sample. When we come to the dynamic figures, size is a liability. This is because growth

in percentage is easier when you are small. Consequently, we see a number of small

companies and companies on the comeback trail which are on the top. Moreover, with the

average sales growth at 57 percent, IT sector is definitely in top gear. The top 10

players have almost 100 percent growth over the previous year. The wide disparity in sales

growth also shows that even though the sector is growing rapidly, the growth is very

skewed across companies. Software companies are the ones which have done well here as they

ramp up for the Y2K phenomenon.

PROFIT GROWTH: The line up of Top 50 in

terms of growth in profits seems more or less a repetition of the sales growth list as

profits seem clearly linked to sales growth in the sector. Here also, the companies which

are making an entry into the IT sector or are on a comeback trail reach the top of the

list. Software is a winner here as well. The companies made tremendous gains in profits

with the rising dollar and growth in the number of people, making it one of the

fastest-growing sectors in terms of profitability in India. Profit growth, especially

future profit growth, is a major factor in determining the investment attractiveness of a

stock. Even past profit growth is a good indicator of a company's likely performance as

many companies are able to show similar profit growth over a period of time. However, very

sharp profit growth can indicate some creative accounting or some large inflows which may

not recur in future.

ASSET GROWTH: Asset growth is based on the

increase of gross fixed assets for a company. Here too, some of the middle market

companies are at the top as they attempt to enter the big league. Some of these companies

would turn out to be the winners of sales and profit growth in the next few years as

investments are necessary for growth even in the software sector-only companies with

well-equipped and state-of-the-art facilities would be able to get business at the price

they want.

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ROCE: Return On Capital Employed (ROCE) is

operating profits of a company divided by the total capital employed in a company. This is

the sum of shareholder funds and loans and is perhaps the best measure of a company's

efficient operations. This has been reduced by the intangible assets such as prior-year

losses, patents, capitalized expenses etc. Other than the companies which are making

losses in the past, ROCE is a measure of how efficiently a company operates both in terms

of its margins as well as usage of capital. In a country and a sector where finance has

been a problem, a high ROCE is a good indicator of a company's performance. Here apart

from the top player, most of the companies in the Top 10 ranks are the companies which

have been established a few years ago but done extremely well.

OVERALL: The overall winners of the list

are clearly the ones who not only have high investments in fixed assets but also those who

have sizable sales and profits. These companies also put a high premium on growth and yet

are efficient users of capital which is scarce. While most of the members of the Top 10 in

this list are known to be great companies, there are others who could well reach the top

in the near future. These are the companies to watch for. They may lack the size of the

majors, but prove that excellence does not come by size alone.

Looking Ahead



While our companies include the ones which are

not listed, a majority of them are traded on the stock exchanges. No analysis of their

performance can be complete without looking at their rankings on the market

capitalization. These however have not been considered for the overall rankings. The

markets have responded favorably during fiscal 1997-98 to the rising fortunes of the

software companies. In overall terms the market capitalization of the top 10 IT companies

has gone up an astronomical 240 percent against the BSE Sensex which has more or less

stayed in the same position. This increase reflects not only the excellent performance of

the companies involved but also the re-rating the entire IT sector has been going through

in the period. Increasingly, the investor community is being drawn to the sector as rest

of India Inc goes through a tough period.

At the top of the list of market capitalization stands

Wipro whose market capitalization has increased by over 500 percent to enable it to rise

from the third position during the year. While NIIT dropped down to the third position,

Infosys was second. On the fourth position stood Pentafour which has improved its position

by one rank. The fifth highest in market capitalization is Satyam whose share price has

gone up over 300 percent over the period.

As we move to the future, software companies and even some

hardware companies who are moving into system integration and software services business

are likely to improve their market capitalization further. Apart from their performance,

improved communication to the investor community and better accounting standards would

play a major role in this area. Companies would do well to keep their investors informed

about their performance and even an unexpected downturn as the better informed investor

takes more rational decisions. The information technology sector has now got the full

support of the investor community and companies have a responsibility to reciprocate this

faith by providing a true and fair picture of their state of affairs.

As one goes through the numbers and rankings, there is one

factor which stands out across the lists: Invest or perish. Investing in infrastructure,

especially for software companies, has now become a necessity more than ever before.

Starting with Infosys, companies which made investments in software development facilities

were the ones which also managed to get the best rankings in terms of sales growth as well

as profit growth. More than that, it is also clear that most of the companies which made

substantial investments in infrastructure have also done it in the past. This is the entry

barrier of asset size which is slowly rising in the industry and in the coming years, size

of the facilities will determine success or failure of software companies.

As time goes by, companies which don't have the right

infrastructure are likely to face not only poor sales growth but also find it difficult to

attract people and clients. The larger companies in terms of assets will be able to add

more people each year as well as impress clients with their excellent facilities and team

sizes. The success of a Satyam or a Cybertech is primarily based on the availability of

state-of-the-art facilities and a proactive approach to the whole game of software

business. Even companies like Leading Edge, which are primarily in the body shopping

field, are making investments to move up the value chain.

On the other hand, there are countless companies outside of

the list who prefer to stagnate at Rs 1 crore to Rs 3 crore turnover year after year

without looking at expanding operations. It's really the chicken-and-egg story. If you

have the orders then you build facilities is the logic. But can you get orders without a

proper infrastructure, without telecom links and the latest software platforms? Will you

get the right people that you want in working conditions which are not up to the mark?

Things are changing fast as we move on to the next century. Given the increasing marketing

power of the big players as well as the entry of the MNCs, smaller companies will have to

make the tough choice of either exiting the business or making adequate investments into

infrastructure. There are few other alternatives.

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