OVERVIEW: Life in Uncertain Times

"Adversity, if for no other reason, is of benefit, since it is sure to

bring a season of sober reflection. People see clearer at such times. Storms

purify the atmosphere."

–Henry Ward Beecher

It was as if the worst nightmares of the Indian IT sector had come true. The

dot-com bust, technology meltdown, telecom crash and 9.11 all combined together

to create a vortex that threatened to suck the promise out of the IT sector. But

despite the reversals, the industry showed remarkable resilience–showcasing

the adaptability of the industry, the capabilities of the management, and the

strong competitive advantages of Indian IT in the global economy.

Cost-cutting, improved sales processes and strategic alliances brought in

committed revenues and helped smarter players keep both topline and bottomline

steady in trying times. The maturity that the sector showed was remarkable,

considering the fact that many of its older counterparts across the globe found

themselves ill-equipped to handle the situation. With moribund capital markets

and a slowing global economy, fund-raising was the last thing on anyone’s

mind, and not a single IT company raised money in financial 2001-02–iFlex did

tap the market, but that was in fiscal 2002-03. The Tata Consultancy Services

IPO is also likely to hit the market on this financial year.

Snapshot 2001-02
	Markets had a flat year, as repeated reversals in the form of 9.11, 12.13 and war threats saw benchmark indices oscillate wildly
	Not a single Indian IT company tapped the market in fiscal 2001-02. It was iFlex alone that entered the market in fiscal 2002-03. The TCS IPO is also likely this year
	n Acquisitions, mergers and alliances were hot, as the bigger players went on a consolidation spree in a tough year
	n The divestment of CMC to Tata Sons and PSI Data Systems’ sale to Aditya Birla Group were among a battery of buyouts and tieups
	Strong move to built up vertical domain skills: HCL Tech bought out Deutsche Bank’s software arm, and NIIT picked up an ERP firm
	Move toward business process outsourcing across the IT sector being seen as a manifestation of India’s potential in the segment and its likely growth into an industry as large as SW services
	As cost-cutting gathers steam, IT implementation will get more into vogue–leading to fatter toplines. However, it will be a while before bottomlines stabilize
	Clear correlation between the three indices–Nasdaq, BSE and DSE–with the movement of any one mirroring that of the other two
	There was a 6% increase in market cap among the 55 listed companies included in the survey, to net a total of Rs 95,869 crore
	n The total revenues of the 55 listed companies in the survey was Rs 18,084 crore, compared to Rs 15,812 crore in fiscal 2000-01

Acquisitions, mergers and alliances were hot, as the bigger players went on a

consolidation spree in a tough year. The divestment of the CMC stake to Tata

Sons and PSI Data Systems’ sale to the Aditya Birla Group from its parent,

Bull, were only a few among a veritable cascade of acquisitions and tieups. HCL

Technologies’ majority acquisition of Deutsche Bank’s software arm Deutsche

Soft, and NIIT’s buyout of a mid-sized ERP consulting company in the United

States indicated a move towards building vertical domain skills.

Strategic investments and partnerships were also ongoing, as the cash-rich

Wipro invested in Gurgaon-based contact center company Spectramind, and Infotech

Enterprises joined forces with Pratt & Whitney. Similarly, Geometric

Software tied up with Dassault Systems for a 70:30 joint venture, while Infosys

announced the setting up of Progeon, with funding from Citigroup for BPO

services. Other companies that announced BPO services were Satyam Computer

Services, Digital GlobalSoft, HCL Technologies, HCL Infosystems, NIIT and Hughes

Software Systems, among others. The move towards BPO across the IT firmament is

a manifestation of India’s potential in the segment and its likely growth into

an industry as large as software services as well. Considering the domain

knowledge required in BPO services, this would help create a stronger vertical

focus in the software sector as a whole.

THE BIG GUNS: Wipro was the runaway leader in terms of market capitalization, contributing Rs 39,562 crore to the total of Rs 95,869 crore. Market cap figures were heavily tilted in favor of the bigger players, with the Top 5 making up 85% of the overall market cap of the 55 listed IT firms in the country

With probably the worst year for the IT industry behind us, financial 2002-03

comes with hopes of recovery. As consolidation gathers momentum in the IT

sector, further acquisitions and alignments can be expected–especially in

vertical domains–as companies strive to move up the value chain. With

cost-cutting becoming a global phenomenon, both in the IT sector and among buyer

enterprises, topline growth is likely to be robust as companies increase

outsourcing of services. At the same time, bottomline growth may take a few more

quarters to revive, as the economic recovery remains slow. Mid-market companies

are at greater risk than ever before, as IT buyers re-look at risks associated

in working with smaller vendors–so investors would do well to avoid such

companies unless they are vertically focused.

There is a clear co-relation across the three indices, reflecting the

dominance of technology even in the domestic stock market (Bombay Stock

Exchange). The three charts moved in tandem, dipping in the month of September,

when terrorism struck the United States. The charts have thereafter shown a

steady rise, indicating a possible recovery in the environment and investor

sentiment. The Sensex declined from a peak of 3,742 points to 2,600 points in

September, but recovered by the end of the year to close at 3,469 points. On the

other hand, the DSI-10 touched a low of 474 points in September and stood at 923

points by the year-end, compared to 839 at the beginning of the year. The

improvement in the DSI-10 was due to better-than-expected Q3 and Q4 results,

when most software majors were able to meet their projections. On the other

hand, the Nasdaq remained flat–a number of companies went into the red and

announced layoffs, with telecom companies being worst off.

TOP HEAVY: The top two listed stocks in the IT sector–Wipro and Infosys Technologies–hung on to their rankings easily, scoring way ahead of the others in the FINDEX* rankings, based on seven financial parameters. The lower rungs, however, held out a different story–there were as many as eight new names in the top 15 rank-holders

In India, the 55 companies included in the survey of listed IT companies saw

a 6% jump in market capitalization, with the number of mid-sized companies

showing remarkable gains. Most of these companies had witnessed a sharp decline

in share prices in the previous year, indicating that in a panic situation, the

smaller companies were the first to be divested. However, most took definitive

steps to strengthen their sales through strategic alliances and marketing

efforts. Consequently, on the face of their improved performance, the investors

returned.

This analysis was done using a sample of 55 companies, with a total revenue

of Rs 18,084 crore. The data used for the study was strictly based on the latest

audited figures available from the companies. Consequently, a few companies

whose fiscal year ended on March 31, 2002 could not provide the audited reports.

Similarly, for companies whose accounting year ends on June 30, September 30 and

December 31, the data used pertains to the previous year. The authenticity of

all data is assured by the fact that it is audited. However, given the fact that

the data pertained to different years–2001 and 2002–inter-company

comparisons cannot be made or reflect the current performance of the company.

The analysis also did not take into account associated or group companies, as

these are yet to be incorporated in accounting figures under Indian law.

Therefore, companies like Mastek, Silverline Technologies, HCL Technologies,

NIIT and Satyam Computer Services–all with a large proportion of business from

subsidiaries–would have been ranked differently. Further, some companies such

as DSQ Software and Maars Software have extended their year-end and, therefore,

their last audited results pertain to that of fiscal 2000–such companies have

been excluded from the survey.

MIRROR IMAGE: Indian indices, which had bucked global trends last year, reverted to aping the Nasdaq in fiscal 2001-02. The three benchmarks moved in a common band, staying flat through the year, dipping or rising only to acknowledge extraneous factors–global events like 9.11 and the Afghan war, or domestic disturbances like 12.13 and threats of war with Pakistan

In recent times, financial statements audited by large audit firms are being

put to test. Clearly, with accounting standards being weaker in India than in

developed markets, numbers need to be taken with a pinch of salt. Further, even

if they were entirely fair, they only tell half the story–only a deeper

analysis of these numbers can provide a clearer picture.

TOP 10 RULE: Clearly, this was a list of 55 companies totally dominated by the Top 10 players, across all parameters–these ten companies together had an over 70% share in all parameters analyzed

Sales: The key determinant



Perhaps the most important criteria for determining the strength of a

company would be sales, especially in the year of the slowdown. However, within

the group, the share of the Top 10 companies remained at the same level (69%) as

last year, whereas the Bottom 10 companies improved their contribution to total

sales marginally. Also, few companies were able to change their rankings

significantly, compared to the previous year. This also reiterated the

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

is now complete, with only two hardware companies in the Top 10 list.

Profits: Smaller players hit hardest



While sales may be the most important factor in the marketplace, in terms of

meeting the objectives of the shareholders, profits are the sacred figure. Here

too, a skew of the distribution provided a picture of increasing consolidation

in the sector. The Top 10 companies provided hogged a heady 81% of the total net

profit of the 55 companies in the sample, against 77% last year. The Bottom 10,

on the other hand, had a negative contribution, showing that some of the smaller

players had faced the brunt of the slowdown.

Gross block: Big get bigger



In recent years, the Indian IT sector has been resource-starved, and serious

investments in fixed assets have been made through profits and further issues of

capital. Larger companies have continued to invest in infrastructure and will

benefit most from the recovery expected in 2003. Smaller companies hit by the

slowdown have refrained from setting up new facilities and focused on preserving

their capital. While the Top 10 companies’ share of gross block grew from 72%

to 76%, there was no change in the share of the Bottom 10 companies, which

remained at 1%.

Sales growth: The small made merry



Sales growth across the sample fell significantly, from 50% last year to 14%

in fiscal 2001-02. The Top 10 companies showed 20% growth over their previous

year’s sales, substantially lower than the 45% growth shown in the previous

year. On the other hand, the Bottom 10 companies, in terms of turnover size,

showed 46% growth. This was due to the fact that majority of these companies

reported 2001 figures and their sales grew on a much lower base, which made

comparisons difficult.

Profit growth: Slowdown blues



The average jump in net profit was 14%, compared to 91% in the previous year,
showing the extent of damage due to the technology meltdown. The profit growth

of the Top 10 companies in this list was 31%, against a 26% decline in the

Bottom 10, showing the even wider skew in profit growth over sales growth.

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, sharp profit growth

can indicate some creative accounting or some large inflows that may not recur

in future.

Gross block growth



Gross block growth is based on the increase of gross fixed assets for a

company. Here too, some of the middle market companies were at the top, as they

attempted to enter the big league. The Top 10 grew their assets by 31%, against

20% for the Bottom 10, showing the vast disparities in asset acquisitions by

companies. Some companies will turn out to be the winners of sales and profit

growth in the next few years, as investments are necessary for growth and

increasing even in the software sector. Only those with well-equipped state-of

the art facilities will be able to get business at the price that they want. The

average growth rate in gross block during the year was 30%, compared to 46% in

the previous year.

ROCE: Experience talks



Return on capital employed is perhaps the best measure of a company’s

efficient operations. ROCE is defined as operating profits of a company divided

by the total capital employed in a company. This is the sum of shareholder funds

and loans. From this, intangible assets such as prior year losses, patents and

capitalized expenses are deducted. ROCE is a measure of how efficiently a

company operates both in terms of its margins as well as usage of capital. In a

sector where finance has been a problem, a high ROCE is a good indicator of a

company’s performance. Here, apart from Wipro, most in the Top 10 were older

and more established as compared to the group last year. Notably, average ROCE

declined from 27% last year to 21%, which indicated that a number of companies

made substantial investments, which are yet to yield results in terms of

profits.

Conclusion



This has been a watershed year for the IT sector as a whole–it is only in

times like these that the men can be separated from the boys. Unlike the time

when all was rosy and wonderful, the true capabilities of the management becomes

visible only in a downturn. The winners of this year’s ranking were those who

grew in all parameters, despite the continued uncertainty. The analysis leads us

to believe that these are the companies which will remain leaders for a

significant period of time, taking necessary steps to build vertical domain

knowledge and size. The consolidation phase in the IT sector will continue–with

size and skill-sets becoming the key determinant of success, rather than mere

labor rate arbitrage.

Methodology



Finding a single parameter to rank all companies of different sizes, ages

and segments is indeed a difficult task. We have used a set of static and

dynamic parameters to define our yardstick. These include sales, profits after

tax, gross fixed assets and return on capital employed as our static criterion.

Growth in sales, profits and assets–all non-static–were used to rank the

companies.

SLUGGISH TIMES: Though the Top 10’s total market cap–Rs 86,859 crore–was a heady 91% of overall numbers, growth rate was slow, up a measly 5% from Rs 82,848 crore in fiscal 2000-01

This analysis also presents evaluation of a company’s performance based on

all parameters, along with a final ranking. Starting with sales, the figures

reveal a high degree of skew–this meant that a few companies at the top showed

very high profits and sales, whilst a majority had low figures. When ranking

such a sample, variance in the data made simple ranking difficult, 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 implies that the top ranking company in any parameter–say sales–got 100

points, and the following companies were given points in proportion to their

sales achievement against the first company’s score. Thus, a company that may

be second in ranking in sales, but has only half the sales of the first company,

is given only 50 points. Consequently, companies at the bottom of the list would

get very few points. In overall terms, this gives importance to size as a

ranking parameter, rather than just a position on the list.

All parameters were not equal in importance and equal ranking of parameters

may not have been the best choice. However, to avoid subjectivity in our

rankings, the same weightage has been given to all parameters.

	Final Rankings		Sales		Profit
	Return On Capital Employed		Market Capitalization