OVERVIEW: Tech Shining

DQI Bureau
New Update

Thanks to Indian IT's growth story, India is now better known for its

techies and call agents rather than its elephants and snake charmers. The credit

for this must go not only to the entrepreneurs who were quick to spot this

opportunity but also to the government that, for once, let go of its control

mania to allow the sector to grow unfettered. However, now as the sector has

matured, the challenges for the entrepreneur are greater, and while the

opportunity for growth still remains, the areas such as software development

services and BPO services are now quite crowded, with little space for new

businesses to emerge.


With the maturity, the excitement of the early years has been replaced by

quiet growth and consolidation. So in the middle years, there are no dramatic

happenings, but the major players have all been building strengths in different

verticals so as to complete their services portfolio and move up the food chain.

The big three, having accomplished the billion dollar turnover milestone, are

now working hard to reach the next target-of getting the $100 mn accounts.

This they hope to accomplish through a series of acquisitions, overseas delivery

centers, entering new geographies, and aggressive recruitment. Out of the

limelight, but growing stronger, nevertheless, are the niche players-some of

them in the product areas have spent the last couple of years in investing into

IPR development, marketing and distribution, as well as some acquisitions. We

believe that some of the headline news is going to come from these product

companies as they begin to generate interest for their offerings from global

corporations and leapfrog into the big league. The middle rung companies

continue to look at survival rather than growth, trying hard to maintain margins

in an increasingly harder business situation.


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On Capital Employed

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Block Growth


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The early part of the year saw the much-awaited TCS IPO, as well as that from

Datamatics, joining the ranks of listed companies after many years of

operations. There were no other major IT-related IPOs due to the uncertain

political situation and a flurry of IPOs from other emerging sectors. The other

major corporate activity was in the area of M&As where one saw reasonable

number of transactions. Among the biggies, Technologies BPO Service Limited,

Northern Ireland, a joint venture with HCL Tech and British Telecom, acquired

the assets of the AnswerCall Direct Contact Centre in Northern Ireland in a deal

worth Rs 29.4 crore. A number of BPO companies are now setting up centers nearer

to their clients to increase the number of outsourced processes and have greater

stickiness to clients. Mumbai-based Patni, which had come out with an IPO in

2004, also acquired a US-based IT services company, Cymbal Corporation, for $68

mn to enter the telecommunications segment. i-flex Solutions, the banking

product company, acquired Equinox Corporation, a provider of BPO services to

mortgage institutions, auto financers and credit card companies. It also

acquired Login, a French provider of front and middle office treasury software.


Following in the footsteps of the Big Brothers, the mid-cap companies also

took up the inorganic route of expansion by acquiring companies domestically as

well as internationally. Pune-based Aztec completed the acquisition of Disha

Technologies India by paying $12.1 mn. Flextronics acquired Bangalore-based

telecom technology company, Deccanet Design, which provides design services in

telecom infrastructure and mobile handhelds.

Helios & Matheson acquired US-based Maruthi Info Tech Incorporated and

Jayamaruthi Software for a cumulative amount of $7.5 mn to augment the

development of strong overseas marketing infrastructure and expanding the client



They Ranked
Rank 2004-05 2003-04
1 TCS Infosys
2 Infosys Wipro
3 Wipro HCL

4 Aztec Moser

5 Moser

6 Satyam Patni





10 Cranes

11 Tata


12 Hexaware

13 Geometric


14 Geodesic HCL

15 Flextronics

16 i-flex


17 Subex

18 Patni Polaris

19 Infotech


20 Nucleus Tata

21 Jetking


22 Sonata


23 Rolta Blue

Star Infotech
24 Hinduja


25 iGate




27 Zenith

28 KLG

29 Helios

30 RS


The IT Stocks Moved


IT stocks rocked in FY 2004-05. While the BSE Sensex

grew by 15%, the BSE TecK raced ahead with a 45% jump.

No point comparing the other tech index, Nasdaq, which grew by a
marginal 4% only

In the BPO sector, Hinduja Group's HTMT acquired 100% of US based Source

One Communications for $8.5 mn, from its holding company. The company had also

acquired C3, a Philippines-based call center, and is enroute to reaching a

critical mass in this sector. There were other acquisitions in the BPO space but

outside the listed space. In a small but trend setting transaction, the telecom

software product company, Subex Systems, acquired certain assets and liabilities

related to the Fraud Centurion product from Lightbridge, a leading value-added

transaction processing company. This acquisition helped Subex add 14 new clients

in the fraud management solutions domain.

The overall trend in M&As is clearly that companies are acquiring targets

for a specific advantage in terms of customers, domain, or geography. H ence

companies are looking at M&A as a route for growth in a very particular

direction rather than a means of growing turnover. This is certainly a

refinement of the strategy seen in the early phase of M&As by Indian

companies. We believe that this trend will continue and Indian companies will be

constantly scanning the environment for acquisition targets in the US and

Europe, to further improve their front-end marketing resources as well as

enhance their service offerings.


Apart from M&As, companies also formed JVs and alliances to strengthen

their positions in the market place. The Big Three were fairly active in this

area, tying up with software product vendors and systems integrators to reach

out to a larger number of clients. As the Indian software services sector grows

in size and starts delivery of strategic consulting services as well, a number

of software product majors will be looking at tie-ups with Indian software

companies for product implementation and consulting services. This trend is

likely to continue as Indian companies become the center point for third-party

software development, and other industry players would want to align with them

for getting closer to their clients.


We Ranked Them

one metric to measure the performance of all companies of different

sizes, ages, and segments is indeed an impossible task. We have used

a set of static and dynamic parameters to determine the overall

rankings. These include sales, profits after tax, gross fixed

assets, and return on capital employed. Growth in sales, profits,

and assets of a company that are dynamic in nature have also been

used to rank the companies.

Starting with sales, most of the

figures reveal a high degree of skew. 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, variance

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, proportional ranking has been used for this


This implies 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 against the first company. Thus, a company which may be

second in line but has only half the sales of the first one is given

only 50 points. Companies which are at the bottom of the list would

thus get only very few points. This, in overall terms, gives

importance to size in ranking rather than just a position in the


All parameters are necessarily not

equal in importance and equal ranking of parameters may not have

been the best choice. However, to avoid any subjectivity in our

rankings, we chose to give equal weightage to all the parameters.

The continuance of improving fortunes of the global technology sector and

bullish conditions in the Indian bourses saw the BSE TecK index moving faster

than the NASDAQ and BSE Sensex.


On a y-o-y basis, the total market capitalization of the 71 companies

analyzed saw an increase of 118%. Among these, the Top 10 companies, in terms of

market capitalization, as on 31st March 2005, saw a rise of 126% over the

previous year, and the Bottom 10 companies saw a rise of 69% in the same period.

To reflect on the consolidation taking place in the Indian technology sector the

Top 10 market capitalized companies formed 92% share of the total market

capitalization of the 71 companies. The increasing consolidation in the services

sector, however, does not reflect the growth of a few niche product companies,

some of whom could very well leapfrog into the big league in the next couple of


Our analysis has been made using a sample of 71 companies, which together had

revenues of Rs 50,968.3 crore. The data used for this study was strictly based

on the latest audited figures available from the companies. In some cases, where

the results of a few companies whose fiscal year ended on March 31, 2005 were

not available, the previous year's figures were used. Similarly, companies

whose year ending is 30th June, 30th September, and 31st December, the data used

pertains to the previous year.


data used for this study was strictly based on the latest audited

figures available from the companies.

While we are by and large satisfied with the rankings that in some ways also

reflect the changing fortunes of the individual companies, numbers often do not

reflect the whole truth and, therefore, there could be some aberrations.

How they performed

A look at how the listed companies performed on various parameters:

Sales: Fiscal 2005 saw large IT companies ramping up sales, while

their smaller cousins were still struggling to find their feet. Within the

group, the share of Top 10 companies continued to improve, from 73% of total

revenues to 78% of total revenues, of the sample. Very few companies have been

able to change their rankings in a significant way over the previous period,

reflecting the maturity of the sector and the vendor consolidation being carried

out by the global corporations.

Profits: Like sales, the Top 10 companies' share in the overall

profits has improved from 86% to 90% of the total net profits of the sample. In

case of the rest of the sample size, profit share has decreased from 14% to 10%.

The fact that the profits are increasingly skewed clearly indicates that despite

the upturn in demand the fortunes of the second and third rung companies has not

really undergone any changes from the times of the tech meltdown.

Gross Block: The Top 10 companies' decreased their share of gross

block to 64%, from 77.5%, whereas the rest of the companies, as per the sample,

increased their share from 22.5% to 36%. This reflects that the investments made

in infrastructure, by the top companies, in the last couple of years, allowed

them to expand capacity without adding fixed assets, while the smaller companies

are only now investing in capacity build-up.

Sales Growth: Growth in the sector came back with a bang. The Top 10

companies have improved their growth rate and have grown 44% over their previous

year's sales. On the other hand, the rest of the sample size, in terms of

turnover size, have also witnessed 18% growth in sales, reflecting the growing

divide among the fortunes of top and bottom companies. We believe that this

trend is going to continue and is especially true for the software services


Profit Growth: The net profit of the sample grew by 52%, reflecting

the improving fortunes of the sector led by growing demand and improving scales

of economy. The Top 10 companies managed to grow by 46%, along with the rest of

the sample size reporting 130% profit growth. The lower profit growth of the top

rankers probably reflects the fact that recovery happened earlier for the big

companies while the smaller ones saw a major improvement in fortunes only this

fiscal, after the meltdown.

Gross Block Growth: Gross block growth is based on the increase of

gross fixed assets for a company. The year witnessed equated growth in gross

block among all the companies, led by the Top 10. The average growth in the

gross block stood at 27%, with the Top 10 companies growing by 33%, and the rest

of the sample, in terms of the gross block, growing by 12%. This is another

indicator of the fact that the smaller companies are unable to generate

resources to invest into infrastructure and, in an era of increasing order

sizes, are getting left out of the outsourcing party that their bigger rivals

are enjoying.

ROCE: Return on capital employed (ROCE) is perhaps the best measure of

a company's efficient operations both in the utilization of resources as well

as profitability. 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 total, intangible assets such as prior year losses,

goodwill, 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 is no longer a problem, a high ROCE is a

good indicator of a company's ability to make efficient use of capital.

Notably, average ROCE increased from 30.05% last year to 32.18%, which indicated

that a number of companies that have made substantial investments are starting

to yield results slowly. The ROCE of the Top 10 companies declined from 60.03%

to 50.95%, whereas the rest of the sample grew from 15.86% to 18.72%.

Where do we go from here

With the markets in the software services as well as BPO services getting

largely controlled by the Big Three and a few of the other majors, the days of

the small and medium software companies would seem to be limited. While this may

be true for most companies, we believe that it is here that the skills of an

entrepreneur come into the fore, one who can convert a bleak situation into an

opportunity. Most small and medium software services companies are trying hard

to become bigger in size by taking on larger clients. Going forward, it will be

the level of domain knowledge, ability to create IPR and value-added services

that will determine the success of the mid market companies rather than the

increases in turnover. Those who are unable to make this crossing could be wise

to look at being acquired by larger entities or by getting their clients to

invest into their companies so as to establish long-term relationship, thereby

reducing marketing costs.

The smaller companies that have gone into the product development domain have

also successfully shown the path to prosperity by leveraging their cost

competitive development skills to seek out niche markets where there is limited

competition. For these companies, raising additional capital and increasing

revenues would be key as they invest heavily into marketing infrastructure and


From an investment perspective, we continue to believe that the Indian IT

sector offers an excellent investment avenue for retail investors. Apart from

the big three where there is scope for considerable appreciation in the medium

term, there are a few diamonds among the product companies that could provide

handsome returns to investors as the markets continue to remain in the positive

zone. There are likely to be some IPO offerings from both BPO and software

services companies that can be subscribed. However, caution must be exercised

while investing into IPOs of small and middle rung companies which we believe

continue to remain prone to margin pressure and slow revenue growth. These

stocks may go up in the initial period, soon after the IPO, but are unlikely to

continue their rise over a significant period of time. Also, the liquidity in

these small cap stocks is low and it may not be always possible to exit from

them in the stock markets. Investors would be well advised to exit a major

portion of their investments in such companies soon after their listing.

Sushanto Mitra The

author is the founder of Technology Capital Partners