OVERVIEW: Warming up to the New Spring

BSE tech sector index BSE TeCK gained 91% over last year, ahead of NASDAQ at 36% and BSE at 89%

While the M&A scenario was not like fiscal 2002-03, acquisitions happened either to penetrate a new geography or a new vertical

The top 5 companies saw a rise of 24% over the previous year in their market cap, while the bottom five companies gained 12% in the same period

How the IT Stocks Moved

Indian IT’s Listed Companies

Final Rankings

With two long years of slowdown behind them, the Indian technology sector is now warming up to the upcoming market rebound. Cautious optimism has slowly given way to the good feel factor and both large and small companies are gearing up in their own different ways to be ready for the next boom. However, with the consolidation happening in the industry over the last two years, smaller companies will find it increasingly harder to grow and only those who have a very niche focus or have IP related revenue streams will find resources to divert for growth.

The fiscal 2004 has been, in all respects, much better than 2003 with both big and small companies improving topline and bottomline growth. The larger companies have seen better sales growth and to some extent improved profits. Smaller companies have been hit both by lower sales growth and lower margins as they face longer sales cycles and a limited entry to large accounts. Once the US technology markets make recovery and mid market companies start outsourcing, we believe that, given the better economies of scales, larger companies will be able to compete even on price with smaller companies and it will be only when the demand rises beyond the capacities of larger companies, will smaller companies see slight improvement in fortunes.
Hence, while smaller companies were busy trying to make their both ends meet, their larger cousins were busy doing what the situation demanded: winning larger accounts to be able to benefit from the economy of scales and side by side recruiting people to fill up capacity.

Unlike last year, M&A activity was somewhat subdued this year, thanks to the pre-occupation of big companies in customer acquisitions and recruitment. The acquisitions that happened were either to penetrate a new geography or a vertical where the company felt it was weak. Infosys acquired 100% equity of Expert Information Services Pty Ltd, Australia for approximately $22.9 mn. Similarly, Wipro acquired NerveWire-which operated in the financial services market for approximately $18.7 mn in cash. In other notable deals, i-flex Solutions acquired SuperSolutions, a US-based consumer lending software provider, in an all cash deal for $11.5 mn. iGate was among the most prolific acquirers with three companies in the back. It acquired Bangalore-based IdeaSpace Solutions for Rs 7.7 crores. The company also bought GMR Group’s 51% stake in Quintant Services, which offers BPO services, in a cash deal to augment the former’s domain expertise and thereby strengthening its presence in the financial services segment for Rs 87 crore. iGate also acquired the BPO related businesses of IT&T, a listed company for Rs 19

In an interesting development, Digital Globalsoft, which was a 51% subsidiary of HP, decided to de-list from Indian stock markets and an exit price was established at Rs 850 per share and HP had to put up Rs 1,418 crore to fully acquire Digital Globalsoft. A similar move by e-Serve, the Citigroup BPO company, is under process. Citigroup is set to acquire the outstanding shares of e-Serve International valued at Rs 550 crore and make it a fully owned subsidiary. The only remaining listed MNC software company in India, Hughes Software, had a change of parentage, as its 55% parent Hughes Corporation was acquired by Rupert Murdoch controlled News Corp. These have been acquired by

In overall terms, the M&A activity, though somewhat less prolific last fiscal, shows the ongoing trend of consolidation in the IT services markets as well as the increased focus on verticals. We believe this trend will continue into the current fiscal too, making Indian companies larger and more resilient to volatility and at the same time with a more vertically focused business operations with improved skill sets and more solid client referral lists.

The improving fortunes of the global technology sector and bullish conditions in the Indian bourses saw the BSE TeCK index moving northwards in tandem with both NASDAQ and BSE Sensex outperforming both. While NASDAQ moved up by 36% last fiscal and BSE moved up by 89%, the tech sector index BSE TeCK showed a 91% improvement over the year. The bullish sentiment remained strong from the commencement of the fiscal until around December 2003, when the growing concerns of the economic repercussions of the Iraq War and political uncertainty at home forced the indices to move southwards, though it maintained most of the gains during the year.

On a year-to-year basis, the total market capitalization of the 57 companies analyzed saw an increase of 38%. Among these, the top five companies in terms of market capitalization as on March 31, 2004 saw a rise of 24% over the previous year and the bottom five companies rising 12% in the same period. To reflect on the consolidation taking place in the Indian Technology Sector, the top five market capitalized companies formed 77% share of the total market capitalization of the 63 companies.

Our analysis has been made using a sample of 57 companies, which together had revenues of Rs 30,696 crore. The data used for this study was strictly based on the latest audited figures available from the companies. Consequently, a few companies whose fiscal year ended on March 31, 2004 was not available and hence figures from the previous year. Similarly, companies whose year ending is June 30, September 30 and December 31, the data used pertains to the previous year. Among the major companies, NIIT, which was restructured into the software and education entities, was not considered for rankings due to lack of prior year comparisons. The data is assumed to be authentic considering these are based on audited figures. However, given the fact that the data pertained to different years-2003 and 2004-inter-company comparisons cannot be made.

This is the first time that we are taking consolidated figures as per the Indian Generally Accepted Accounting Principles (GAAP) of 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 in rankings due to it.

Finding one metric to measure 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 as our static criterion. 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, consequently, proportional ranking has been used for this purpose.

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 who 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 list.

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 the equal weightage for all parameters.

Size is one of the most important factors for success in the IT sector. Sales not only determines the strength of a company, but reflects its ability to sign on large and long term contracts providing stability to its operations. Fiscal 2004 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 has improved from 69% of total revenues to 73% of total revenues of the sample. Very few companies have been to able change their rankings in a significant way over the previous period reflecting the maturity of the sector.

While sales may be the most important factor in the market place, in terms of meeting the objectives of the shareholders, profits are a sacred figure. Here too, a skew of the distribution provides a picture of increasing consolidation in the sector. Unlike sales, the top 10 companies share in the overall profits remained static at 86% of the total net profits of the sample. Same has been the case with the rest of the sample size whose profit share stood at 14%.

The Indian technology sector had in the past been a resource-starved sector and serious investment in fixed assets has only been made in recent times. Overall, the top 10 companies marginally decreased their share of gross block to 71.5% from 73% whereas the rest of the companies, as per the sample, increased their share from 27% to 28.5%. This reflects that the investments made in infrastructure by the top companies in the last couple of years allows them to expand capacity without adding fixed assets.

Growth in the sector came back with a bang. The top 10 companies have improved their growth rate and grew 39% over their previous year sales. On the other hand, the rest of the sample size in terms of turnover size have also witnessed a 13% growth in sales reflecting the growing divide among the fortunes of top and bottom companies.

The net profit of the sample grew by 19% reflecting the improving fortunes of the sector. The top 10 companies managed to grow by 18%, along with the rest of the sample size report in a 22% profit growth. The lower profit growth of the top rankers probably reflects the fact that some them have focused the last fiscal on sales growth sacrificing margins to some extent.

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 companies. The average growth in the gross block stood at 19% with the top 10 companies growing by 16% and the rest of the sample in terms of the gross block growing by 25%.

Return on capital employed (ROCE) 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 shareholders funds and loans. From this total, 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. Notably, average ROCE increased from 21.5% last year to 22.4%, 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 marginally declined from 28.8% to 28.0% whereas and the rest of the sample in terms of the ROCE grew from 9.7% to 12%.

This year has been much better than 2003 fiscal and current quarter trends seem to indicate an even better 2005. Larger companies have been on a recruiting spree and with this expectation 2005 is likely to see solid sales and profit growth from these companies. Smaller companies on the other hand, with limited resources, have tried their best to maintain and improve immediate profitability. While some of them have invested in infrastructure it remains to be seen how they will be able to cope with increasing vendor consolidation by client companies and increasing sales cycles and yet at the same time maintain profitability and have resources available for growth. Smaller companies have either to increase their focus on a particular niche or be creative in managing costs, especially overseas marketing expenses to be able to remain in the reckoning in the coming years.

Sushanto Mitra The author is the founder of Technology Capital Partners

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