India IT Services Sector: Macro concerns vs. low penetration

India IT Services Sector: Macro concerns vs. low penetration

● While some of the US macro indicators have looked up recently,
concerns about the Europe macro continue, leading to concerns
about the revenue flow for the IT services companies from that
geography. The debate on low penetration vs. macro concerns:
can the low penetration of offshore IT services in Europe
compensate for the macro concerns?
● Contract wins in the past few days (and management
commentary) tilt the debate slightly in favour of low penetration, in
our view. We estimate <4% penetration in Europe vs. 8% in the
US. In some cases, the offshore vendors seem to have replaced
the incumbent European players.
● While discretionary demand will likely remain weak, push for costsavings
on non-discretionary projects could aid growth in Europe
for the Indian companies.
● Europe grew faster for each of TCS, Infosys, Wipro and HCL Tech
in the nine months ended December 2011. Europe contributes a
quarter of the revenue and has contributed nearly 30% of the
growth during this period.

Order flows continue from Europe despite macro
concerns…

TCS-TDC: News articles today suggest that TCS has won a large deal
worth over US$100 mn from TDC (Denmark’s largest
telecommunications firm) replacing incumbent, CSC to manage its IT
operations and maintenance services.

HCLT-Statoil: Yesterday, HCL Tech announced an infrastructure
management contract across 36 countries from Statoil (a Norwegian
govt. owned oil company). HCL Tech said it would also open a
delivery centre in Stavanger, Norway to service Statoil.
TCS-Europcar: Last week, TCS announced a multi-year, multi-million
EUR deal win from Europcar (an European car rental company, not
listed) to manage strategic IT services development for its French
operations.

…and management commentary has been “cautiously
optimistic”
We estimate penetration of offshore IT services in Europe to be less than
half that in the US (<4%+ vs. 8%). Also, compulsions to cut costs can
potentially accelerate the acceptance of offshore IT services in Europe.

In the last earnings call, Infosys’s management commented that
revenues from Europe are likely to grow faster than revenues from
America driven by low penetration and increasing acceptance of
offshored IT services. Similarly, TCS indicated that it continues to see
good deal flow from Europe and this is broad-based across verticals.
According to management, while a large part of this was driven by the
need to reduce costs, there were a number of transformational
projects as well.

Even smaller companies such as Hexaware sound confident of growth
in Europe. In its recent analyst meet, management indicated that
revenue growth from the European geography is likely to outpace
overall revenue growth guidance of 20% in CY12.

Admittedly, there are some data points such as Cognizant’s
(relatively) slow growth in Europe vs. the US and HCLT’s reported
decision to shut down an office for its BPO business in N Ireland that
suggest that Europe still bears watching. However, Cognizant’s
management has spoken about a ramp-down of some M&A projects
from a couple of European financial services clients in early 2011. It
does remain confident on Europe over the longer term as it sees
clients there becoming more open to outsourcing now than earlier.

India IT Services Sector valuation metrics