"Have you given thought to this feeling you have?
Anybody going slower than you is an idiot, and anyone going faster than you is a
maniac"
—GEORGE CARLIN
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In the IT stocks domain, the downturn lived on—the BSE TeCK index lost 260 points from its closing of 1,648 points in fiscal 2001-02 |
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M&A activity was fierce—signifying the ongoing trend of consolidation in the IT services markets and increased focus on verticals |
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BPO activity, which began in fiscal 2001-02, continued to gain momentum |
Fiscal 2003 was—in all respects—just as bad as 2002, and
probably worse for the smaller companies that saw the pressure of margins and
sales de-growth sending red ink running across their financials. Larger
companies were more resilient, cornering marketshare from smaller companies as
global corporations pruned their vendor lists and cut back on outsourcing.
While some companies were busy nursing their wounds, their
smarter cousins were busy doing what the situation demanded—diversifying into
BPO, acquiring businesses to increase their vertical focus or penetrate non-US
markets... The BPO phenomenon that started in the previous fiscal became a rage,
with almost every company in the Findex 30 having set up or announced the
intention of setting up a BPO unit (see box on Page 28).
The speed with which all this happened seemed reminiscent of
the dot-com boom, but with one difference—this is for real. Dollar arbitrage
apart, the skill base of India in technology, and the sheer power of numbers of
English-speaking people make it an ideal location for process outsourcing. Also,
one sees the possibility to use technology itself to further strengthen our
competitive advantages in this area.
The other activity among these top companies was
acquisitions. Laden with cash from the dotcom era preferential issues and
encouraged by the down market valuations, it was acquisition time for India
Software Inc. The biggest M&A being the marriage of Polaris with Orbitech,
making it the largest company in the BFSI segment. Wipro and the Shiv Nadar
Group were among the more prolific acquirers, with Wipro acquiring 100% stake in
GE Medical Information Technologies in July 2002 for $5.73 million at around 2
times its last year revenues. Wipro also acquired the global energy practice of
American Management Systems, a $1 billion global business and IT consulting
firm, in November 2002, at a cost of $26 million in cash apart from acquiring
the balance shares in Spectramind making it a 100% subsidiary.
The Shiv Nadar-promoted HCL Tech acquired Gulf Computers
whose last year revenues were $13.4 million. HCL Tech also picked up a 35% stake
in Bangalore-based Aquila Technologies, whose reported revenues were Rs 3.04
crore in fiscal 2002. Former group company NIIT’s acquisitions included BFSI
specialist and US-based Data Executives International, a privately-held company,
for an undisclosed sum in September 2002. In November 2002, NIIT took over AD
Solutions AG, which was providing custom solutions in the logistics and
financial industry space. In the domestic markets, the company took over the
content, technology and brand of e-Gurucool, a provider of e-learning in the
schools segment in February 2003 for Rs 1 crore. Another acquisition by NIIT was
of US-based Cognitive Arts, operating in the knowledge solutions market, in
February 2003.
Other notable acquisitions included SSI’s acquisition of
Aptech in February 2003, Tata Infotech’s acquisition of 40% stake of their JV
partner Sitel’s stake in Sitel India and Mascot Systems’s acquisition of
US-based eJiva and Hyderabad-based Aqua Regia Technologies. Among others, Mumbai-based
Aftek Infosys acquired a 49% stake in Munich-based Arexera Information
Technologies for a consideration of Euros 8.86 million. The company also
retained the right to acquire the entire 100% equity in Arexera based on certain
milestones over a period of time. In a unique transaction where the merger ratio
was partially determined by the business generated in the new entity, Cummins
Infotech Ltd, a subsidiary of Cummins Inc, merged into KPIT Infosystems in
January 2003 to form KPIT Cummins Infosystems.
In overall terms, the M&A
activity last fiscal showed the ongoing trend of consolidation in the IT
services markets, as well as increased focus on verticals. We believe this trend
will continue into the current fiscal 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 continuing downturn in the technology sector was
reflected in the stock prices, with the BSE TeCK index falling by over 260
points from its last fiscal closing of 1,648. With poor first-quarter results,
stocks fell further till September, when the first whiff of a possible recovery
and increased M&A activity took prices upwards. However, majority of the
third-quarter results from the sector were far below market expectations—and
added to the lower guidance from companies like Mastek and Infosys—stocks fell
back once again. There were other secular trends as well, including the SARS
scare and the Gulf War that continued to dampen investor sentiments till the
year-end.
Another major factor for the downslide of the Indian
technology stocks was the appreciating rupee versus the dollar. Since over 70%
of Indian technology services revenues originate from the US, margins of most
companies were hit by the falling dollar.
While technology stocks marginally outperformed performed the
BSE Sensex last year, given the recovery in the domestic economy and the lack of
it in the global IT markets, this performance is unlikely to be repeated this
year. Incidentally, the Indian technology stocks also outperformed the Nasdaq,
giving credence to the belief that the Indian technology sector, being more
services-oriented, is less volatile than its US counterpart.
On a year-on-year basis, the total market capitalization of
the 62 companies analyzed saw a decline of 18%. Among these, the top five
companies in terms of market capitalization as on 31st March 2003 saw a fall of
16% over the previous year, whereas the bottom five companies declined 76% in
the same period. To reflect on the consolidation taking place in the Indian
technology sector, the top five market capitalized companies formed 85% share of
the total market capitalization of the 62 companies.
Our analysis has been made using a sample of 62 companies,
which together had revenues of Rs 20,502 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 31 March 2003 could not
provide audited reports. Similarly, companies whose year ending is 30 June, 30
September and 31 December, the data used pertains to the previous year. The
authenticity of all data is assured by the fact that its data is audited.
However, given the fact that the data pertained to different years—2002 and
2003 —inter-company comparisons cannot be made and do not reflect the current
performance of the company. The analysis also did not take into account the
consolidated figures of companies since these were not available for some
companies for the previous year. Therefore, companies like Mastek, MphasiS, HCL
Technologies, NIIT and Satyam Computer Services, which have a high large
proportion of business from subsidiaries, would have been ranked differently.
Further, some companies such as Rolta and Silverline Technologies have extended
their year-end and, therefore, their last audited results pertain to that of
2001. Such companies have been excluded from the survey.
While we are by and large satisfied with the rankings (which,
in some ways, also reflect the changing fortunes of the individual companies),
numbers need not necessarily speak the whole truth.
Methodology
Finding one stick to measure all companies of different sizes, ages and
segments is a tall order. 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, all of which are dynamic in nature, have
also been used to rank 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 in 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 that are at the bottom of the list would thus get very few points.
This, in overall terms, gives importance to size in rankings, rather than just a
position in the list.
All parameters are not necessarily 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 equal weightage for all parameters.
Sales
Size is one of the most important factors for IT companies, especially
during downturns. 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 2003 saw . Within the
group, the share of top 10 companies has improved from 67% of total revenues to
82% of total revenues, whereas the bottom 10 companies have witnessed a decline
in their contribution to total sales. Few companies have been to able change
their rankings in a significant way over the previous period, reflecting the
growing maturity of the sector. The dominance of software companies is now
complete, with only two hardware companies in this list.
Profits
While sales may be the most important factor in the marketplace, in terms of
meeting the shareholder objectives, profits are a sacred figure. Here too, a
skew in the distribution provides a picture of increasing consolidation in the
sector. As with sales, the top 10 companies improved their share in overall
profits from 78% last year to 88% of this year’s net profits. The bottom 10
found the going tough and increased its losses during the period, with its share
standing at a negative 5%, compared to less than 1% last year.
Gross block
In the past, the Indian technology sector had been a resource-starved
segment and serious investment in fixed assets has only been made in recent
times. The slowdown has, however, curbed fresh investments in fixed assets as
many companies have under utilized infrastructure. Nevertheless, the top
companies continued to expand their capacity and bid for larger contracts.
Smaller companies hit by the slowdown have refrained from setting up new
facilities and focussed on preserving their capital. Overall, the top ten
companies’ marginally increased their share of gross block to 74% from 71%,
whereas the bottom ten’s share was under 1%.
Sales growth
Indian IT companies, used to 30%-plus growth in sales, have witnessed a
sharp decline in sales over the last two years. Across the sample, sales growth
has fallen significantly from 19% last year to just 9%. The top ten companies
have maintained their growth rate and grew 21%. On the other hand, the bottom
ten companies in terms of turnover size have witnessed a fall of 24% in sales.
Profit growth
For the first time perhaps, the sample witnessed a de-growth in the profits.
The net profit of the sample declined by 9% compared to a jump of 23% in the
previous year showing the extent of damage due to the technology meltdown. While
the top ten companies managed to grow by 5%, the bottom ten reported losses.
Profit growth, especially future profit growth, is a major factor in determining
investment attractiveness. Past profit growth is a good indicator of a company’s
likely performance as many are able to show similar profit growth over a period
of time. However, sharp profit growth can indicate creative accounting, or some
large inflows that may not recur.
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 companies,
led by the top ten. The average growth in the gross block stood at 21%, with the
top ten growing by 23% and the bottom ten by 19%. With size of operations
gaining importance, IT companies preferred to use cash in increasing the
infrastructure and bid for volume-led large contracts. Moreover, the advent of
BPO has led to a number of companies setting up new facilities. Overall, the BPO
opportunity is likely to drive gross block growth.
ROCE
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 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, high ROCE is a good
indicator of performance. Apart from Wipro, most in the top ten ranks are older
and established companies, as compared to far younger companies last year.
Conclusion
This has been another tough year for the Indian technology sector and, as
was expected, the bigger companies have managed to live out these tough times
far more comfortably than the smaller ones. Falling margins, M&A,
diversifications into related areas like BPO—all reflect the growing maturity
of the sector in India. While there will be some companies that will break into
these rankings in coming years, a majority of players here would remain in the
list for quite some time to come. The Indian IT sector has come a long way to
reach this level and tougher challenges are ahead in terms of growing
competition from MNCs in India. While the going will be tough for most, this
sector is here to stay and remain a prime property for both investor interest
and entrepreneurial activity.
A DQ REPORT
