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With the maturity, the excitement of the early years has been replaced by quiet growth and consolidation.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.

	OVERVIEW Final Rankings Sales Profit Return On Capital Employed Market Capitalization Sales Growth Profit Growth Gross Block Gross Block Growth

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 base.

How The IT Stocks Moved Tech Shining: 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.

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 years.

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.

*The 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 sector.

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 distribution.

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