Indian Outsourcers: Cognizant Leads The Brigade

The $60 billion Indian IT industry is optimistic about the economic recovery, and the players have not only improved on their quarterly performance, but are also raising their outlook for the coming quarters. Analysts suggest that the recession in the United States has bottomed out and recovery is expected in 2010, which should translate to an outsourcing market growth of 4%-5%. Personally, I am somewhat skeptical about the recovery because the unemployment number sits at more than 30 million, which means that we’re having a jobless recovery of sorts, and this is very fragile. Nonetheless, prices and volumes are stabilizing for the outsourcing industry, resulting in revenue growth. Further, it looks as though the focus on operational efficiency parameters, especially utilization improvement, has enabled big players to improve margins despite the strengthening Indian rupee.

Cognizant Technology Solutions (NASDAQ:CTSH) leads the brigade and saw its stock reach a two-year high following the announcement of Q3 results. Revenues of $853.5 million increased 16% over the year and beat the market’s expected revenues of $805.6 million. Revenue growth of $76.9 million over the previous quarter was the largest in the company’s history. EPS of $0.48 also exceeded the market’s expected earnings of $0.41.

By segment, application management contributed 56% to revenues and grew 22% over the year and 10% over the quarter. Application development represented 44% of revenues and grew 10% over the year and 9% sequentially.

Cognizant added 46 new clients to its list during the quarter. While the company did have a strong pipeline at the beginning of the quarter, it was still surprised by the “speed at which decisions were made.” Cognizant’s growth is also reflective of the strengthening banking, financial services, and insurance (BFSI) segment, which contributed 43% of revenues and grew 7.4% over the year. Health care was the other high-growth segment, contributing 27% of revenues and growing 30% over the year.

Cognizant strengthened its foothold in the BFSI space with the recent acquisition of the India-based captive service center for UBS AG for $75 million. As part of the agreement, Cognizant will provide BPO, KPO, IT, and remote infrastructure management services to UBS divisions with a focus to reduce time-to-market while improving productivity, efficiency, and the quality of services delivered.

Cognizant continued to invest in platform development. Earlier this quarter, it announced the acquisition of the assets of Pepperweed Advisors to strengthen its IT infrastructure service practice by broadening the portfolio of consulting offerings, advising on business performance, risk management, and infrastructure cost management.

The company is also developing its global platform, which it views as a pillar of its success. Cognizant 2.0 is a Web 2.0 platform that allows the company to bring expertise from around the world on each client engagement. Similar to a social networking site, the platform connects associates, clients, and stakeholders, thus enabling people to share knowledge and experience and collaborate across regions.

Cognizant tied up with Sanofi Pasteur, the world’s largest company for developing and researching human vaccines. As part of the agreement, Cognizant, with teams based out of France, the United States, and India, will partner with Sanofi Pasteur for clinical trial data management. Cognizant claims to have increased “effectiveness as measured by time to value and reduce process hiccups for bringing vaccines to market.”

To cater to the needs of nearshore centers, Cognizant expanded its sites in the United States and Canada, opened a new delivery center in Manila and expanded the Phoenix delivery center’s operations to include BPO services alongside application development, application maintenance, and testing. I would not be surprised if in 2010, we see a lot more near-shoring in the United States. With unemployment at 30 million, there is likely a very large resource pool willing to work for low wages all over the country.

In any event, most IT players are trying to decouple revenue growth from headcount growth. This non-linear growth was reflected not only in utilization improvement, but in the billing model shift as well. In terms of the nature of contracts, 31% of revenues came from fixed-price contracts compared with 30% in the previous quarter and 26% last year.  Cognizant hired 3,900 people and attrition improved by 500 basis points over the year to 12.3% during the quarter. Offshore utilization stood at 74% during the quarter including trainees and 78% excluding them. On-site utilization was 90% for the quarter. At the end of the quarter, Cognizant had over 3,400 people in its training programs.

To further develop the non-linear growth model, for its core businesses, Cognizant is reevaluating the services that it offers clients and is creating transaction- or outcome-based pricing models. Customers prefer such billing models because they can keep their costs entirely variable and dependant on their own revenue growth. Cognizant successfully deployed an outcome- based model with the Sanofi Pasteur relationship.

Cognizant also realizes the importance of SaaS to help develop the non-linear growth market and is investing in R&D projects such as working on the possibilities of cloud technology to identify possible ways to create such  opportunities. Cognizant realizes that the customers want to go beyond traditional cost-saving models of outsourcing and labor arbitrage.

The outlook for Q4 was also impressive. The company projects EPS of $0.49 on revenues of $880 million. It expects to end the year with revenues of $3.26 billion and EPS of $1.88. Analysts were projecting Q4 EPS of $0.42 on revenues of $830.5 million.

The stock reached a two-year high of $42.40 earlier this week but has dropped since and is trading at $41.97, taking its market capitalization to $12.3 billion.

Tata Consultancy Services, (NSE:TCS), the largest Indian player, also grew. Revenues of $1.54 billion increased 3.9% over the quarter but fell 2.3% over the year. Net income of $336 million grew an impressive 8%. TCS added 30 new clients to its portfolio and landed 10 deals worth more than $100 million in the quarter.

By region, North America contributed 58.4% of revenues compared with 56.9% a quarter ago. Europe continued to decline and fell to 27.1% for the quarter compared with 27.9% a quarter ago, while emerging markets contributed 14.5% compared with 15.2% in the previous quarter.

During the quarter, TCS’ headcount dropped by nearly 300 people despite lower attrition levels. Attrition improved by 114 basis points over the quarter to 11.4%, with attrition in the BPO segment falling to 18% from 20.5% and in the IT segment to 11% from 12.1% in the previous quarter. Overall, utilization metrics remained among the best in the industry at 79.5% utilization excluding trainees and 73.6% including them. Utilization improved even though 1,820 trainees were hired in the in the quarter out of the 24,885 campus offers made last year. TCS’ fixed-price projects contributed 47.2% compared with 43.4% a year ago.

TCS already has delivery locations in locations outside of India’s major metropolitan areas. As I have mentioned earlier, these companies should increase delivery capacity in the rural or other non-metropolitan locations as a means to address cost and attrition.

The stock is trading at Rs 625.70, (approximately $13.30) after recently having reached a 52-week high of Rs 658 (approximately $14.00).

Wipro (NYSE:WIT), the third largest player, saw revenues grow 5% over the year to $1.44 billion, ahead of the market’s expected $1.35 billion. EPS of $0.17 exceeded the market’s expected $0.14. The IT Services segment recorded revenues of $1.07 billion, growing 3% sequentially but declining 4% over the year. On a constant currency basis, revenues would have been $1.05 billion, growing 2% over the quarter and falling 2% over the year. Earnings of $242 million increased a significant 20% over the year driven by improvements in utilization and other cost-control measures adopted during the past year.

By segment, consulting revenues grew 16% sequentially, BPO 7% and Application Development & Maintenance 5%.

Wipro’s focus on utilization remained strong, and the rate improved 84 basis points to 70.8%. Like its peers, Wipro’s headcount decreased despite volume increases. Overall headcount was down by 630 people in the quarter. Wipro’s share of fixed-price projects also grew to 40% compared with the 32% contribution a year ago. The company attributes improvements in technology and productivity to its increased ability to offer fixed-price projects, which, when managed properly, generally tend to be more profitable than non-fixed-price ones.

During the quarter, Wipro added 37 new clients, its biggest addition in the past seven quarters. In accordance with its strategy of becoming an end-to-end provider of services, the company entered into multi-year contracts with many clients for end-to-end infrastructure management, including end-user computing services, networks and security services, data center services, asset management, and service desk support services.

A recently released Forrester report evaluated Wipro as the leader in the Oracle services by rating the company the “strongest at the technical elements of Oracle implementations.” The report also lauded the company’s capabilities of “a growing focus on process and transformational consulting.”

Wipro projects revenues from the IT Services business to be in the range of $1.09 billion to $1.11 billion, aggressively projecting sequential revenue growth of 2.5%-4.5%.

The stock is trading at $17.36, taking its market capitalization to $25.3 billion. The stock reached 52-week high of $19.53 earlier last month.

HCL Technologies is the fourth big name in the Indian software market and provides software-led IT solutions, remote infrastructure management, engineering and R&D services, and BPO services to its global client list.

The company’s last fiscal revenues grew 17% over the year to $2.18 billion. Fifty-nine percent of these revenues came from the United States with Europe contributing 28% and Asia Pacific the remaining 13%.  Net income of $264 million for the year had fallen 6% over the year driven by recessionary pressures and foreign currency movements.

However, the situation now seems to be improving with revenues growing 26% over the year to $630.1 million. In the past year, HCL has announced new deals worth $2.65 billion even in the recessionary market, a sign that its presence is felt. But, while other players are managing to improve their margins, HCL saw earnings fall 12.3% to $66.5 million. The company blames the loss on a bad hedging decision that has resulted in severe foreign exchange losses to be realized even in the coming quarters.

Earlier last year, HCL purchased Axon by outbidding Infosys. Axon’s leadership in the SAP space is helping HCL to acquire new business. During the quarter, the company added 29 clients to its portfolio.

Like others, HCL is witnessing stability in pricing and volumes. Yet, the company isn’t being too aggressive in its outlook and hopes to see recovery only during the next year. It is, however, confident of achieving double-digit growth rates as customers consolidate IT vendors.

Unlike competitors, HCL does not seem to have a big training bench, which is visible in the marginal gap in the utilization numbers including and excluding trainees. Utilization including trainees stood at 76.2% compared with 76.5% utilization excluding them. Also, where others are reducing headcount, HCL is hiring and took on 665 new employees during the quarter. Attrition levels were higher than peers’ and stood at 12.8% for the software segment and 11.1% for the BPO segment. A quarter ago, the software segment saw attrition of 13% while BPO had attrition of 9.3%.

The stock is trading at Rs 287.80 (approximately $6.12) after having reached a 52-week high of Rs 352 (approximately $7.50) a month ago.

Meanwhile, Satyam’s (NYSE: SAY) results are still being restated. Following its acquisition by Tech Mahindra(NSE:TECHM.NS), Satyam’s quarterly results have yet to be published as its accounts are being restated from 2002 onwards to clear out the accounting mess. The financial restatement was originally scheduled to be completed by December but has now been pushed back by six months.

The new owners maintain that Satyam is holding a revenue run rate of $1.0 billion to $1.2 billion for the year. Volumes had bottomed for the company in July and August but have since picked up and are expected to stabilize by January.

Satyam is focusing on the emerging markets, especially the Middle East and North Africa (MENA) region and is targeting to double its revenues from the region in the next two years.

Satyam’s stock is trading at $5.14 with a market capitalization of $1.73 billion after having recovered from the accounting fraud-induced sub-dollar levels it had fallen to at the beginning of the year.

Many believe that the addition of clients to the Indian players’ portfolios was driven by the recession, which had tightened discretionary spending budgets. With customers looking to control costs, consulting budgets were the worst hit and the cheaper solutions provided by outsourcing services managed to sustain these players. Further, customers were looking to consolidate vendors, and growing existing accounts was possible. However, as the economy gradually recovers, these big deals won’t be as easy to bag. And with consulting purse strings opening, competition from the likes of IBM and Accenture will likely be more intense.

The current labor arbitrage model will not sustain the Indian industry in the long term, and only players who manage to morphwill survive the competition. Cognizant’s strategy seems to have a direction, and I like it. The rest are still too body-shopping oriented for my taste.