Edecutive Summary

Executive Summary

Indian scale players to post strong growth, led by growing demand for offshore IT services
Large Indian IT services players are on course to post sustainable 25%-30% growth over the next four
to five years on the back of healthy offshore IT services demand outlook. The 25%-30% growth will be
achieved with increasing proportion of services delivered from offshore. Demand for diverse and value
chain encompassing services, from the entrenched vendor will continue to tip the scales in favour of
the Indian scale players. Along with a handful of global services players, the Indian scale players in IT
services such as TCS, Infosys, Wipro, and Satyam will lead the current global phenomena of creation
of extended enterprises, which is being achieved through value added outsourcing and offshoring.

Profit margins to expand – fund growth

Large Indian IT services players will experience sustenance to improvement in profitability – contrary to
the expectations that their margins are on a secular decline. The sustenance to improvement in
profitability scenario will be on account of much more number of ‘client accounts’ delivering profits over
FY07E-10E compared with the present time. We also see a sustained billing rate improvement sce-
nario for the scale players, which will also contribute to comfort on the margins front. We however
believe that most of the surplus margins earned will be reinvested in the business, which will create
newer engines of growth for these companies.

Indian IT becoming part of global IT capex cycle, reducing risk profile

We see the themes of increasing market share, innovation, and client entrenchment, to lead to
reducing risk profile of the Indian scale players. Innovation in creating new services, producing software
and deliveries is leading to deeper client entrenchment than ever before. Increasing proportion of
revenues of these players - across service lines - is annuity like rather than project-based leading to
lowering risk profiles.

Large IT outsourcing deals unbundling, favouring offshore players

Over USD 100bn worth of deals with end-users are expected to come up for renewal over the next two
years. We see a strong trend of unbundling desegregation trend that will see five to seven players
sharing long term IS outsourcing contracts that were hitherto delivered by only one or two of the global
vendors. Almost mandatory introduction of offshore element in this deals unbundling trend is creating
new sources of revenues for the Indian scale players.

Ability to scale, diversify creating commensurate rewards

The Indian scale players have commanded sustained and range bound market capitalization per
employee over the past 12-16 quarters. In a pure (or substantially) IT services business, the market
capitalization per employee is a function of per employee productivity, profitability and sustainability of
these parameters. We believe that going forward per employee productivity – as adjusted for offshore
shift – and profitability will be sustained or improved. We see 30%-35% increase in employee base over
the next 2-3 years to translate into similar increase in these companies’ valuations.

Healthy valuations for emerging global leaders

We see the valuations of the large Indian IT services players to remain in the higher band of their PER
range driven by improving visibility, composition, and profitability of their businesses. These companies are
on their way to assume global leadership in various spheres of IT outsourcing. Our estimate of 31% EPS
growth in FY06E to 08E EPS for the scale players is ahead of consensus. We believe that the trends
outlined above justify the bullish view and will result in 25%-30% CAGR investment returns from the sector
over the next three years. We retain our overweight view on the sector and recommend `BUY’ on Infosys,
Satyam, HCL Tech and i-flex Solutions and ‘ACCUMULATE’ on TCS, Wipro and Patni.