IT's growing and fast!

Krishnan Thiagarajan

FRONTLINE IT companies such as Wipro have already drifted from being a low-cost outsourcing partner for Fortune 1000 clients to providing them with new business models which are expected to offer them the time-to-develop and time-to-market advantage in an increasingly competitive environment.

A McKinsey study for Nasscom in 1999 projected India's export revenues from IT services to grow from $3.9 billion (Rs 17,750 crore) for the year ended March 31, 2000 to $30 billion (Rs 1,35,000 crore) by March 31, 2008.

Similarly, International Data Corporation (IDC) has also estimated that the global IT services market is expected to grow by 10.7 per cent annually from $308.8 billion in 1998 to $582.8 billion by 2004. Wipro and its frontline peers are expected to be at the vanguard of this massive emerging opportunity.

Outsourcing opportunity: Over the past year or so, Wipro has become a strong provider of information technology solutions for the enterprise (e-enabling) and technology (e-infrastructure) markets. In the e-enabling area, Wipro is strongly focussed on electronic commerce, business intelligence, extended enterprise and application integration, offering solutions to specific domains such as finance, manufacturing, telecom, retail, utilities and healthcare. Here, it has already forged strategic alliances with technology vendors such as Ariba, Open Market, Vignette and Forte to imbibe the latest expertise, tools and technologies.

Similarly, in the e-infrastructure market, Wipro has begun targeting the software needs in communications and computing products and embedded systems. To provide clients with a time-to-market advantage, it has been undertaking development services in technology areas such as Intelligent Networks, Wireless Applications, Embedded Systems, Systems on Chip Design, Board Design and Kernel/Operating System Software. It has also forged alliances with ARM and Symbian for an entrenched presence in this segment. Having targeted the fastest growing segments, Wipro's outsourcing opportunities are immense. But these are not without risks that would have to be managed carefully.

AAcquisition risk: In the ADS Registration Statement, Wipro has stated that it would pursue selective acquisitions of IT service companies to fill gaps in skill sets and position itself better with clients globally. In any potential acquisition, Wipro will risk either failing to acquire the right candidates or assimilate their personnel, operations, technology or software. If Wipro fails to do either properly, its revenue growth, operating incomes and cashflows may suffer.

*Threat of manpower shortages: As the ADS Registration Statement states, if the global IT services division has to sustain its growth, it has to continue to:

*recruit and retain sufficiently skilled technical, marketing and management personnel;

*provide adequate training and supervision to maintain high quality standards; and,

*preserve ``our culture, values and entrepreneurial environment.''

If it fails on any of these counts, the growth of Wipro's global IT services division may be affected. Wipro, which faced a second round exodus of key senior executive personnel recently, appears to be depending largely on the strength of its solid middle management. If this segment fails to deliver results, Wipro's long-term growth of revenues and profitability may plunge.

*Threat from skill-surplus countries: Wipro (and the industry in general) faces a major competitive threat from other hubs such as Ireland, Singapore and the Philippines for software development work. The sooner Wipro broadbases its overall revenue profile to encompass a prudent mix of high- and low-end application, migration and development work, the placed it would be better to counter threats from skill-surplus countries such as Ireland and the Philippines.

The valuation paradigm

Is the $63.86 per ADS (Rs 2,927 per share) offer price justified? Business Line attempted to evaluate Wipro's valuation using the latest PEG model. Using the future earnings estimates provided by Barra Global (consensus estimates of analysts), provided at www.icicidirect.com, Wipro's price to earnings growth (PEG) ratio for 2000-01 worked out to 1.68 vis-a-vis 1.22 for Infosys as on September 15, 2000. Except for a brief period in late May, when Wipro's and Infosys' PEGs were at similar levels, Wipro's PEG has always worked out to over 25 per cent premium to that of Infosys.

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If Wipro and Infosys financials are assumed to be on even keel, given the fundamental weaknesses of Wipro in terms of its diversified profile, low floating stock and lower operating profit margins relative to Infosys, it is likely that the offer price may need to be suitably discounted. Even assuming that the growth prospects are superior to that of its frontline peers, a 10-15 per cent discount to the offer price seems to be in order. In all probability, Wipro's ADS offer price may be fixed at $53-58 (Rs 2,450-2,650). At the current market price, shareholders can stay invested. Fresh exposures may be contemplated if the ADS price is fixed at $53-58. Only this price range can offer healthy returns for ADR investors, and by extension, to Wipro's domestic investors.