Growth pangs for mid-cap IT firms

Sluggish volume growth and mark-to-market losses have affected the performance of a majority of mid-cap information technology companies in the January-March 2008 quarter. Analysts expect that growth will continue to be sluggish in the next two quarters.

"We were expecting flat growth from the mid-cap companies this quarter. But some of them have clearly surpassed our expectations," explained Ruchir Desai, research analyst, Pinc Research. "However, the growth is a mere reflection of cost-cutting measures rather than increased sales."

Analysts also reckon that many companies have announced an incremental increase in hiring, but enhanced utilisation at the same time.

Ashwin Mehta, research analyst, Mangal Keshav Securities, concurs, "Some of the firms have also reduced their hiring or are going for just-in-time hiring rather than having a bench. Clearly the volumes are under pressure. From maintaining a bench, companies will now concentrate on managing the bench." For instance, Polaris Software Lab plans to adopt a just-in-time hiring strategy.

In terms of mark-to-market losses, many point out that mid-cap firms are going seriously wrong on hedging strategies.

Volatility in cross-currencies - Euro, Swiss Francs and others - has led to market losses in the derivatives portfolio of several Indian IT firms. This trend began Hexaware Technologies in the quarter ended December 31, 2007, for which period the company reported a loss of Rs 102.9 crore (Rs 1.03 billion). Last week, the company announced a further forex loss of Rs 5.6 crore (Rs 56 million).

KPIT Cummins, was another big loser among IT firms with MTM losses of Rs 89.26 crore (Rs 893 million) on account of the strengthening of the euro against the dollar. Market experts feel that since firms do not have a route for rupee-euro hedging most of them have entered into a tripartite agreement - US-euro and US-rupee - hedging.

Patni Computer Systems posted an MTM loss of $2.2 million (Rs 8.9 crore) for the March quarter. Gross margins were also affected by increased immigration cost on account of H1B filing impact (-1.3 per cent) and new hires that saw a drop in utilisation which impacted margins by 0.5 per cent.

However, some mid-cap and even small IT firms, saw their differential strategy come into play this quarter. Especially for firms like Mastek, 3i Infotech, Rolta, Geodesic and Zensar.

For instance, BFSI is the largest revenue segment for 3i Infotech but it has still maintained its margins. The company which has been growing through acquisitions (35 so far) has been able to hold its ground with a proper product and services mix and a focus on new geographies. Analysts note that the recent acquisition (of US-based Regulus) will allow it to increase cross-selling.

The same applies to Mastek. Its niche focus in insurance and government, and investment in IP platforms, is expected to further growth.

"Mastek still has the same risk as other IT firms.  But then it has a high level of fixed price contracts, which allow it to manage margins better. Of course the utilisation of the company has also gone up to 80 per cent," said an analyst tracking the firm.

Zensar is another example of how focus on new markets has allowed it to diversify. Business from India and West Asia grew by 143 per cent annually.

Whereas, business from South Africa and Japan grew 88 and 89 per cent respectively. Utilisation, however, was at 85 per cent.  Still, market experts feel that while mid-cap firms are playing their niche card well, overt dependence on a single vertical may not always work.

A case in point is Sasken. The Bangalore-based company did quite well in the March quarter as compared with the previous two quarters.

"The company's business is overtly dependent on the telecom segment and the OEMs. Besides a lot depends on the flow of shipments of telecom products. The same is the case for Tech Mahindra, but since the firm has a services' focus it can better diversify the risk," an analyst said.

Experts believe that going ahead, these firms will have muted growth. "We see uncertainty for the next three to six months.

But we expect volume growth in the range of 15- 20 per cent," said Harit Shah, research analyst, Angel Broking.