Ahead of the recovery, buy rebounders where expectations...

Prepare for the leap ahead

Ahead of the recovery, buy rebounders where expectations are low

We expect revenue growth of Tier-1 IT names to moderate to low- teen levels in FY13F from 22% in FY12F.

However, trends such as: 1) consolidation; 2) offshore penetration; 3) productisation; and 4) pervasiveness of technology should push revenue growth of Tier-1 IT names closer to the trendline over the long term, with a revival as early as 2HFY13 likely, on our analysis.

Ahead of the recovery, we believe buying stocks where there is higher risk perception (INFO/CTSH/HCLT) will generate outlier returns over consensus favourites (TCS/WPRO).

Key analysis in this anchor report includes:

• Breakdown of FY13F growth potential by geography

• A look at how much growth the pure flow business can support in future

• Identification of four trends that should take Tier-1 IT growth back to its historical average

• Strategy and competitive positioning of the Tier-1 IT companies around these four trends

EQUITY RESEARCH

AN

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January 3, 2012

Research analysts

India Technology/Services & Software

Ashwin Mehta - NFASL [email protected] +91 22 4037 4465

Pinku Pappan - NSFSPL [email protected] +91 22 4037 4360

See Appendix A-1 for analystcertification, important disclosures and the status of non-US analysts.

India IT services

India IT services

TECHNOLOGY

EQUITY RESEARCH

ANCHOR REPORT: Prepare for the leap ahead

Ahead of the recovery, buy rebounders where expectations are low

January 3, 2012

Demand moderation in FY13F, but no falling off the cliff We see revenue growth in FY13F moderating to low-teen levels from our estimated 22% in FY12F for Tier-1 IT companies, largely on clients’ decision-making inertia and not structural impairment of demand. Cost moderation, pricing stability and rupee depreciation will however take EPS growth to 15%, ahead of revenue growth in FY13F, on our estimates.

Tier-1 IT growth: Shift in IT spend allocations and simple economics to power revenue growth closer to trendline Our analysis suggests that the flow business is likely to support just half of the historical industry growth rate. However, we believe Tier-1 IT players will grow faster, at the expense of local players/MNC incumbents as trends of increasing: 1) consolidation; 2) offshore penetration; 3) productization; and 4) pervasiveness of technology play to their advantage. Clients' inability to fund skill up-gradation of their local/captive tech workforce, as well as macro-driven cost constraints, increase the attractiveness of offshore outsourcing, in our view. We estimate Tier-1 IT revenue growth will rebound to ~18% in FY14F as the speed of decision-making improves.

Action: Buy HCLT/INFO; Raise CTSH to Buy; iGATE: top Tier-2 pick We believe buying into perceived risk and/or high pessimism (INFO, HCLT, CTSH) will generate higher returns than buying into consensus favourites (TCS, WPRO). We see HCLT gaining market share in a consolidating / under-penetrated environment, and benefiting from the resumption of productization spending. We upgrade CTSH to Buy on it benefiting from consolidation/increased regulation spending trends given higher reinvestments and client connect. INFO appears well-positioned for a rebound when productization and pervasiveness of technology (BFSI regulation spending) resume from 2HFY13F. At Wipro, the turnaround pace is likely to disappoint investors; while TCS, despite continuing to outperform peers, will likely see limited upside due to expensive valuations.

Valuation hit unlikely in near term; MNC outperformance may reverse We expect Tier-1 IT firms to perform better than multi-national company (MNC) IT players (e.g., Accenture/IBM), as clients shift towards higher offshore delivery to save costs and rupee depreciation benefits India IT firms more than MNCs.

Fig. 1: Stocks for Action

Source: Nomura estimates; Pricing as of 27 Dec 2011

Anchor themes

Shift in IT spend allocations and and simple economics should help power Tier-1 IT growth closer to the trend line. Within Tier-1, we favour companies better equipped for a rebound scenario and those that have greater street pessimism built in.

Nomura vs consensus

We prefer HCLT/CTSH/INFO over the consensus favourites TCS/WPRO.

Research analysts




Company Ticker Rating Price

HCLT HCLT IN Buy 392 530

Cognizant CTSH US Buy ↑ 64 82 ↑Infosys INFO IN Buy 2,759 3,300 ↑iGATE IGTE US Buy 16 20 ↑TCS TCS IN Neutral 1,179 1,230 ↑Wipro WPRO IN Neutral 407 390 ↑

Target price

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | India IT services January 3, 2012

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Contents

5 Executive Summary

6 Demand moderation in FY13F, but no falling off the cliff

6 Why material pricing cuts may not occur in FY13F

9 What gives us comfort on our low-teen-percentage growth expectation?

10 Low-teen-percentage growth estimate builds no growth from Europe

11 Breaking down our FY13F estimates by geography

14 Regulation and CTB spending to drive rebound in 2HFY13F

15 Growth moderation to come with cost moderation

16 Rupee depreciation to more than offset slowdown impacts

17 Consolidated summary of earnings and comparison to consensus expectations

19 No stopping growth of Tier-1 IT names

19 How much growth is likely to be driven by pure flow business?

21 Our model suggests flow business can support only half the historical growth rates for the next 10 years

22 What will add incremental growth to Tier-1 IT names for a rebound to near trendline levels?

22 1. Market consolidation towards fewer large providers and shifting market share among the large providers

24 2. Under-penetration across key segments and a shift from in-house to offshoring

27 3. Increasing pervasiveness of technology and mandatory spending on regulation

29 4. Increased productization

31 How are Tier-1 IT names placed to exploit these trends?

33 Prefer the rebound candidates, where expectations are low

35 We like the defensiveness of IT services in the tech segment

36 Case for reversal of preference for MNC over Indian IT players

38 3QFY12F preview


3

40 Cognizant

47 HCL Technologies

53 iGATE

60 Infosys Technologies

66 Tata Consultancy Services

72 Wipro

78 Appendix A-1


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Fig. 2: Valuation summary

Note: Pricing as of 27 Dec 2011; FY12F corresponds to Oct-11 for MPHL, HPQ, Dec-11 for CTSH, PATNI, IGTE, IBM and CAP, while it corresponds to Aug-12 for ACN, Jun-12 for HCLT and Mar-12 for others. Tier-1 IT includes TCS, Infosys, Cognizant, Wipro and HCL Tech.

Source: Bloomberg consensus estimates for Not Rated stocks, Nomura estimates

Com pany Ticker Rating FY12F FY13F FY12F FY13F FY12F FY13F

Indian IT

TCS TCS IN NEUTRAL 21.7 18.7 15.4 13.7 22.0 15.9

Infosys INFO IN BUY 18.8 16.5 12.8 10.9 23.1 13.8

Cognizant CTSH US BUY 22.6 18.7 13.6 10.7 19.8 20.9

Wipro WPRO IN NEUTRAL 17.9 16.0 13.6 11.8 6.3 11.6

HCL Tech. HCLT IN BUY 12.5 10.7 7.9 6.8 36.9 16.3

Tech Mahindra TECHM IN REDUCE 9.6 9.9 9.1 8.8 64.0 -3.1

Mphasis MPHL IN NEUTRAL 8.3 8.1 7.0 5.6 -29.4 2.6

Patni PATNI IN NEUTRAL 17.4 15.7 10.8 8.1 -39.8 11.4

iGATE IGTE US BUY 21.0 12.6 11.2 5.5 -16.8 67.0

Tier-1 IT average 18.7 16.1 12.7 10.8 21.6 15.7

MNC IT

Accenture ACN US NOT RATED 13.9 12.6 8.3 7.7 12.3 10.9

IBM IBM US NOT RATED 13.8 12.5 9.1 8.6 16.9 10.8

HP HPQ US NOT RATED 5.4 6.2 4.0 4.5 6.0 -13.4

Cap Gemini CAP FP NOT RATED 10.4 9.7 4.2 4.1 12.6 7.3

Group average 10.9 10.2 6.4 6.2 12.0 3.9

P/E (x) EV/EBITDA (x) EPS grow th (%)


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Executive Summary Demand moderation in FY13F, but no falling off the cliff; we expect a rebound in 2HFY13F Given current economic uncertainties, we see a slowdown in demand in FY13F, and estimate growth to drop to low-teens percentage vs ~22% in FY12F for Tier-1 IT companies. However, we believe this is likely to be just a temporary blip in a continuing growth story for the Tier-1 IT companies. We attribute the likely demand softness to decision-making inertia and not to any structural impairment in demand. In this scenario, we expect growth to rebound to ~18% in FY14F as the speed of decision-making improves. We believe our FY13F revenue growth estimates are likely to be met, even in a scenario of flattish growth in Europe, with growth largely contributed by the rest of the world (ROW) and the US. We expect cost moderation, relative pricing stability and rupee depreciation to more than offset the revenue slowdown impact, with Tier-1 IT companies’ earnings growing ahead of revenues in FY13F.

No stopping Tier-1 IT growth: Shift in IT spend allocations and simple economics likely to power revenue growth closer to trend line growth Our analysis, which is based on headcount additions in computer-related occupations in the US and Europe and their associated offshore headcount additions, suggests that the flow business is likely to support just half of the historical industry growth of 24% over the past seven years. In our flow business model, we do not factor change in slope of outsourcing or increased technology adoption, which might push growth higher.

Favourable trends like increasing 1) consolidation; 2) offshore penetration; 3) productization; and 4) pervasiveness of technology which will play to the advantage of Tier-1 IT and enable them to expand faster at the expense of local players/MNC incumbents. Clients' inability to fund the skill up-gradation of their local/captive tech workforce, as well as macro-driven cost constraints, increases the attractiveness of offshore outsourcing.

Buy into perceived risk and not defensive plays We believe buying into perceived risk and/or high pessimism (HCLT,INFO,CTSH) is likely to generate outlier returns, while stocks that the Street perceives as defensive plays are likely to generate limited upsides (TCS) or turn into risky investments (Wipro). We upgrade CTSH to Buy on it benefiting from consolidation/increased regulation spending trends given higher reinvestments and client connect. We believe that HCL Tech straddles both market-share gains in consolidation/under-penetration scenarios and potential upside from a productization revival. Margin sustainability concerns are unfounded, in our view, and best-in-class earnings growth is likely to result in stock re-rating. Infosys, in our view, should post growth that is comparable to that of its peer group over the next two quarters and we believe it is well positioned for a rebound on a revival in productization and the increasing pervasiveness of technology (BFSI regulation spending) from 2HFY13F. In our opinion, the Street’s current pessimism has not factored in these possibilities. In that light, while we like TCS for its ability to gain from all the underlying trends, but heightened Street expectations and limited scope for positive surprises make us cautious on the stock. At Wipro, we believe the turnaround pace is likely to disappoint investors; we expect its revenue and earnings to continue to lag that of its peers.

Near term valuation hit unlikely; MNC outperformance may reverse Current valuations are at a discount of 10% vs historical averages. We believe investors’ concerns of valuation multiples structurally correcting are unlikely to play out in the near term as growth moderation is temporary and margin structures remain viable.

In addition, MNC players such as IBM and Accenture outperformed India’s Tier-1 IT names by 20-40% in 2011, and we expect the Tier-1 IT companies to perform better as: 1) they exhibit greater revenue defensiveness than MNCs, for which there is a risk of onsite revenue cannibalisation towards offshore and a higher dependence on consulting (first to be hit during a downturn); 2) rupee depreciation benefits India ITs more than MNCs; and 3) MNC valuation discounts to Tier-1 ITs could widen on higher revenue volatility.

We believe HCLT, INFO and CTSH will be able to generate outlier returns compared to consensus favourites TCS and WPRO.


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Demand moderation in FY13F, but no falling off the cliff Given current economic uncertainties, we see a slowdown in demand in FY13F and estimate that growth will decline to low-teen-percentages compared to the ~22% level seen in FY12F for Tier-1 IT companies. However, we believe this is a temporary blip in a continuing story. The softness is largely on account of clients’ decision-making inertia in our view, and not because of any structural impairment on demand. Longer-term sustainable growth rates will still be in the 12-14% range for the industry, in our view, with Tier-1 players beating this growth rate. We also expect growth to rebound to ~18% in FY14F as the speed of decision making improves.

Fig. 3: USD revenue growth expectations for Tier-1 IT names Growth moderation in FY13F, but rebound closer to trend line In FY14F

Source: Company data, Nomura estimates

Our expectation of low-teen-percentage growth in FY13F is built on:

• Assumption of relative price stability in FY13F.

• Indications from company filings, hiring plans and industry body Nasscom.

• Comfort on volume growth, given our analysis of demand/contribution to revenue by geographical area.

Why material pricing cuts may not occur in FY13F

In our view, one concern that may be at the back of investors’ minds is that pricing cuts (if they recur as they did after the Lehman crisis) could take stock prices even lower and might structurally impair the multiples for the sector. During the global financial crisis, pricing declined between 5% and 10% across the Tier-1 vendors. We agree that severe pricing cuts, should they occur, would lead to a structural de-rating of the sector, but our view remains that we will not see material cuts in reported pricing in FY13F. In addition, a large part of the client-imposed cost pressures can be mitigated through contract structuring, in our view. Our rationale for why pricing is unlikely to be cut is outlined below:

Pricing is lower than pre-2008 peak levels and scenarios are different The scenario post 2008 was different in that pricing prior to 2008 had seen an improvement of ~5% on average across vendors. A similar scenario is not there now, as: 1) pricing has not recovered to pre-2008 levels, 2) clients are not in “panic mode” and 3) vendors are less likely to agree to pricing cuts, as a large number of clients, where pricing was cut, did not raise prices when their situation improved.

Company FY11 FY12F FY13F FY14F

Cognizant 40% 34% 22% 21%

HCL Tech. 31% 19% 16% 18%

Infosys 26% 17% 13% 18%

TCS 29% 25% 15% 17%

Wipro 19% 14% 10% 15%

Tier 1 IT 28% 22% 15% 18%

We expect revenue growth moderation to low-teen levels in FY13F, but slowdown environment related and not structural, in our view

Pricing across tier-1 IT vendors is below pre-2008 levels


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Fig. 4: Normalised offshore-pricing trend prior to previous downturn Pricing has not increased for the last 3.5 years and is below pre-2008 peaks

Source: Company data, Nomura research

Pricing discipline is likely to be maintained by ‘cartel’ of Tier-1 firms + global MNCs According to TPI, the largest global third-party deal advisor in IT, 75% of deal total contract value (TCV) is typically won by the 15 vendors, which comprise basically global MNCs (e.g., IBM and Accenture), and Tier-1 IT vendors (e.g., Infosys and TCS). Both these camps have much to lose should they engage in pricing disruption and hence they are likely to behave like a cartel by maintaining the status quo in pricing, in our opinion, for the following reasons:

• For an MNC that is already cannibalising its onsite work by moving work offshore, cutting offshore pricing would be a double-whammy as: 1) they would generate lower revenues and 2) still make lower margins than pure offshore players because of their use of more experienced staff, compared to Tier-1 players. For MNC players, which make 12-15% services EBIT margins, or for European players (e.g., Cap Gemini, Atos), which make single-digit-percentage margins, the impact of pricing cuts on profitability is likely to be much more severe than for Tier-1 IT firms that make EBIT margins of between 20% and 30%. Thus, in our view, MNCs are likely to match pricing with Tier-1 IT competitors, and not undercut them.

• A Tier-1 IT player cutting its offshore pricing would be putting its existing business pricing at risk, as the pricing discount to one client would likely trigger a chain of requests from other clients. For example, Tech Mahindra played the pricing game and managed to win a significant chunk of business from its competitors at British Telecom (BT), but BT has, since then, further cut pricing and now news reports suggest that a few of its US clients are also asking for pricing cuts (Source: Marketwatch).

Give-or-take scenarios are likely to be situation-specific and not widespread We do not deny that a scenario in which some vendors (as highlighted by HCL Tech, which has indicated that it would be looking to pass on rupee depreciation benefits to clients on a selective basis) might be disruptive on the pricing front. However, this disruption is likely to be deal-specific or client-specific and not widespread, as these vendors also do not want to disrupt pricing in their existing business. Thus, even if a pricing cut were to occur, it would happen to only a limited portfolio of clients that contribute the bulk business. In our view, the top-20 clients are more prone to this. The top-10 clients contribute 20-28% of revenues across Tier-1 players (company publically disclosed data), so essentially even a 10% cut implies a cut of less than 3% on a portfolio basis.

Additional investors’ concerns on pricing cuts are unlikely to play out We have encountered two key investors’ concerns on pricing:

• Clients see the margin benefits of rupee depreciation and would want some of the benefits of this to be shared.

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We expect pricing discipline across large vendors; client cost pressures likely to be mitigated by using contract structuring, rather than price cuts


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• Clients are being squeezed and they need to cut costs, and cutting pricing is the easiest method of achieving this.

We believe that pricing cuts might not be severe in such situations because:

• Rupee depreciation is likely to be a temporary situation and vendors would not want to have a permanent reduction in pricing based on a temporary situation. Second, in the past, when the rupee appreciated no positive pricing trend was seen. This is because clients typically want the vendor to take the currency risk and maintain constant costs for them.

• Client pressure on costs can be eased through contract structuring with increases in fixed-price proportions (FPP)/non-effort-based pricing models vs T&M contracts and greater offshoring. This was something that was illustrated pretty well by Wipro during the last downturn, when pricing remained largely stable (see the previous figure). Wipro managed client-cost pressures through an increase in FPP and offshoring significantly.

One area in which we do believe pricing pressure will continue is in the telecom segment, which is an area that has been sluggish for Tier-1 IT players, with price-sensitive players such as Tech Mahindra growing the pie much faster than the industry as a whole. We believe that if business is largely decided on prices, we are unlikely to see the Tier-1 players participate aggressively in the business, leading to our belief that the telecom segment could continue to be sluggish, even though telecom-client fundamentals show no severe pain.


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What gives us comfort on our low-teen-percentage growth expectation?

Preliminary indication from companies/Nasscom suggest a low-teen-percentage growth outlook We derive comfort from management and industry body Nasscom’s commentary, which suggests expectations of low-teen-percentage growth in FY13F. Key indications include:

• Nasscom, during our interaction, suggested expectations of a double-digit-percentage growth outlook in FY13F, based on preliminary feedback from clients and members (outlook expected in February 2012)

• Cognizant suggests 18-23% growth in revenues in CY12F (based on its 8-K filing for 50-100% vesting of restricted stock units (RSUs) for senior management). Except for CY08, Cognizant has not missed the targeted revenue growth at ~100% of the vesting of RSUs.

Fig. 5: Cognizant senior management revenue growth targets, guidance and actuals Except for 2008, Cognizant has been in line or above the targets for 100% RSU vesting


• Cognizant’s expectations of 23% growth for 100% of RSU vesting to its senior management in CY12F also provide comfort to our expectations of low-teen-percentage growth for Tier-1 peers. The Tier-1 peers have historically grown at ~10-15% slower than Cognizant, but we believe that the gap is likely to diminish on slowing growth in the US (~80% of Cognizant revenues).

Fig. 6: Revenue growth differential between Cognizant and its Tier-1 IT peers Cognizant has shown double-digit-percentage outperformance on revenue growth vs Tier-1 IT peers


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over Infosys over TCS over HCL Tech

Cognizant’s senior management incentive target of 23% revenue growth in CY12F provides comfort to our estimates.


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• FY13F targets for fresh graduate staff additions at TCS and Infosys suggest to us that they are working with a low-teen-percentage growth expectation:

– TCS has indicated its intention of hiring of 45,000 recent college graduates in FY13F. Assuming an 80% strike rate for fresh-graduate hires, and a 60:40 ratio of fresh-graduate hires to lateral hires, points to ~60,000 gross adds. Assuming attrition at similar numbers as in FY12F, net additions could be of the order of 30,000 people. This, on TCS average headcount of ~220,000 for FY12F, would imply ~13-14% volume growth.

– Infosys expects to hire 23,000 recent college graduates in FY13F. Applying a similar calculation would imply ~10% volume growth. This, coupled with the ~4% lower than recent peak utilisation levels, would imply low-teen-percentage growth as the base-case scenario that Infosys also seems to be working with. IT companies can also recruit off-campus recent graduates over the course of the year, and decisions on these hires are usually made after the end of the client-budgeting cycle in January or February.

Growth to get a push from regulation and CTB spending in 2HFY13F We expect 2HFY13F to show an improvement as a result of 1) regulation-related spending in BFSI; 2) ramp-ups as a result of a shift from in-house to offshore work; and 3) improvement in discretionary demand as cost savings on run the business (RTB) spending is redeployed for change the business (CTB) spending.

No growth scenario for Tier-1 IT companies suggests 5-9% growth in FY13F Even in a no-growth scenario over 4QFY12F, Tier-1 IT companies are likely to show growth of 5-9% in FY13F, in our view.

Fig. 7: FY13F growth in no-growth scenario over 4QFY12F Tier-1 IT companies should grow at between 5% and 9%, even in a no-growth scenario


Low-teen-percentage growth estimate builds no growth from Europe

We have tried to arrive at an estimate for FY13F growth by splitting the contributions to growth geographically. Trend-line growth has been of the order of 16% over the past three years, and this can be further broken down into 17% in the US, 11% in Europe, and 22% in the rest of the world (ROW).

Our estimates of low-teen-percentage growth for Tier-1 IT firms are likely to be met, we think, even in a scenario of Europe remaining largely flattish at FY12F levels.

Fig. 8: Tier-1 revenue growth by geography – last downturn, LTM and past three years ROW has grown at 1.3-1.6x higher than the US, Europe showing improvement over last 12 months


At constant 4QFY12 levels FY13F growth

Infosys 5%

TCS 5%

Wipro 5%

HCL Tech 6%

Cognizant 9%

Geography LTM Share Past 3yr CAGR Previous downturn LTM y-y

US 60% 17% 10% 24%

Europe 24% 11% 1% 30%

ROW 16% 22% 15% 38%

Overall revenue growth 16% 8% 28%

Revenue growth scenarios

TCS and Infosys fresher hiring targets suggest they are targeting base-case growth of low teens in FY13F

Low-teens revenue growth possible in FY13F even with no growth from Europe


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Key conclusions from our analysis

• We expect the ROW to contribute at least 4-5% y-y growth in FY13F, even if the growth rate halves from current levels of ~40% (LTM y-y). The ROW currently contributes ~20-30% of the incremental growth for Tier-1 companies and has grown at ~40% y-y on an LTM basis.

• We expect the US to show double-digit-percentage growth and contribute at least 7-8% y-y to the overall growth in FY13F. Our analysis on US economic data, tech unemployment trends and US Fortune 500 profitability are key determinants to our view.

• Europe uncertainty would remain and we do expect decision-making to suffer in the near term. However, we believe core European business out of the UK (two-thirds of India IT European exposure) is likely to be less impacted and in France/Germany penetration seems too low to be a concern. We see significant account openings in Europe during FY13F as Europe looks more seriously at offshoring to cut costs in an uncertain revenue environment. Our mid-teen-percentage revenue growth projections for FY13F are building in flattish growth expectations in Europe. Increased traction on new account openings and offshoring in Europe could provide upside to our estimates.

Breaking down our FY13F estimates by geography

ROW should drive at least one-third of our anticipated FY13F revenue growth While there are investor concerns on growth in the US/Europe, one segment where we are confident that growth would continue is the ROW. The ROW for Tier-1 IT companies includes geographies like India/Middle East/Latin America/ANZ/SG/HK and Japan.

The ROW now contributes between 14% and 21% of revenues of Tier-1 IT companies (excluding Cognizant) and has contributed to 22-31% of incremental revenues over the past 12 months. The ROW has grown at a pace of 1.3-1.6 times that of the developed markets.

If the ROW were to continue to grow at even ~20% levels (half of its current pace of growth), we estimate that it would still contribute 4-5% growth to India’s Tier-1 IT companies in FY13F. This is nearly one-third of our FY13F expectations for Tier-1 IT growth. Even during the last downturn (Sep-08 to Sep-09), the ROW exhibited growth of 14% y-y. We believe: 1) Indian IT companies’ scale and competitive position; 2) increased IT adoption and 3) eased worries vs that in the last downturn are likely to drive a higher growth rate than the previous downturn in this region.

Fig. 9: Comparison of Tier-1 IT companies on growth by geography (LTM %) 20-30% of incremental revenue growth for Tier-1 IT is coming from ROW, despite a lower 16-18% revenue contribution


Growth (y-y) TCS INFO CTSH WPRO HCLT Overall Overall (ex CTSH)US 30 19 37 11 22 24 21Europe 33 22 39 28 30 30 29ROW 32 45 58 27 66 38 37Overall 31 23 38 18 30 28 26LTM revenue contrib(%) TCS Infosys Cognizant Wipro HCL Tech Overall OverallUS 53 64 78 53 55 60 56Europe 25 21 19 28 27 24 25ROW 21 14 4 18 18 16 18Overall 100 100 100 100 100 100 100LTM growth contrib(%) TCS Infosys Cognizant Wipro HCL Tech Overall OverallUS 52 56 76 33 42 55 48Europe 27 20 19 41 27 26 28ROW 22 24 5 25 31 20 24Overall 100 100 100 100 100 100 100


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Two other data points that give us comfort on ROW growth are:

• The strength in ROW growth is strong across companies in the IT services segment, with global MNCs such as Accenture growing in the ROW at 35% y-y on a last 12 month (LTM) basis.

• Software sales, which are an early cycle indicator of a slowdown in services revenues, continue to be strong for both generic and banking, financial services and insurance (BFSI) product vendors in this region

– SAP/Oracle: SAP and Oracle have shown application license growth of 22-31% in the ROW, along with robust overall application license growth of between 18%- 30% on an LTM basis.

– Banking product vendors: Even in the most impacted banking and financial services segment, the license sales of Temenos and product revenues at Oracle Financial (two of the world’s largest vendors in the core banking software segment) in the ROW have grown at a healthy pace ahead of their average growth rates on a LTM basis. Our interactions with both companies suggest that their pipelines continue to look strong in the ROW and they have not seen any signs of deceleration due to the global macro slowdown.

Fig. 10: Software revenue growth at generic and BFSI players in ROW and overall (%) Strong ROW growth at both generic and BFSI product companies, overall slowdown too not visible yet


Note: * data corresponds to overall product revenues (incl. AMC and implementation), while it is license revenue for other companies

US to drive the balance two-thirds of our estimated growth in FY13F Given our expectations that the ROW can contribute at least 4-5% of incremental y-y growth and flattish growth for Europe, we believe the US will need to grow at double-digit-percentage to meet our mid-teen-percentage growth expectation for Tier-1 IT in FY13F. In our view, the US should deliver double-digit-percentage growth in FY13F, which could add 7-8% to the growth rate of the Indian Tier-1 players.

Even in a no-growth scenario in the US, Tier-1 players should still add 3-7% to incremental revenue growth in the US in FY13F, on our estimates. This is assuming that for the next two quarters, the US would grow in line with our growth expectations for the Indian Tier-1 companies.

Fig. 11: FY13F US growth and growth contribution (assuming no growth post 4QFY12)The US would grow at 5-10% in a no growth scenario as well


LTM growth ROW Company

Generic

SAP 31% 30%

Oracle 22% 18%

BFSI

Temenos 35% 16%

Oracle Financial* 17% 12%

Company US contribution (%) Growth Incremental growth contributionInfosys 65% 5.8% 4%TCS 53% 5.7% 3%Wipro 52% 4.0% 2%HCLT 56% 6.4% 4%CTSH 78% 9.5% 7%

ROW sales for software product vendors continue to be strong, providing comfort to our ~20% growth estimate for tier 1 IT’s ROW


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We expect the US to deliver double-digit-percentage growth as:

• US economic data are seeing an improvement and US corporate profits/cash positions are at historical highs and past pre-2008 downturn peaks.

• Trends in US tech unemployment do not suggest a sharp fall-off in demand as in 2008. This is because the US tech unemployment level of 4.1% as of Nov-11 remains significantly below the 2008 peak level of 6%-plus.

• Among the key clientele of Tier-1 IT services companies (US Fortune 500 companies), only BFSI has shown indications of pain. In the last downturn, there was more prolonged pain across the sectors. This indicates to us that in the current environment, there is no similar panic as seen in the post-Lehman crisis and, hence decision-making is still happening and has not ceased entirely. Our interactions with Tier-1 players have underscored our view.

Fig. 12: US corporate profits (USD bn) US corporate profits exceed pre-Global financial crisis peak

Source: BEA, Nomura research

Fig. 13: US corporate cash and liquid assets (USD bn) Cash and liquid assets at a historical high in excess of USD2tn

Source: BEA, Nomura research

Fig. 14: US GDP forecasts see an improvement post initial downgrades US GDP forecasts have been upgraded after the S&P downgrade of the US

Source: Bloomberg, Nomura research

Fig. 15: US Tech unemployment rate vs India’s Tier-1 IT revenue growth Inverse correlation between tech unemployment and India’s Tier-1 IT growth

Source: BLS, Nomura research

1,977

0

400

800

1,200

1,600

2,000

Dec

-90

Feb

-92

Ap

r-93

Jun

-94

Au g

-95

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-01

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-02

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-04

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-08

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-10

2,047

20

420

820

1,220

1,620

2,020

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-91

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-92

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93S

ep-9

4

No

v-95

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-97

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-98

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-99

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00

Sep

-01

No

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-04

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-05

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-06

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07

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-08

No

v-09

Jan

-11

3.23.3

3.0 3.0

1.8

2.2

1.6

2.2

2.0

2.3

1.8

2.2

1.0

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3Q 2011 4Q 2011 Avg 2011 Avg 2012

Mar survey Sep survey Nov survey

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7

Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11

Computer occupations - unemployment (LHS)

Tier 1 growth (RHS)

(%) (y-y)


14

Fig. 16: US Fortune 500 revenue and operating income progression prior to last downturn and now Banks and Insurance are the only segments that show financial deterioration; but the pain is less severe than in the last downturn


Regulation and CTB spending to drive rebound in 2HFY13F

We expect BFSI and package implementation to be impacted the earliest across services and verticals; however, we expect improvement in both towards 2HFY13F, as regulatory or discretionary work in BFSI and reinvestment of savings on cost initiatives gets ploughed back to change the business (CTB) initiatives. In our view, retail, energy and utilities among verticals and infrastructure management services (IMS), business process outsourcing (BPO) and application maintenance are likely to remain resilient.

Below, we present our outlook for service lines and verticals and compare them with the rebound post the Lehman crisis.

Then Now

y-y growth (%) Q3 Q4 Q1 Q2 Q3 Q4 Q2 Q3 Q4 Q1 Q2 Q3BanksRevenue 15 -3 -9 -15 -17 -28 -9 -2 9 -9 -9 -1Op. income -11 LP -77 -59 -80 LP 20 143 123 0 -30 16InsuranceRevenue 2 -13 -25 -10 -33 -50 2 11 8 4 10 2Op. income -1 -64 -95 -72 LP LP 37 30 6 -14 -16 -26RetailRevenue 6 5 5 6 4 -1 4 3 3 3 5 7Op. income -3 -5 -12 -3 -10 -25 12 10 12 3 5 3ConsumerRevenue 7 10 11 14 11 3 14 14 18 12 11 10Op. income 1 -3 6 13 -3 -14 0 11 1 29 13 -1Oil & GasRevenue 2 35 42 49 44 -29 21 16 17 28 39 35Op. income -24 41 26 9 75 -43 118 43 54 57 48 59TelecomRevenue 34 32 6 4 4 1 4 2 3 6 12 12Op. income 40 51 17 18 6 -8 -18 -1 19 8 51 25Mfg - HiTechRevenue 1 2 7 7 5 -20 42 29 16 19 12 12Op. income 11 40 45 59 18 -83 7476 84 16 8 -9 -1Mfg - ChemicalsRevenue 9 21 20 22 19 -11 15 9 13 14 18 20Op. income 9 65 31 20 18 -69 43 26 42 45 29 16Mfg - AutoRevenue 11 10 4 0 -12 -30 31 8 1 12 11 17Op. income LP LP 34 LP -46 LP LP 88 10 21 -7 4Aero and DefenseRevenue 12 9 10 9 4 -6 -2 3 3 4 4 5Op. income 24 24 17 11 -1 -16 0 69 1 4 14 12

20112007 2008 2010


15

Fig. 17: Verticals and service – Factors that led to recovery during last crisis and current outlook We expect retail, manufacturing and energy & utilities to remain resilient with verticals; we are more positive on IMS and BPO within services

Source: Nomura research

Growth moderation to come with cost moderation

We believe growth moderation in FY13F will come with cost moderation, as

• Wage hikes moderate from historical double-digit levels to 7-8% in FY13F, with possibility of deferment if things were to worsen.

Fig. 18: Offshore wage hike (%) trends for top-3 Indian IT companies We estimate wage hike moderation to single-digit levels of ~8% vs historical double-digit wage inflation


Verticals Factors that led to recovery post Lehman crisis Outlook

BFSI Bank M&As, vendor consolidation and cost take-outs led to large IT outsourcing, with the larger Indian IT players benefiting. This coupled with pickup in discretionary spending helped in the rebound

Layoffs and spending cuts announced at many banks. 1H decision making could be stalled especially on discretionary front end facing projects due to uncertainty. Regulatory work and reallocation of savings in cost efficiency projects getting ploughed back to discretionary work should lead to a 2H rebound.

Retail Multi-channel delivery, low offshore penetration were factors that helped Indian IT

Believe fear of obsolescence, changing business models with online/mobile becoming important and need to cut costs should continue to drive strong performance

Manufacturing Was a laggard, with recovery only very recent Positive on Hitech/auto, while discrete manufacturing could be sluggish

Telecom Clients cut down dramatically on costs which led to deep pricing cuts. Financials of Telecom clients were also weak

Outlook remains sombre, however, do not see sharp cuts as seen during last downturn. Vendors likely to be selecting given cost pressures in this segment

Energy & Util Rise in crude prices and strong profitability led to big increase in discretionary spending

Good growth likely to continue

Service line Factors that led to recovery post Lehman crisis Outlook

IMS Strong growth driven by low penetration, market share shifts with large rebid contracts coming up for renegotiation led to this segment continuing to growth even during the downturn

Continue to expect strong growth in this segment with TCS and HCL Tech expected to be key beneficiaries.

Package implementation Saw sharp declines on its discretionary nature during the downturn, but has rebounded since on trends towards increased productization vs application development and extended ERP prominence to aid business decision making

Expect a mixed bag with large scale transformations possibly being deferred, but spending on extended ERP, consolidation of multiple instances, multi channel integration and analytics to continue to be strong

ADM Vendor consolidations, deal rebids, M&A Integration and market share gains led to a rebound in ADM demand

Expect next round of vendor consolidations but M&A integration as a lever absent. Pricing pressures might recur in this segment

BPO The segment has underperformed IT services as this segment is more tied to the economy, which hadn't shown a full blown recovery

Incrementally turning more positive on this segment, though pickup might be lagged given sensitivities associated with job losses in the developed world.

Products Products showed a sharp improvement in demand and grew better than other segments as banks embarked on discretionary spending and emerging markets continued to show strengths

The growth might moderate as these are first decisions which could be deferred and lack of revenue growth visibility might curb investments

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13F

Infosys 17 13-15 14-15 13-15 11-13 8 14 10-12 8

TCS 15 11 15 12-15 10 0 13 12-14 8

Wipro 15-18 12 12-13 12-13 7-8 8-9 0 12-15 8


16

This is largely on account of moderating supply-side concerns in view of slowing IT industry growth. The demand slowdown is already reflected in reduced attrition levels across companies, cautious hiring, and employees staying put at perceived safety of their existing jobs.

• Variability in staff costs to be exercised if growth moderates. Variable compensation is c.4-6% of revenues for Tier-1 IT companies and c.20-30% of their offshore salary costs, although not all of it is would be utilised unless extreme circumstances occur. Our channel checks at Tier-1 IT companies suggest marginal variable salary cuts compared to previous quarters have already started in view of the uncertainty in demand and recent performance.

Fig. 19: Variable component of salary for Tier-1 IT companies ~4-6% margin buffer present in the extreme circumstances, though not all of it would be exercised

Source: Company, Nomura estimates

• Reaction times of management to be faster post the experiences of the last downturn in terms of rationalisation in hiring and timing of intake to coincide with demand, utilisation improvement (wherever there is scope) and increased fixed-bid/ offshoring. Infosys, e.g., has given the market a conservative target for fresh graduates hiring for next year, which it would relook at post budget decision-making in January 2012.

Fig. 20: Operational scope comparison across Tier-1 IT Infosys and HCL Tech appear to have better operational scope, TCS seems to be running a very tight ship


We find Infosys and HCL Tech better placed on operational scope, as there have been some inefficiencies built over the last 12 months at these companies. At Wipro, despite better operational scope, we believe that not all levers would be utilised by management, as we believe it would be unlikely that the company would commit the same mistake as in the last downturn, when because of excessive optimisation it lost out on growth. We also believe Wipro would have to look at increased S&M spending to bridge the growth lag with its peers. In our view, TCS is running an optimised ship; we do not see incremental benefits from operational improvements during this downturn.

Rupee depreciation to more than offset slowdown impacts

In 2011, the rupee depreciated by ~20% against the US dollar. In addition, it has depreciated across all the other major invoicing currencies (GBP, EUR and AUD).

Fig. 21: 3QFY12 INR performance against key invoicing currencies The rupee has depreciated against all key invoicing currencies materially


Company Variable % of offshore salaries Offshore salary as % of revenue

Infosys 30% 18-20%

TCS 25% 27%

Wipro 15-20% 18-20%

LQ Average Max Max - Current LQ LTM change LQ LTM change

Infosys 70.2% 69.7% 74.3% 4.1% 37.7% -2.2% 50.1% 0.3%

TCS 76.4% 74.6% 77.7% 1.3% 46.8% -2.2% 54.8% -1.3%

Wipro 76.1% 77.3% 80.7% 4.6% 45.2% 1.2% 45.7% -2.6%

HCLT 69.7% 73.5% 76.4% 6.7% 44.0% 2.9% 42.3% 0.6%

Utilization (incl. trainees) Fixed price proportion(%) Offshore revenue mix (%)

USD EUR GBP AUD USD EUR GBP AUD

Average 50.8 68.6 79.9 51.4 10.9% 6.0% 1.1% 7.0%

Closing 53.0 69.3 83.1 53.9 8.3% 4.0% 6.5% 13.9%

Rates (INR) Change (q-q)

20-30% of offshore salary cost is variable – which can be used as a margin lever if growth moderates


17

Fig. 22: 3QFY12 USD performance against key invoicing currencies The US dollar appreciated against key Invoicing currencies on an average


We expect stocks to react positively to rupee depreciation A widely held view by investors has been that IT stocks do not react positively to rupee depreciation, but they react negatively to rupee appreciation. We believe this judgement has largely come about from the past downturn experience where the stocks corrected by 30% to 50% despite the rupee depreciating by ~19% on average over that period. We believe realities were different then, as pricing declines happened. We maintain our stance that if a sharp pricing correction does not happen and the rupee sustains at these levels for at least a quarter or two, the markets will start attributing benefits over a longer period of time, leading to stocks reacting positively.

Fig. 23: Normalised CNX-IT vs USD-INR moves (base 100) CNX-IT has largely moved in line with USD-INR, except FY11 when demand overrode INR appreciation


The chart above indicates that CNX-IT has reacted positively to rupee depreciation and negatively to the opposite scenario, except in FY11, when the demand rebound was strong enough for the stocks to perform, despite rupee appreciating, though in some cases there has been a lag in the CNX-IT performance after currency starts moving in a particular direction.

Consolidated summary of earnings and comparison to consensus expectations

Fig. 24: USD Revenue growth expectation Cognizant likely to lead and Wipro to lag among Tier-1 IT companies, rebound in revenue growth expected in FY14F after moderation in FY13F

Note: FY11 corresponds to Dec-10 for Cognizant, iGATE, Jun-11 for HCL Tech, Mar-11 for Infosys, TCS and Wipro


EUR GBP AUD EUR GBP AUD

Average 1.35 1.57 1.01 -4.5% -2.3% -3.5%

Closing 1.31 1.57 1.02 -2.4% 0.5% 5.1%

Rates (USD) Change (q-q)

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USD-INR(RHS)

Divergence in INR and IT move on demand reboundLag in currency &

Stock moves

USD revenue growth (%) FY11 FY12F FY13F FY14F CAGR (FY12-FY14F)

TCS 29.1 25.2 15.0 17.0 16.0

Infosys 25.7 17.4 13.3 17.8 15.5

Wipro 18.9 13.9 10.3 15.4 12.9

Cognizant 40.1 33.6 21.9 20.8 21.3

HCL Tech 31.1 18.9 16.1 18.3 17.2

iGATE 45.3 7.9 7.3 11.1 9.2

IT stocks likely to react positively to rupee depreciation if sharp pricing correction does not happen


18

Fig. 25: EBIT margin expectations (%) We expect margins to largely remain stable over FY12-14F, except at iGATE where we see significant improvement


Fig. 26: Earnings expectations We expect 13-17% EPS CAGR over FY11-14 for Tier-1 IT (except Wipro), iGATE likely to lead growth on earnings

Note: Cognizant and iGATE earnings in USD, rest in INR


Fig. 27: Nomura vs consensus We are largely below consensus on revenue and margins for FY13F, for Tier-1 IT

Source: Bloomberg, Nomura estimates

Fig. 28: Sensitivity of earnings (FY13F EPS estimates) to USD-INR rate EPS sensitivity of 1.4-2.3% for every 1% INR depreciation, we assume USD-INR of 48 for FY12/13F

Source: Nomura estimates

EBIT margin (%) FY11 FY12F FY13F FY14F Change (FY12-FY14F)

TCS 28.1 28.1 26.7 25.8 -2.2

Infosys 29.5 29.0 28.8 28.3 -0.7

Wipro 18.4 17.2 17.4 16.7 -0.5

Cognizant 18.8 18.5 18.5 18.3 -0.3

HCL Tech 13.4 14.6 14.2 13.8 -0.8

iGATE 18.9 12.8 17.8 18.1 5.4

EPS FY11 FY12F FY13F FY14F CAGR (FY12-FY14F)

TCS 44.5 54.3 63.0 69.8 13.3

Infosys 119.4 147.0 167.4 186.6 12.7

Wipro 21.6 22.7 25.4 28.2 11.4

Cognizant 2.37 2.84 3.44 4.11 20.2

HCL Tech 23.0 31.5 36.6 41.6 14.9

iGATE 0.90 0.75 1.25 1.53 42.9

FY12F FY13F FY12F FY13F FY12F FY13F

Infosys 0.7 (1.7) 3.3 2.1 50 bps 70 bps

TCS 2.2 (0.1) 1.6 0.8 50 bps -50 bps

Wipro 0.2 (1.7) (2.0) (3.2) -10 bps -10 bps

Cognizant 0.1 0.2 (4.7) (2.6) -30 bps -20 bps

HCL Tech. 2.3 (0.1) (0.8) (0.8) -10 bps -20 bps

Revenue (%) Earnings (%) EBITDA margin (bps)

USD-INR @50 USD-INR @52 EPS sensitivityInfosys 6% 12% 1.4TCS 7% 14% 1.7Wipro 9% 18% 2.1HCL Tech 12% 22% 2.3


19

No stopping growth of Tier-1 IT names While we see moderation in growth in FY13F, we analyse the fundamental question of whether long-term growth for India’s Tier-1 IT names is likely to remain depressed or will rebound to historical trend-line growth.

IT services businesses and especially offshore businesses have been driven by cost arbitrage/skill availability, low penetration and quality provided by offshore locations such as India. This has largely been a flow business with the industry as a whole benefiting and that has been reflected in export revenues of India IT showing a 24% CAGR over the last seven years.

Fig. 29: India IT at a glance USD revenue CAGR of 24% over the last seven years

Source: Nasscom, Nomura research

In our analysis, we address:

• How much growth is likely to be driven by pure flow business?

• What will add incremental growth to Tier-1 IT for a rebound to near trendline levels?

How much growth is likely to be driven by pure flow business?

The core flow business for India IT services companies is coming from two geographies: the US and Europe (~90% of India IT export revenues). Penetration of India IT appears to be low at 11% in the US and around 6% in Europe. However, if we exclude the in-house proportions (at least 50% of overall IT spending) and non-focus mid-market segments (which include essentially everything except the Global 1,000 corporates), then India IT penetration within currently outsourced work (local + offshore) would be significantly more than double the reported penetration. This higher penetration essentially constricts flow business velocity to an extent, compared with historical growth.

Indian IT market FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 CAGR

Exports 12.9 17.7 23.6 31.3 40.4 47.1 49.7 59.0 24%

IT 7.3 10.0 13.3 17.1 22.2 25.8 27.3 33.5 24%

BPO 3.1 4.6 6.3 7.6 9.9 11.7 12.4 14.1 24%

Engg. 2.5 3.1 4.0 6.6 8.3 9.6 10.0 11.3 24%

Domestic 3.8 4.8 6.7 8.2 11.7 12.8 14.2 17.2 24%

IT 3.1 3.5 4.5 5.5 7.9 8.2 9.0 10.9 20%

BPO 0.3 0.6 0.9 1.1 1.6 1.9 2.3 2.8 37%

Engg. 0.4 0.7 1.3 1.6 2.2 2.7 2.9 3.5 36%

Overall IT Services 16.7 22.5 30.3 39.5 52.1 59.9 63.9 76.1 24%

Hardware 5.0 5.6 7.1 8.5 10.8 9.4 10.0 12.0 13%

Overall IT 21.7 28.1 37.4 48.0 62.9 69.3 73.1 88.1 22%

Flow business momentum which is driven by cost arbitrage/skill availability likely to slow down compared to the past


20

Fig. 30: Global IT spending and India IT geographical share (%) Europe and Americas contribute 90%+ of India IT revenues


Fig. 31: India IT penetration geographically Penetration in the US is ~2-3x Europe/APAC


Modeling flow business growth potential A key element of IT services has been the linearity in terms of revenue growth and people. We believe a good measure of how the flow business demand in IT services would shape up is the growth rate of the tech work force in the US or Europe. We also apply an offshore multiplier (i.e. for every person employed in the US/Europe which has an offshoring component, there would be between 4 and 5 people employed in a low-cost location) to arrive at the estimates for potential long-term growth from these markets. This model essentially does not assume: 1) an increase in in-house to outsource work; 2) an increase in the pervasiveness of technology and 3) any increases in pricing/cost of living adjustments, which can push growth higher.

Key facts underlying our model • The US currently employs ~3.8mn people in computer-related occupations and the

Bureau of Labor Statistics (BLS) projects it will grow at a rate of 2% per annum over 2008-18.

• Currently, revenue contribution across geographies of India’s Tier-1 IT names is: 60% from the US, 24% from Europe and 16% from the ROW. For overall India IT exports, the contribution is 60% to the US, 30% to Europe and 10% to the ROW.

62

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Indian IT penetration

We try to model flow business potential by linking it to tech workforce growth in the US/Euope


21

Fig. 32: Top down analysis for long-term India IT services growth in developed markets Based on headcount addition trends for US computer occupations

Source: BLS, Nasscom, Gartner, Nomura estimates

Our model suggests flow business can support only half the historical growth rates for the next 10 years

In a pure flow scenario and based on our top-down model for key geographies such as the US and Europe, we conclude that these markets can lend growth of between 11% and 12%. Revenue from the ROW for India’s IT names, which have historically grown at 1.3-1.6 times the pace of the developed markets, would provide further growth of 1%, on our estimates. So essentially we are looking at potential CAGR of ~13% for the industry over the next 10 years, which is almost half the growth rate seen over the past seven years (24% CAGR).

A big swing factor here is the increased pervasiveness of technology, which could take the 2% CAGR assumed over the next 10 years higher. For instance, a 1% increase in growth can add ~3% to the CAGR, taking it to 15%.

Particulars (mn) US Europe Overall Comments

Overall IT employment 3.8 2.4 6.2 Although the market size of Europe is near to that of the US, we apply a 10% discount on limited offshore penetration and a further 30% discount given not all European geographies are targeted by Indian IT names

Assumed long term IT employment growth (%)

2 2 Assuming a 2% CAGR in employment over the next 10 years, in line with the Bureau of Labor Statistics' (BLS) projections

Implied incremental employment 0.8 0.5 1.4

Of which

Assuming in-house proportion (%) 55 65 59 In-house means

Hiring related to offshore work(%) 45 35 41 We assume in-house proportions would be at 55% and 65% of tech headcounts for the US and Europe, respectively. This is in-line with Gartner's estimate of ~40% of outsourcing as % of global IT spend

A. Local headcount addition related to offshore work

0.4 0.2 0.6 Based on offshore work component

Offshore multiplier(x) 4 4 Assuming onsite: an offshore effort mix of 20:80

B. Offshore headcounts 1.5 0.7 2.2

Total headcounts from offshore work(offshore + onsite)

1.9 0.9 2.8 Sum of A and B

Assumed Indian IT market share(%) 70 70 Indian IT overall market share currently at 70% of offshore IT

Indian IT incremental employee addition

1.3 0.6 2.0 Indian IT could add ~2mn people serving US/EUR over the next 10 years

Current Indian IT employment 1.1 Headcounts in Indian IT exports as of FY11F (Nasscom)

Indian IT employment serving particular region (currently)

0.7 0.3 1.0 Breakdown based on currently export revenue breakdown of 60% and 30% for the US and Europe, respectively

Indian IT employees services particular region (10 years hence)

2.0 1.0 2.9 Indian IT could have ~3mn people serving US/Europe in the next 10 years

Implied growth in headcounts 12% 11% 12% Implies the US and Europe can grow at ~12%, despite assuming no improvement in outsourced:in-house business

Flow business likely to drive ~13% CAGR for the industry over the next 10 years – this is half the pace at which the industry has grown in the past


22

What will add incremental growth to Tier-1 IT names for a rebound to near trendline levels? We believe a shift in IT spending allocations and simple economics is visible in the four key trends that we think will add incremental growth to our flow business growth expectations. We believe this will take the growth rates of Tier-1 IT names to near trendline growth of 18-20% in FY14F and beyond. These four key trends are:

• Market consolidation towards fewer large providers and shifting market share among these few large providers

• Increasing offshore penetration across key segments and a shift from in-house to offshore work

• Increasing pervasiveness of technology and mandatory regulation-related spending

• Increasing productization

1. Market consolidation towards fewer large providers and shifting market share among the large providers

Based on Gartner data, India’s top five IT companies and the top five global providers currently capture a combined market share of 23%. This is completely at odds with the total contract value (TCV) trends seen for the top global and Indian offshore players (IOPs), which account for a combined ~78% of deal TCV won (for deals of > USD25mn). Fringe providers, who occupy a significant proportion of the market share, when compared to IOPs, are being squeezed out in terms of deal TCV signed. This squeeze has becoming more evident over the past four years.

Fig. 33: Share of India heritage companies (Tier-1 IT) increasing for deals >USD25mn TCV Fringe players getting squeezed by Tier-1 Indian IT and global MNC players

Source: TPI, Nomura research

Alongside the consolidation towards fewer large players, another sub-trend playing out in the market is a shift in market share across these larger players. So, while seven IT service providers captured a combined 75% of the deal TCV ten years ago, this same amount is now distributed across 15 providers. The new entrants to this list are India’s Tier-1 IT players such as Infosys, TCS, Wipro, HCL Tech and Cognizant, which are joining the ranks of MNC providers such as Accenture, IBM, HP, CSC etc.

87% 81% 79% 78%70% 64% 66%

49% 51%59% 58%

1%1% 1% 4%

2%5% 8%

13%18%

16% 20%

13% 18% 20% 18%29% 31% 26%

38% 31% 25% 21%

0%

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40%

60%

80%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010*

MNCs India - Heritage Rest of market


23

Fig. 34: Increased fragmentation of TCV across the top 15 vendors – Top 15 vendors by geography HCL and TCS are among the top 15 vendors across all three geographies

Source: TPI, Nomura research

Improvement in the competitive profile of IOPs is illustrated by the increased revenue market share and increased incremental revenue market share over the past three years. However, this has come at the expense of Europe-based players and fringe players, with the US top-five players maintaining a steady combined market share (excluding the impact of the HP-EDS merger). Likewise, among the top five players in the US, other than Accenture and IBM, players such as CSC and HP (excluding the EDS merger impact) are losing share. During our interaction with offshore vendors, some of these players have been cited as soft targets in deal rebids on less mature offshore offerings.

Fig. 35: Revenue market share progression Top-5 India gain, Top-5 US hold steady (ex HP), Top 5- Europe lose

Source: IDC, Nomura research

Note: Top-5 US market share increase largely driven by HP-EDS merger, ex of which the market share is flattish

Fig. 36: Incremental revenue market share progression Top-5 India vendors capture 57% share vs Top-5 Global MNCs

Source: IDC, Nomura research

We believe that even in a scenario of shrinking demand with fewer contracts, India’s Tier-1 players will likely continue to increase their share of revenues, which essentially means demand will not fall for the IOPs. Latest Market Vista compiled by Everest Group shows that while total contract numbers dropped q-q from 516 to 472 in 3Q11, the actual number of contracts won by key vendors tracked by the Group, which largely include India IT and top MNC names, increased from 20% to 25%. This is also visible in the deal annual contract value (ACV), which has shrunk progressively over the years. This also explains why some of the smaller India players can gain incremental business on the

1.9%

15.5%

5.0%

2.8%

17.7%

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5%

10%

15%

20%

TOP 5 INDIAN TOP 5 US TOP 5 EUROPE

FY07

FY10

23%

57%

77%

43%

Dec-07 Dec-10

% Share Top-5 Indian % Share Top-5 MNC


24

’law of small numbers’. From among Tier-2 IT players, we like iGate for its stable, mature delivery platform, lower billing rates compared to Tier-1 peers and potential to pose as a veritable competitor to Tier-1 players in areas such as application development and maintenance. iGate currently has annualised revenues of above USD1bn.

In this environment of economic uncertainties where clients are looking to cut costs, we believe IOPs are better-placed to cope with falling demand compared to MNCs, given IOPs’ better offshore propositions. Moreover, MNCs have to contend with their existing large contracts that are up for renegotiations soon. Hence for MNCs, while part of their business is backfill business for the Indian IT names, this is largely incremental business that is being added.

2. Under-penetration across key segments and a shift from in-house to offshoring

Key areas where we still see significant under-penetration for offshoring are Infrastructure Management Services (IMS), business process outsourcing (BPO) and engineering services within service lines and Continental Europe among geographies.

Fig. 37: India IT services penetration by service line Significant under-penetration in IMS, engineering services and package implementation

Source: NASSCOM, Nomura estimates

We believe client-push factors in the current economic environment will expedite penetration for India’s Tier-1 IT names.

• Move from in-house to offshore work and deal rebids to cut run-the-business (RTB) technology spending

• Cutting operational costs on business processes

• Shift savings in operational costs to change the business initiatives to help compete effectively and focus on front ends.

• Economic rationale to cut costs through offshoring (especially in underpenetrated Continental Europe) actually strengthens in a scenario where clients are unsure of their revenue lines.

a) In-house work still occupy a significant proportion of clients’ IT spending We believe a significant change that is likely to happen during this downturn is clients looking at variablizing their IT spending. A significant proportion of this variablization of IT spending is moving from in-house to offshoring. Announcements made by Bank of America and Citibank to cut jobs in technology and operations indicate such trend is taking place. In-house work continues to occupy a significant proportion of IT spending – even in BFSI, which is the most mature segment in terms of offshoring, in-house work comprises ~45% of overall IT spending. Hence, we believe there will be more offshoring, especially in other segments that are not yet as penetrated as that of BFSI .

Service line break-up Global spending (USDbn) Share (%)

Traditional service lines (ADM)

Custom Application Development 35 43.9

Application Management 49 20.1

Overall ADM 85 30.0

Under penetrated service lines

Package Im plem entation & Consulting 131 5.8

IT Consulting 29 8.0

Systems Integration 102 5.2

IMS 214 3.0

Netw ork Consulting & Integration 32 1.2

IS Outsourcing (RIM) 181 3.3

BPO 158 10.7

Engineering Services 1125 1.3

Global IT spend (excl H/W) (USDtn) 1.0 7.5

In-house is still a large proportion of clients IT spend; even in BFSI which is the most mature vertical in offshoring, in-house comprises of ~45% of IT spend


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Fig. 38: Banking and Financial Services IT Spending (ex hardware) breakdown (%) – 2012P Internal spending still ~50% of overall services + software spending at BFS players

Source: AMR Research, Nomura research

Two prime beneficiaries of this trend of moving work from in-house to offshore are:

• Infrastructure management services (IMS)

• Business process outsourcing (BPO)

IMS has traditionally been either done in-house or has been the preserve of the larger MNCs such as IBM, HP-EDS, CSC, or done locally, where a significant amount of rebid traction has being witnessed lately and ~USD8bn worth of deals coming up for renegotiations in 4Q11, according to TPI. The shift from in-house to offshore work and rebid deals are opportunities for Tier-1 IT names, in our view, as reflected in the grow rate of IMS of 30% y-y for Tier-1 IT names over the last 12 months. We continue to see strong growth in this service line with provider commentaries remaining positive. Incidentally, IMS was resilient even during the last downturn and grew at ~18% y-y in the four most severe quarters of the downturn (Sep-08 to Sep-09). HCL Tech and TCS would be prime beneficiaries of this trend, in our view, more so the former as it has the highest contribution (25% of revenues) and is not averse to absorbing client staff in deal situations. In a scenario, where clients are wary of cutting jobs in the US/Europe, HCL Tech’s flexibility to absorb client staff would be a key differentiator in clinching in-house to outsourced deals, in our view.

Fig. 39: IMS growth LTM basis (%) y-y TCS and HCL Tech lead, Infosys lags. HCL Tech and Wipro derive 20%-plus of revenues from IMS, while there rest derive between 5% and 10%


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HCL Tech and TCS likely gain the most from shift of work from in-house to offshore


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b) Moves to cut operational costs to benefit BPO The second trend of cutting operational costs is likely to benefit BPO, in our view. This is one segment that was expected by the market to perform better than IT services on growth and has faced significantly higher headwinds in the past. However, we believe the current downturn will likely change this scenario and expect growth acceleration in this service line. The value proposition of BPO remains strong, in our view, and it would be difficult to continue with in-house operations or work in an onsite-centric manner in developed markets given the current cost-push factors. A caveat, however, is that this service line directly impacts jobs and, hence might be sensitive given the current employment situation in the developed markets (US/Europe); thus, this could be subjected to some lag in decision making.

Fig. 40: LTM BPO growth vs overall company growth y-y (%) BPO growth has lagged overall IT services growth at Tier-1 players, we see BPO growth accelerating


We also believe the competitive positioning of integrated Tier-1 IT names + BPO players is likely to improve further, as: 1) commoditization of voice BPO and the move towards platform/transaction-based BPO, which are gathering pace, are likely to give them an edge given their strong IT background; 2) competing countries such as the Philippines are starting to face similar attrition/wage inflation as they scale up their BPO industry. India is ~20% cheaper on cost per FTE (full time equivalent) compared to the Philippines, according to Everest Group; and 3) rupee depreciation further increases the cost attractiveness of India. The integrated IT+BPO players have historically performed better than pure play BPO players, a trend that we believe will continue.

Fig. 41: BPO revenue (USD mn) and revenue growth comparison for pure play BPO vs integrated IT + BPO players Integrated IT+BPO players have sustainably outperformed the pure play BPO players over the last three years


Note: FY11 corresponds to Dec-10 for Genpact and eXL and June-11 for HCL Tech

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Pure-play BPO FY08 FY11 3yr CAGR IT + BPO FY08 FY11 3yr CAGRGenpact 823 1,259 15% TCS 353 924 38%WNS 460 616 10% Wipro 306 509 18%Firstsource 310 442 12% Infosys 236 340 13%eXL 152 253 18% HCL Tech 224 195 -4%Aggregate 1,745 2,570 14% Aggregate 1,119 1,968 21%

Tier-1 IT’s BPO performance set to improve on higher platform/transaction share and sustained cost advantage


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Fig. 42: BPO cost per FTE (USD) comparison India is the cheapest destination for non voice BPO work, with cost per FTE 1/5th of that In the US

Source: Bloomberg

c) Reinvestment of RTB cost savings into CTB spend We believe under-penetration will reduce, as even in the so called discretionary demand segments – consulting, package implementation and engineering services, low cost delivery has started to take shape. Our interactions with vendors suggest that they are seeing a definite trend of clients expanding their innovation centres in India or doing a large part of the innovation, new initiatives, new products, and new work from India to cut costs, while not stalling their innovation efforts. That is another element why we are positive on the long-term prospects for package implementation, consulting and engineering services. However, we believe clients will continue to delay making decisions into 1QFY13F, as they would need to ascertain how much savings they have made from cost save initiatives before deploying them into CTB spending.

d) Economic pressure to accelerate European offshore penetration Near-term concerns over the developments in Europe will have an adverse impact on the revenue of India’s Tier-1 players from 3QFY12F, in our view. However, we also believe that the demand slowdown is due to stalled decision-making in a period of high uncertainty. The economic rationale to cut costs through offshoring (especially in underpenetrated Continental Europe) actually strengthens in a scenario where clients are unsure of their revenue lines. Over the past 12 months, Tier-1 IT players have seen revenue in Europe growing higher than that in the US on this trend.

We expect significant account openings to happen in Europe during this crisis, especially in RTB service lines such as application maintenance, testing, infrastructure management and a lagged pickup in BPO as European clients are forced to cut costs. With LTM European revenues in excess of USD1bn across Tier-1 players, we believe the scale is there for them to tap European opportunities/showcase their capabilities to clients. We believe HCL Tech and Cognizant are likely to be more successful, as they are less averse to absorbing clients’ staff in deal situations given their lower margin expectation. This is given the sensibilities associated with outsourcing related job losses in Europe (on account of current jobs situation and tough labour regulations).

3. Increasing pervasiveness of technology and mandatory spending on regulation

The increasing pervasiveness of technology and the fear of business models becoming obsolete are likely to drive the spending of IT services higher. A key example is the retail vertical, which under current economic conditions, should have been the worst affected segment from an IT perspective, but has been among the best performers for the industry and outlook continues to be positive for all players in this vertical.

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Competitive pressure likely to force clients in Europe to offshore more, in our view


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Fig. 43: Comparison of growth by verticals q-q (%) for India’s Tier-1 IT (ex CTSH) Retail and energy & utilities lead growth and were ahead of overall growth for the last 5 quarters


We believe changing business models, growing fears of obsolescence and differentiation in a constrained environment are driving tech spending in retail, with offshore players benefiting on provided cost advantages. The following underscore how technology is rapidly changing business models in the retail space:

• E-commerce sales rose 14% y-y to USD48.2bn in 3Q2011 and increased 16% y-y to USD142bn in 2011. E-commerce sales, as a percentage of total retail sales, rose to 4.6% as of 3Q2011, nearly doubled over the last five years. (Source: US Department of Commerce)

• Retailers spend more on web advertising than any other industry, according to eMarketer, a digital media and advertising research firm. Retailers are expected to have spent USD5.73bn on online advertising in 2011, up from USD5.16bn in 2010, accounting for more than one in every five online ad dollars. Spending on web advertising by retailers will increase to USD9.36bn by 2015.

• Forrester Research is projecting US mobile commerce to reach USD31bn by 2016, growing at a 39% compound rate. The report says that mobile commerce is expected to be 7% of overall eCommerce sales by 2016.

• Amazon.com selling more e- books than paperback books — 115 ebooks for every 100 paperbacks in the US market, according to the company.

Fig. 44: Retail vertical key IT spend areas Multi channel sales is leading to increased IT spending by retailers


In our view, the concerns faced by the BFSI sector are identical to those faced by the retailers namely, shrinking profitability and the needs to cut costs and upgrade technology to better serve their customers in a shrinking volume environment. So, while the current crisis is likely to stall decision-making for some time, we believe strategically decisions will continue to be made. Our interaction with Temenos (the world’s leading core banking software provider) suggests to us that a majority of core banking replacements is not aimed at cutting costs but at increasing customers’ focus. Cost saving is the by-product of the same.

Vertical Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 5 QTR CQGR

Telecom + Media 7.6 3.2 0.2 2.3 -1.7 2.3

BFSI 8.7 7.8 3.0 4.1 4.6 5.6

Manufacturing + Hitech 7.2 6.6 6.2 5.9 4.9 6.2

Retail + Tranportation 13.5 7.6 6.1 5.8 5.2 7.6

Energy & Utilities 16.7 10.6 5.0 6.0 13.9 10.4

Overall 9.5 6.5 3.8 4.7 4.5 5.8

Medium Area of tech spendOnline e-commerce platform

Customer buying pattern analysisManagement and monitoring of online advertising

Search engine Search engine optimizationCustomer buying pattern analysisReal time conversion tracking mechanism and reporting dashboard

Mobile Mobile commerce platformApps for smartphones/tabletsPersonalized Shopping experienceLocation-based advertising

Physical stores Multi-channel integration (integrating online, mobile and social media)Cross-channel merchandising Integrated payment solutionBusiness intelligence

Social networks Business intelligenceReal-time analytics


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This pervasiveness of technology is further visible in newer developments such as cloud, mobility/social and analytics – which lead to different technology adoptions. On our understanding, every Tier-1 IT company has started to focus on these three themes (cloud, mobility and analytics), indicating to us the importance of being ready to tap changes when they happen.

In addition to the increased pervasiveness of technology, there is a clear push expected for regulation-related spending in BFSI/Healthcare. We expect Tier-1 IT players to gain disproportionately out of this increased spending. Cognizant is likely to be a beneficiary of both BFSI/Healthcare spending, with TCS and Infosys likely to gain from the increased BFSI spending. Infosys expects regulation-related spending in BFSI to be 4-5 times the merger- and integration-related spending seen by the industry post the Lehman crisis, while Healthcare regulation spending is likely to be higher than Y2K spending, in our view as changes to regulation are much more expansive, compared with what happened in the case of the Y2K problem.

Fig. 45: Details on key regulations in BFSI/Healthcare space ICD-10 opportunity possibly greater than Y2K's; regulation spending in BFSI 4-5x the size of M&A spending although slightly more spread out


4. Increased productization

Another key trend that we expect to have longer-term implications (positive and negative) for the IT services players is increased productization (adoption of third-party software). This would have cannibalizing impacts on the current application development and maintenance market but positive impacts on package implementation and consulting demand. We believe the positives would outweigh the negatives, as the system integration + package implementation & consulting market is nearly 1.5x the size of the application development & maintenance (ADM) market. Also, penetration of Indian IT industry in this market is less than 6% vs 30% in the ADM market.

Regulation Industry segments affected Area of IT spending TimeframeDodd-Frank Act Brokerages Risk management

Banks Compliance reporting

Investment firms Analytics

Insurance Real-time reporting

hedge funds Margin and collateral management

Thrifts Real-time position monitoring

Payment systems companies Leverage management

Performance reporting

Data management

System integration

SEC audit preparation

Employee audit

Integration of risk and compliance systems

Risk information reporting

Consumer fee tracking

Liquidity and asset liability management

Basel III Banks Risk management

Regulatory reporting

Customer relationship management

Regulatory compliance

Information management and data security

HIPAA 5010 Claims adjudication changes

Medicare and Medicaid systems upgrades

Data warehouse updates

BI analytics

Billing and EDI systems upgrade

End to end testing for partner interoperability

ICD-10 Healthcare payers and providers EMR implementation.

Hospitals ICD-10 conversion

Health information exchanges Changes in billing systems

Changes in reporting packages

Changes in decision and analytical systems

Patient tracking

Rules still being framed, currently in the consultative phase, implementation over a period

To be phased in over several years from 2013

Healthcare payers and providers To be implemented by January 2012

To be implemented by October 1, 2013

SI, PI and consulting market is 1.5x the size of ADM and under-penetrated by Indian IT (only 6%)


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Typically, services spending on software implementation can vary from ~1x for business intelligence or analytics-related spending to 3-5x for core ERP or more specialized product implementations.

An indicator of this trend towards increased productization is that software as a percentage of US IT capex is touching ~50%, an increase of ~20% in terms of contribution over the last 20 years. Even in absolute terms, software capex has shown a progressive increase and is currently at USD270bn-plus.

Package implementation, consulting and system integration demand will benefit from: 1) a shift towards packaged software; and 2) increased cloud adoption through infrastructure as a services (iAAS) and software as a service (SaaS), which reduces upfront costs for both hardware and software purchases and increases software adoption, in our view.

Among Tier-1 IT, Infosys in our view would benefit most from this trend because of its long term strategy of deriving two-thirds of its overall revenue from business transformation (system integration, package implementation and consulting) and business innovation (solutions, products & platforms). It currently derives nearly 39% of its revenue from these segments. We believe this is an option for the Indian IT industry to move up the value chain. Here, the services are not commoditized and the MNC players hold the umbrella in terms of pricing in this segment. So Tier-1 IT players have scope to increase their realizations as they expand in these services.

Fig. 46: IT taking significant share of non equipment capex IT touching ~50% of the capex from ~40% levels 20 years ago


Fig. 47: PC/Communication equipment share of IT capex With shifts away from hardware and towards software In IT capex

Source: Bloomberg Nomura research

Fig. 48: US software spend as % of IT capex US Software spending now capture ~50% of IT capex


Fig. 49: US software spending (USD bn) Software spending in absolute terms touching USD274bn


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Infosys likely to be the key beneficiary of increased productization on account of its greater exposure and focus


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BFSI/Telecom offer significant scope for increased productization India’s IT players derive ~60% of their revenues from BFSI and Telecom (currently the big legacy ADM demand drivers) and these are two segments that are significantly underpenetrated in terms of third-party software adoption. We believe these segments offer significant scope for gain in productization over the next 3-5 years, in line with those of consumer, industrial and energy segments where the whole value chain is getting productized.

Fig. 50: Penetration of 3rd party software Manufacturing, energy & utilities and CPG lead adoption, BFSI and Telecom lags

Source: BCG, Forrester, Gartner

How are Tier-1 IT names placed to exploit these trends?

We believe Tier-1 IT names that have correct structure, positioning and strategies will likely generate greater longer-term returns. We analyze each of the players on how they are structured and what is their positioning for growth from these trends. In our opinion, the way each of these players is playing the market is slightly different:

• Infosys: Play on value – Changing the paradigm from cost-based arbitrage to skill-based premium. In our view, Infosys’ focus on higher-value added segments will enable it to benefit from the trends of increasing productization and pervasiveness of technology. This would also obviate the risk of wage inflation and differentiate on this count with its peers. This is a risky strategy, but if successful, can give sustainable competitive edge and enable it to maintain current margin and valuation profile.

• TCS: Play on scale – TCS adopts a ‘Be all and offer all’ approach for its clients across geographies, services and verticals and plays on scale efficiencies to be the best in terms of operational efficiencies. Its highly scalable model is best placed to gain market share through the consolidation and under-penetration trends, in our view. However, TCS in our view is susceptible to competition and client pressures, as differentiation based on process efficiencies can be replicated or disrupted.

• Cognizant: Play on deep domain expertise – Concentrated focus, aggressive growth, deep domain expertise, closer client connect , coupled with a margin profile that aids higher reinvestment. Cognizant benefits from consolidation and pervasiveness of technology (especially regulation driven) on well entrenched positions in Healthcare/BFSI. It is a key threat to scale players such as TCS.

• HCL Tech: Play to strength and be unconventional – HCL Tech focuses on areas where its strength lies and is unconventional in areas where competition is more entrenched. IMS, package implementation and engineering services are its areas of strength. It differentiates by offering a higher experience profile vs peers, a similar margin profile as MNC players and keeping buffers for higher investments to gain market share. HCL Tech benefits from consolidation, under-penetration and the move from in-house to offshoring given its flexibility to absorb clients’ staff in deal situations. It also benefits from the productization trend on account of its SAP consulting capabilities.

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Strategy and positioning different among tier 1 IT players; we find Infosys, TCS and Cognizant to be better focussed strategically


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• Wipro: Diffused positioning – In our view, Wipro has yet to choose the path of either Infosys/ TCS or Cognizant/HCL Tech. We believe choosing one of the two approaches is essential for the company to get its growth strategy right. We expect Wipro to be a part beneficiary of all the underlying trends, but benefits might be more muted compared with its competitors.

• iGATE, Tech Mahindra and Mphasis – Larger is better – The underlying logic here appears to be scale is better for growth and sub-scale players would have difficulties to scale up. We expect iGATE to be a beneficiary of the consolidation trend as businesses gravitate towards larger players, especially in the application development and maintenance segments.

Fig. 51: Positioning of Tier-1 IT player across 4 key underlying trends All Tier-1 players gain from these trends, but TCS most evenly balanced, Infosys gains more from productization/pervasiveness


Overall, we find Infosys, TCS and Cognizant to be better focused strategically, while HCL Tech’s approaches are more tactical and would require better articulation of its longer-term sustainable growth strategy. For Wipro, we would look for greater coherence to differentiate vs peers, which have caused it to lag behind growth and mind share in the recent past.

We expect a 2HFY13F rebound on the productization (increase in CTB spending after ~4 quarters of underinvestment) and pervasiveness of technology (especially BFSI/Healthcare regulation-related spending). This will be supported by the continuing trends of consolidation and under-penetration, in our view.

Consolidation Underpenetration Productization Tech pervasiveness

Infosys

TCS

Wipro

Cognizant

HCL Tech


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Prefer the rebound candidates, where expectations are low We believe buying into perceived risk and/or high pessimism (HCLT,INFO,CTSH) is likely to generate outlier returns, while stocks that the Street perceives as defensive plays are likely to generate limited upsides (TCS) or turn into risky investments (Wipro). We upgrade CTSH to Buy on it benefiting from consolidation/increased regulation spending trends given higher reinvestments and client connect. We believe that HCL Tech straddles both market-share gains in consolidation/under-penetration scenarios and potential upside from a productization revival. Margin sustainability concerns are unfounded, in our view, and best-in-class earnings growth is likely to result in stock re-rating. Infosys, in our view, should post growth that is comparable to that of its peer group over the next two quarters and we believe it is well positioned for a rebound on a revival in productization and the increasing pervasiveness of technology (BFSI regulation spending) from 2HFY13F. In our opinion, the Street’s current pessimism has not factored in these possibilities. In that light, while we like TCS for its ability to gain from all the underlying trends, but heightened Street expectations and limited scope for positive surprises make us cautious on the stock. At Wipro, we believe the turnaround pace is likely to disappoint investors; we expect its revenue and earnings to continue to lag that of its peers.

Greater pessimism built into HCL Tech, Cognizant and Infosys Infosys’ cautious comments, reduced growth expectations and lacklustre performance in business operations have led the Street to believe that the company has structural issues. Consensus target prices at Infosys have dropped over the last three months and recent downgrades from the Street indicate to us a sense of increased pessimism. This pessimism is partly reflected in its valuation, where it trades at a 10% discount to TCS’ vs the historical premium of ~10%. Similarly at HCL Tech, the Street is concerned over its limited revenue outperformance in the recent past compared to its Tier-1 peers, despite having a lower margin profile and management indicating limited upside to margins, even in a rupee depreciation scenario. At Cognizant too, we believe the correction in valuation multiples from 26x 1-yr forward at the beginning of 2011 to ~19x currently, suggests attribution of higher risks by the street.

Contrary to this, the more upbeat commentary at TCS and the outperformance in revenue growth have led to consensus TP upgrades and significant future growth expectations being built into valuations. At Wipro, post the last quarter performance, consensus hopes of a speedy return to comparable growth vs Tier-1 peers have led to recent consensus TP upgrades and greater optimism.

Stock picks in order of preference • HCL Tech: HCL Tech remains our top pick in Tier-1 IT names, as it: 1) straddles both

market-share gains in RTB on strengths in IMS and potential upside from a CTB revival given its large engineering services practise and strong SAP consulting capabilities; 2) its market-share gain focus against MNC players and historical high deal pipeline in the Dec-11 quarter provide comfort on near-term growth; and 3) we find greater comfort in its margin stability and inexpensive valuations in light of its best-in-class earnings growth across Tier-1 universe. Reaffirm Buy.

• Cognizant: We believe Cognizant will continue to outperform its Tier-1 IT peers in revenue growth, driven by its 1) recession- proof healthcare business and closer client connect in BFSI and 2) gains from consolidation trends given its higher reinvestment focus. The stock’s valuation has corrected from 26x to 19x 1-yr forward earnings in 2011, despite better-than-peer group performance. Given the anticipated growth outperformance vs peers, we find the current valuation of 10% premium over Infosys (vs historical premium of ~20%) attractive. Upgrade to Buy.

• Infosys: We believe Infosys is best positioned for a rebound as productization spends and a shift in client spending patterns towards change the business/regulation spends start playing out from 2HFY13F onwards. Contrary to consensus, we believe that Infosys’ troubles are not structural, but more environment-led. In the near-term, too, we believe Infosys would post par growth along with peers such as TCS (much more

HCL Tech, followed by Cognizant and Infosys, are our top picks in tier 1 IT, iGATE is our top tier 2 IT pick

We believe buying into perceived risk could generate outlier returns, and prefer HCLT/CTSH/INFO over consensus favourites TCS/WPRO


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upbeat on commentary); this coupled with bigger potential gains from rupee depreciation and low expectations built into valuations makes us positive on the stock. Reaffirm Buy.

• iGATE: It remains our top Tier-2 IT pick on account of our expectations of high operating leverage, leading to potential improvement in margins over the next two years. Moreover, with revenue synergies of Patni acquisition not yet built into estimates, this could provide upside. iGate’s best-in-class earnings growth potential and mitigation of debt overhangs over the next two years makes us positive on the stock. Reaffirm Buy.

• TCS: While we like TCS for its potential to drive market-share gains in view of its widest vertical, service line and geographical presence across Tier-1 IT companies and recent momentum, we believe disappointments are likely in the interim on any commentary moderation, given high expectations built into its current valuations. We would await such disappointments to play out before revisiting our call. Maintain Neutral.

• Wipro: We believe the stock price rise over the past three months is driven by hopes of a speedy revenue growth revival. There could be disappointments in store on this count with the lag in revenue and earnings growth continuing and valuations staying depressed as the balance sheet improvements might not be forthcoming, in our view. We maintain Neutral and reiterate least preference for Wipro among Tier 1 IT stocks.

We believe company valuations are unlikely to structurally correct significantly from historical average levels, as the margin structures are sustainable and as growth rebound takes shape to get closer to trendline growth in FY14F. Our target multiples for these stocks are already 10-15% lower compared to historical averages and take into account the growth moderation from historical levels.

Fig. 52: Infosys 1-year forward P/E chart Infosys trading at a ~15% discount to historical average


Fig. 53: TCS 1-year forward P/E chart TCS trading at a 10% premium to historical average


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Fig. 54: Wipro 1-year forward P/E chart Wipro trading at a ~15% discount to historical average


Fig. 55: HCL Tech 1-year forward P/E chart HCL Tech trading at a 25% discount to historical average


Fig. 56: Cognizant 1-year forward P/E chart Cognizant trading at a ~20% discount to historical average


Fig. 57: iGATE 1-year forward P/E chart iGATE trading at a ~15% discount to historical average


We like the defensiveness of IT services in the tech segment

We like the defensiveness of IT services in a slowing environment. This was seen during the last downturn when hardware capex, followed by software capex and consulting, was most impacted and yet Tier-1 IT names continued to post growth. Likewise, in a recovering scenario, growth of Tier-1 IT services saw a sharper rebound compared with segments such as hardware, software or consulting. The defensiveness of Tier-1 IT names is also seen in Oracle/SAP application license growth vs. Tier-1 IT growth, where the former usually shows a sharper correction in a slowing environment. Likewise, in this current downturn, we expect the same defensiveness and believe the revenue of Tier-1 IT services will largely remain in double-digit-percentage growth trajectory. Lesser exposure to consulting should help cushion the fall in revenue growth of Tier- 1 IT names, in our view.

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Fig. 58: Comparison of consulting, IT services, hardware (h/w)and software (s/w) capex trends IT services most defensive, h/w capex early indicator of slowdown, consulting & s/w capex largely coincident indicators

Source: BEA, Company data, Nomura research

Fig. 59: Comparison of Tier-1 IT revenue vs SAP & Oracle app. license growth (y-y) Tier-1 IT revenues are more defensive in a downturn scenario vs SAP/Oracle license growth


Case for reversal of preference for MNC over Indian IT players

MNC players such as Accenture and IBM outperformed the Indian IT players by ~30-50% in 2011, driven by:

• Investors’ view that as cannibalization of onsite revenues decreases and offshore proportions increase for these players, growth would look better

• As offshore proportions increase, these companies would show consistent margin increases vs anticipated margin declines at Tier-1 IT progressively.

• Significant valuation discounts to Tier-1 IT names

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Fig. 60: 2011 price performance of Top MNC and India IT players IBM and Accenture outperform all the India IT players in 2011


We believe there could be a case for this preference to start shifting towards the more reasonably valued India’s Tier-1 IT players as:

• Valuation discounts of MNCs vs the Indian Tier-1 IT players are inline with historical averages and these discount could widen if revenue growth of MNC’s shows greater volatility compared with Indian IT.

Fig. 61: Accenture 1-year forward P/E discount to Infosys Accenture P/E discount to Infosys inline with historic discount


• Current economic conditions could create similar push factors like during the last downturn, when MNCs showed sharper declines in revenue growth. This is on account of: 1) accelerating cannibalization of onsite revenues as clients look to cut costs; 2) the business cycle of consulting is one that usually gets affected first because of downturns and consulting exposure of MNC players such as IBM and Accenture is higher compared to India’s Tier-1 IT companies, which are more outsourcing focused.

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Fig. 62: IT Service revenue growth y-y (%) Revenue declines at MNC players sharper during last downturn


Fig. 63: Accenture revenue growth by services y-y (%) Consulting showed sharper declines than outsourcing


• We also believe recent rupee depreciation improves the competitive position of India IT players on account of greater proportion of costs in INR, a benefit that MNC players do not have to such a large extent.

3QFY12F preview

In our report “More pain or scope to gain”, September 2011, we had cautioned that Indian IT companies would start to warn about demand deterioration from 3QFY12F and that revenues would start to feel the impact of the slowdown from 4QFY12F. Indeed, this has already started to happen, with cautious commentary from: 1) Infosys, which warned about delays in decision-making and deterioration from the previous quarter; and 2) Tech Mahindra and HCL Tech, which announced that the demand for discretionary has dried up. In our opinion, 3QFY12F results will likely reveal moderating revenues, due to: 1) clients conserving cash ahead of the year-end closing, especially for discretionary projects; 2) seasonal weakness on account of lower billing days and shutdowns; and 3) adverse impact on revenue growth of Tier-1 IT companies from cross currency movements. We expect Infosys and TCS to give different comments but to post largely similar revenue growth.

Results expectations • We expect the Indian Tier-1 IT companies to post USD revenue growth of between

2.5% and 3.5% q-q in 3QFY12F with Infosys’ at the lower end of its guidance (3.2-5.4% q-q) and TCS posting similar revenue growth as Infosys. We expect Cognizant to be ahead of guidance at 4.7% q-q (vs guidance of 3.7%)

• Higher benefits would be seen at Infosys and TCS on margins due to rupee depreciation. Cognizant is unlikely to see material rupee depreciation-related margin positives given its higher hedging. We expect EBITDA margin improvements of between 70-250bps across the Tier-1 IT companies (except for Cognizant), with the lowest benefits at HCL Tech and highest at Infosys.

• Below the operating line, we believe impacts are likely to be divergent based on hedging levels, with Infosys being the least affected by forex losses among the Tier-1 IT names, while TCS, Wipro and HCL Tech would get hurt more given their higher hedging levels.

Key things to watch out for • Cognizant’s FY12F revenue growth guidance would, in our view, offer the first peek into

the demand for IT services in calendar year 2012. We expect Cognizant to guide for at least 21% growth - within the 18-23% range indicated by the company in its 8-K filing for 50-100% vesting of its senior management’s restricted stock options (RSU).

• Infosys’ FY12F revenue growth guidance may be revised down marginally, in our view, as its 3Q revenues might be closer to the lower end of its guidance, making it difficult to

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39

achieve the higher-end of its revenue growth guidance of 17-19%. The likely change in guidance for FY12F, in our view, would be driven by headwinds such as decision-making delays, clients’ holding back on budgets and adverse cross currency impacts.

• At Wipro, we believe its next quarter revenue growth guidance needs to be closely monitored, especially after its above-expectation guidance for 3Q. This should indicate to us whether Wipro is able to sustain its revenue growth recovery. Lower-than-3% q-q growth guidance (for 4QFY12F) would be taken negatively, in our view.

• HCL Tech’s deal announcements, amid expectations of a strong deal-signing quarter, will be another key event to watch out for, in our view.

Result plays • Despite divergent commentary, we expect Infosys and TCS to show similar revenue

growths in 3QFY12F - similar to the previous quarter. Hence, we would recommend to Buy Infosys, where the Street’s expectations are low and earnings growth would likely be higher than TCS, on account of lower forex losses.

• Wipro is one stock that we believe the risks of disappointment are highest among the Indian IT companies, as expectations of a revenue growth recovery have been built and failure to materialise is likely to lead to a negative stock price reaction, especially given that the stock has outperformed the Nifty by 22% over the past 3 months.

• Among Tier-2 IT names, we are positively inclined towards iGATE, which remains our top Tier-2 pick in the sector. We expect it to see positive progress on closing the gap with its stated EBITDA margin guidance of 25% by June 2013.

Fig. 64: 3QFY12F – Sequential performance expectations

Note: Cognizant and iGATE net profit estimate is in USDmn, EBITDA margin is EBIT margin for Wipro (IT services), Revenue for Wipro is for the IT services division while Net profit is at the consolidated level, Net profit estimate for Tech Mahindra is adjusted for restructuring fee and is excluding contribution from Mahindra Satyam. Net profit for HCL Tech includes stock compensation expenses.


Revenue (USDmn)

q-q growth (%)

EBITDA margin (%)

q-q change (bps)

Net profit (INRmn)

q-q growth (%)

Cognizant 1,677 4.7 20.3 10 241 5.9

Infosys 1,807 3.5 33.5 250 23,796 24.8

TCS 2,611 3.4 31.4 230 28,203 15.6

HCL Tech 1,028 2.6 17.4 70 5,188 8.2

Wipro 1,510 2.5 21.5 160 13,917 7.0

Mphasis 280 2.1 18.9 100 2,008 9.7

iGATE 268 1.0 22.0 270 26 83.2

Tech Mahindra 295 (0.6) 16.9 150 2,229 (7.3)

We expect INFO and TCS to post similar revenue growth rates in 3QFY12F

Key company data: See page 2 for company data and detailed price/index chart.

Cognizant CTSH.OQ CTSH US

SOFTWARE & SERVICES

EQUITY RESEARCH

Upgrade to Buy

Valuation premiums to tier-1 IT likely to sustain on highest comfort on revenue growth

January 3, 2012

Rating Up from Neutral

Buy

Target price Increased from 75.00 USD 82.00

Closing price December 27, 2011 USD 64.19

Potential upside +27.7%

Action: Upgrade to Buy on market share gain focus and predictability We expect Cognizant to register best-in-class revenue growth of 28% CAGR over FY10-12F (compared to 12-20% for its peers), owing to gains from trends of 1) consolidation and 2) increased regulatory spending. We like its reinvestment focus to drive higher growth and derive comfort from the 18-23% revenue growth (vs our est. of 18% growth earlier) indicated by its management incentive target. The stock’s valuation has corrected from 26x to 19x 1-yr forward earnings in 2011, despite better-than-peer group performance. Given the anticipated growth outperformance vs peers, we find the current valuation of a 10% premium over Infosys (vs historical premium of ~20%) attractive and upgrade the stock to Buy.

Client connect in BFSI/recession-proof Healthcare to drive growth We expect Cognizant to outperform on its 1) well entrenched position in Healthcare (27% of revenue, which grew at ~40% on an LTM basis) where we see limited competition from tier-1 IT and which should continue to show strong growth as in the last downturn (25% y-y) driven by regulation spending, and 2) superior client connect and domain capability in BFSI where consolidation, in-house to offshore and regulation should drive growth.

Catalyst: Outperformance in BFSI (41% of revenues) over peers

Valuation: TP raised to USD82 based on better FY12F outlook We expect USD sales CAGR of 28% and EPS CAGR of 20% over FY10-12F. Our TP rises to USD82 (based on 20x 1-yr forward earnings) on rolling forward our valuation base and higher FY12F growth expectations.

31 Dec FY10 FY11F FY12F FY13F

Currency (USD) Actual Old New Old New Old New

Revenue (mn) 4,592 6,134 6,134 7,233 7,479 8,679 9,031

Reported net profit (mn) 734 884 884 1,035 1,069 1,215 1,277

Normalised net profit (mn) 734 884 884 1,035 1,069 1,215 1,277

Normalised EPS 2.44 2.91 2.91 3.41 3.52 3.98 4.18

Norm. EPS growth (%) 33.7 19.5 19.5 16.9 20.8 16.9 18.9

Norm. P/E (x) 27.1 N/A 22.6 N/A 18.7 N/A 15.6

EV/EBITDA (x) 17.9 15.7 13.6 12.8 10.7 10.5 8.5

Price/book (x) 5.4 N/A 4.4 N/A 3.5 N/A 2.9

Dividend yield (%) na N/A na N/A na N/A na

ROE (%) 23.5 22.1 22.1 20.9 21.5 20.0 20.8

Net debt/equity (%) net cash net cash net cash net cash net cash net cash net cash


Anchor themes

Shift in IT spend allocations and and simple economics should help power tier-1 IT growth closer to the trend line. Within tier-1, we favour companies better equipped for a rebound scenario and those that have greater street pessimism built in.

Nomura vs consensus

Our earnings estimates are inline with consensus, we believe street pessimism on valuation multiples will fade as Cognizant continues to outperform peers.

Research analysts





Nomura | Cognizant January 3, 2012

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Key data on Cognizant Income statement (USDmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FRevenue 3,279 4,592 6,134 7,479 9,031Cost of goods sold -1,906 -2,725 -3,611 -4,404 -5,340Gross profit 1,373 1,868 2,523 3,075 3,692SG&A -709 -949 -1,297 -1,591 -1,916Employee share expense -46 -57 -89 -105 -126Operating profit 618 862 1,137 1,380 1,649

EBITDA 708 966 1,254 1,537 1,838Depreciation -89 -104 -117 -157 -190Amortisation

EBIT 618 862 1,137 1,380 1,649Net interest expense 16 26 38 45 54Associates & JCEs

Other income 3 -9 -11 0 0Earnings before tax 637 879 1,165 1,425 1,702Income tax -102 -145 -281 -356 -426Net profit after tax 535 734 884 1,069 1,277Minority interests

Other items

Preferred dividends

Normalised NPAT 535 734 884 1,069 1,277Extraordinary items

Reported NPAT 535 734 884 1,069 1,277Dividends 0 0 0 0 0Transfer to reserves 535 734 884 1,069 1,277

Valuation and ratio analysis

FD normalised P/E (x) 36.1 27.1 22.6 18.7 15.6FD normalised P/E at price target (x) 38.3 28.7 23.9 19.8 16.6Reported P/E (x) 35.2 26.3 22.0 18.2 15.3Dividend yield (%) na na na na naPrice/cashflow (x) 31.2 29.8 41.4 22.6 18.8Price/book (x) 7.1 5.4 4.4 3.5 2.9EV/EBITDA (x) 25.6 17.9 13.6 10.7 8.5EV/EBIT (x) 29.3 20.1 15.1 11.9 9.5Gross margin (%) 41.9 40.7 41.1 41.1 40.9EBITDA margin (%) 21.6 21.0 20.4 20.6 20.4EBIT margin (%) 18.9 18.8 18.5 18.5 18.3Net margin (%) 16.3 16.0 14.4 14.3 14.1Effective tax rate (%) 16.0 16.5 24.1 25.0 25.0Dividend payout (%) 0.0 0.0 0.0 0.0 0.0Capex to sales (%) 3.5 4.2 4.1 3.9 3.2Capex to depreciation (x) 1.3 1.9 2.1 1.8 1.5ROE (%) 23.2 23.5 22.1 21.5 20.8ROA (pretax %) 34.8 40.1 40.6 38.7 38.8

Growth (%)

Revenue 16.4 40.1 33.6 21.9 20.8EBITDA 19.7 36.4 29.8 22.6 19.6EBIT 19.7 39.3 31.9 21.4 19.5Normalised EPS 22.8 33.7 19.5 20.8 18.9Normalised FDEPS 23.3 33.6 19.8 20.9 19.4

Per share

Reported EPS (USD) 1.82 2.44 2.91 3.52 4.18Norm EPS (USD) 1.82 2.44 2.91 3.52 4.18Fully diluted norm EPS (USD) 1.78 2.37 2.84 3.44 4.11Book value per share (USD) 9.05 11.92 14.58 18.10 22.22DPS (USD) 0.00 0.00 0.00 0.00 0.00Source: Company data, Nomura estimates

Relative performance chart (one year)

Source: ThomsonReuters, Nomura research

(%) 1M 3M 12M

Absolute (USD) 3.6 -3.5 -12.2

Absolute (USD) 3.6 -3.5 -12.2

Relative to index 3.2 1.5 10.3

Market cap (USDmn) 19,527.6

Estimated free float (%) 99.0

52-week range (USD) 83.48/53.54

3-mth avg daily turnover (USDmn)

194.31

Major shareholders (%)

Fidelity 8.4

Waddell & Reed Financial 5.0

Source: Thomson Reuters, Nomura research

Notes

We look for 22%/21% revenue growth in FY12/13F

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Cashflow (USDmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FEBITDA 708 966 1,254 1,537 1,838Change in working capital 56 -99 -131 -26 -94Other operating cashflow -144 -200 -640 -627 -685Cashflow from operations 620 666 483 884 1,060Capital expenditure -116 -193 -250 -290 -290Free cashflow 504 473 232 594 770Reduction in investments 3 151 0 0 0Net acquisitions

Reduction in other LT assets -59 -41 -83 0 0Addition in other LT liabilities 0 0 0 0 0Adjustments

Cashflow after investing acts 449 583 150 594 770Cash dividends 0 0 0 0 0Equity issue 170 227 11 7 1Debt issue

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Others 18 17 28 45 54Cashflow from financial acts 188 244 39 52 55Net cashflow 637 827 189 647 825Beginning cash 763 1,399 2,226 2,415 3,062Ending cash 1,399 2,226 2,415 3,062 3,888Ending net debt -1,399 -2,226 -2,415 -3,062 -3,888Source: Company data, Nomura estimates

Balance sheet (USDmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash & equivalents 1,399 2,226 2,415 3,062 3,888Marketable securities 0 0 0 0 0Accounts receivable 709 1,014 1,341 1,599 1,926Inventories 0 0 0 0 0Other current assets 199 278 260 241 278Total current assets 2,308 3,518 4,016 4,902 6,091LT investments 151 0 0 0 0Fixed assets 482 570 704 837 937Goodwill 192 224 289 289 289Other intangible assets 76 85 103 103 103Other LT assets 130 185 544 815 1,074Total assets 3,338 4,583 5,656 6,946 8,494Short-term debt

Accounts payable 55 75 101 120 144Other current liabilities 592 855 1,008 1,202 1,447Total current liabilities 647 931 1,109 1,322 1,592Long-term debt

Convertible debt

Other LT liabilities 38 68 124 124 124Total liabilities 685 999 1,232 1,446 1,716Minority interest

Preferred stock 0 0 0 0 0Common stock 668 850 850 850 850Retained earnings 1,965 2,699 3,583 4,652 5,929Proposed dividends

Other equity and reserves 20 36 -9 -2 0Total shareholders' equity 2,653 3,584 4,424 5,500 6,778Total equity & liabilities 3,338 4,583 5,656 6,946 8,494

Liquidity (x)

Current ratio 3.57 3.78 3.62 3.71 3.83Interest cover na na na na na

Leverage

Net debt/EBITDA (x) net cash net cash net cash net cash net cashNet debt/equity (%) net cash net cash net cash net cash net cash

Activity (days)

Days receivable 71.7 68.5 70.1 71.9 71.2Days inventory 0.0 0.0 0.0 0.0 0.0Days payable 9.1 8.7 8.9 9.2 9.0Cash cycle 62.7 59.8 61.2 62.8 62.2Source: Company data, Nomura estimates

Notes

Steady increase in cash flow from operations

Notes

Cash levels are on the rise


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Upgrade to Buy on high degree of revenue and valuation comfort We upgrade Cognizant to Buy for the following reasons:

• High degree of revenue comfort: Management performance incentives suggest revenue growth in the range of 18-23% for FY12F, higher than our earlier expectation of 18%. In addition, Cognizant’s market share gain focus and healthcare vertical strength should lead to sustained outperformance over other Tier-1 IT players, in our view.

• Attractive valuation: The stock’s valuation multiples have corrected from 26x to 19x 1-yr forward earnings in 2011, despite better-than-peer group performance. Given the anticipated growth outperformance vs peers, we find the current valuation of a 10% premium over Infosys (vs historical premium of ~20%) attractive.

We expect USD revenue CAGR of 28%, flattish EBIT margins and EPS CAGR of 20% over FY10-12F. We raise our TP to USD82 (from USD75) based on 20x 1-year rolling forward earnings and better FY12F growth expectations.

Management incentive plan suggests 18-23% revenue growth achievable

We expect Cognizant to grow revenues by 22% in FY12F, in line with the management’s target incentive plan. Cognizant in its 8-K filing has kept the FY12F revenue growth target for senior management as 23% (for 100% vesting) and 32% (for 200% vesting) of restricted stock units (RSUs). Except for CY08, Cognizant has not missed the targeted revenue growth for 100% of the vesting of RSUs.

Fig. 65: Cognizant actual revenue growth vs guidance and mgmt performance targets Cognizant fell short of management target in 2008 while exceeding that target in 2010 and is likely to meetthe top-end of its guidance in 2011F.


Healthcare vertical adds defensiveness to Cognizant’s portfolio

Cognizant has the largest healthcare vertical among Tier-1 peers and is ahead by a wide margin. Its life sciences practice serves 27 of the top 30 global pharmaceutical companies and 15 of the top 20 health plans, as per the company. The vertical has grown faster than the company in three of the last four years and has seen growth of ~40% on LTM basis. During the previous downturn, healthcare grew by 25% (vs 16% company growth) and we expect in a slowdown scenario, too, the healthcare segment would steal a march over overall company growth, especially as spends on regulation continue to increase in the wake of changes like ICD-10 and HIPAA5010.

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Fig. 66: Comparison of healthcare vertical growth along with company overall growth Healthcare vertical grew faster than company in all the years except for FY10.


Fig. 67: Comparison of healthcare vertical performance among tier 1 companies Cognizant has the largest healthcare practise and the highest revenue contribution among tier 1


Fig. 68: Regulatory changes in the healthcare industry We expect Cognizant to benefit most from the significant regulatory led spending in Healthcare on account of its leading position in the vertical


Outperformance over peers to sustain

We expect Cognizant to post industry-leading revenue growth of 28% CAGR over FY10-12F (compared to 12-20% for its peers), driven by 1) its well entrenched position in the Healthcare segment (27% of revenue, which grew at ~40% on an LTM basis) where we see limited competition from Tier-1 IT peers and continued growth driven by regulation spending, 2) superior client connect and domain capability in BFSI where consolidation/in-house to offshore and regulation will drive growth. However, we continue to hold the view that growth outperformance vs market share-focused players such as HCL Tech and TCS would reduce progressively over the years on account of more concentrated portfolio; hence, our valuations multiples are lower than those of the Street.

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Company Healthcare

Cognizant Infosys TCS HCL Tech Wipro

LTM revenues (USD mn) 1,501 328 490 298 569

Contribution (%) 26 5 5 8 11

Growth (%) 39 34 34 32 n.a

Regulation Industry segments affected Area of IT spending TimeframeHIPAA 5010 Claims adjudication changes

Medicare and Medicaid systems upgradesData warehouse updatesBI analyticsbilling and EDI systems upgradeEnd to end testing for partner interoperability

ICD-10 EMR implementation.ICD-10 conversion

Hospitals changes in billing systemsHealth information exchanges changes in reporting packages

changes in decision and analytical systems patient tracking

Healthcare payers and providers

To be implemented by January 2012

Healthcare payers and providers

To be implemented by October 1, 2013


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Fig. 69: Cognizant revenue outperformance over peers, past and projected We expect Cognizant revenue outperformance to narrow from double digits in FY10 to single digits In FY12F


Valuation premium over Infosys below long-term average

The stock’s valuation multiples have corrected from 26x to 19x 1-yr forward earnings in 2011, despite better than peer group performance. Given the anticipated growth outperformance vs peers, we find the current valuations — 10% premium over Infosys (vs historical premium of ~20%) — attractive and upgrade the stock to Buy.

Fig. 70: Cognizant 1-yr forward P/E chart Cognizant trades at ~20% discount to historical average P/E


Estimates – raising revenue growth forecasts

We have increased our revenue growth estimates for FY12/13F on the back of the management incentive growth target that suggests a range of 18-23% for FY12F. We now look for revenue growth of 22%/21% in FY12/13F. Our margin assumptions are largely unchanged.

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Fig. 71: Earnings revisions


Valuation methodology We value Cognizant at 20x our one-year forward earnings per share estimate of USD4.1, which is at a 10% discount to its long-term average to reflect higher risk in the macro environment and risks related to higher BFSI exposure. We raise our TP to USD82 (from USD75) on 20x rolled forward earnings and better FY12F growth expectations. Our methodology and target multiple remain unchanged.

Risks to valuation The key downside risks include: 1) a faster-than-anticipated demand slowdown and 2) deviance from pricing discipline in the industry.

FY11F FY12F FY13F FY11F FY12F FY13F FY11F FY12F FY13F

Revenue (USD mn) 6,134 7,479 9,031 6,134 7,233 8,679 0.0 3.4 4.1

EBIT margin (%) 18.5 18.5 18.3 18.5 18.45 18.1 0 bp 0 bp 20 bp

Tax Rate (%) 24.1 25.0 25.0 24.1 25.0 25.0 0 bp 0 bp 0 bp

Diluted EPS (USD) 2.84 3.44 4.11 2.84 3.33 3.91 0.0 3.3 5.1

New Old Change (%)


HCL Technologies HCLT.NS HCLT IN

SOFTWARE & SERVICES

EQUITY RESEARCH

Top pick in IT services

Revenue surety, best-in-class earnings growth and inexpensive valuations; Buy

January 3, 2012

Rating Remains

Buy

Target price Remains

INR 530

Closing price December 27, 2011

INR 392


Action: Reiterate Buy and top-pick status within Tier-1 IT HCL Tech remains our top pick among tier-1 IT as: 1) it straddles both market share gains in run-the-business (RTB) spend on strength in infrastructure management and upside from a revival in change-the-business (CTB) spend given its large engineering services practice and strong SAP consulting capabilities; 2) its market share gain focus against MNC players and historically high deal pipeline in the Dec-11 quarter provide comfort on near-term growth; and 3) we find greater comfort in its stability of margins, coupled with inexpensive valuations on its best-in-class earnings growth across the tier-1 IT universe. Reaffirm Buy and TP of INR530.

Catalyst: Strong deal signings and margin stability

Margin comfort from operations scope and improving pyramid mix We expect flattish margin levels of ~14% over FY12-13F and see HCL benefitting more from any likely wage moderation in FY13F, on account of a higher lateral proportion relative to peers. Utilisation scope of ~300bps from the recent peak and upsides from rupee depreciation (highest EPS sensitivity to rupee depreciation among tier-1 peers), provide us with confidence in our margin expectations.

Best-in-class earnings growth and attractive valuations, in our view We expect HCL Tech to post higher-than-peer group earnings growth at ~26% over FY11-13F (vs 8-19% at peers). The stock trades at 10.7x FY13F P/E and we believe a further re-rating is possible on improving predictability of margins, combined with industry-leading revenue growth.

30 Jun FY11 FY12F FY13F FY14F

Currency (INR) Actual Old New Old New Old New

Revenue (mn) 158,555 198,271 205,608 221,248 232,484 262,697 266,493

Reported net profit (mn) 16,028 21,108 22,024 24,803 25,703 28,491 29,263

Normalised net profit (mn) 16,028 21,108 22,024 24,803 25,703 28,491 29,263

Normalised EPS 23.49 30.60 31.93 35.83 37.13 41.05 42.16

Norm. EPS growth (%) 34.3 30.3 35.9 17.1 16.3 14.6 13.5

Norm. P/E (x) 17.0 N/A 12.5 N/A 10.7 N/A 9.4

EV/EBITDA (x) 10.9 8.6 7.9 7.3 6.8 6.1 5.8


Dividend yield (%) 1.9 N/A 2.6 N/A 2.0 N/A 2.0

ROE (%) 20.7 22.5 23.4 22.0 22.6 21.5 21.7

Net debt/equity (%) 19.0 13.2 13.1 0.3 0.4 net cash net cash


Anchor themes


Nomura vs consensus

Our FY13F earnings estimate is in line with Bloomberg consensus.

Research analysts





Nomura | HCL Technologies January 3, 2012

48

Key data on HCL Technologies Income statement (INRmn) Year-end 30 Jun FY10 FY11 FY12F FY13F FY14FRevenue 125,650 158,555 205,608 232,484 266,493Cost of goods sold -87,391 -113,318 -145,045 -165,645 -191,023Gross profit 38,259 45,237 60,562 66,839 75,470SG&A -18,466 -23,935 -30,469 -33,917 -38,648Employee share expense

Operating profit 19,793 21,302 30,093 32,922 36,823

EBITDA 24,802 26,221 35,798 39,311 44,137Depreciation -5,009 -4,919 -5,705 -6,389 -7,314Amortisation

EBIT 19,793 21,302 30,093 32,922 36,823Net interest expense 0 0 -1,036 -1,155 -947Associates & JCEs

Other income -5,302 -544 510 1,831 2,377Earnings before tax 14,491 20,758 29,567 33,599 38,253Income tax -2,724 -4,730 -7,540 -7,896 -8,989Net profit after tax 11,767 16,028 22,027 25,703 29,263Minority interests 0 0 -3 0 0Other items -1 0 0 0 0Preferred dividends

Normalised NPAT 11,766 16,028 22,024 25,703 29,263Extraordinary items 372 0 0 0 0Reported NPAT 12,138 16,028 22,024 25,703 29,263Dividends -3,153 -6,000 -8,071 -6,478 -6,499Transfer to reserves 8,985 10,028 13,953 19,225 22,765


FD normalised P/E (x) 22.9 17.0 12.5 10.7 9.4FD normalised P/E at price target (x) 31.0 23.1 16.8 14.5 12.8Reported P/E (x) 21.7 16.7 12.3 10.6 9.3Dividend yield (%) 1.0 1.9 2.6 2.0 2.0Price/cashflow (x) 15.1 17.7 16.0 9.4 9.2Price/book (x) 3.7 3.2 2.6 2.2 1.9EV/EBITDA (x) 11.7 10.9 7.9 6.8 5.8EV/EBIT (x) 14.7 13.4 9.4 8.2 6.9Gross margin (%) 30.4 28.5 29.5 28.7 28.3EBITDA margin (%) 19.7 16.5 17.4 16.9 16.6EBIT margin (%) 15.8 13.4 14.6 14.2 13.8Net margin (%) 9.7 10.1 10.7 11.1 11.0Effective tax rate (%) 18.8 22.8 25.5 23.5 23.5Dividend payout (%) 26.0 37.4 36.6 25.2 22.2Capex to sales (%) 6.1 5.4 5.3 4.5 4.1Capex to depreciation (x) 1.5 1.7 1.9 1.6 1.5ROE (%) 19.1 20.7 23.4 22.6 21.7ROA (pretax %) 15.6 15.7 19.5 18.9 19.4

Growth (%)

Revenue 18.5 26.2 29.7 13.1 14.6EBITDA 10.9 5.7 36.5 9.8 12.3EBIT 10.7 7.6 41.3 9.4 11.8Normalised EPS -2.6 34.3 35.9 16.3 13.5Normalised FDEPS -4.0 34.5 36.9 16.3 13.6

Per share

Reported EPS (INR) 18.05 23.49 31.93 37.13 42.16Norm EPS (INR) 17.49 23.49 31.93 37.13 42.16Fully diluted norm EPS (INR) 17.09 22.99 31.47 36.60 41.56Book value per share (INR) 104.61 123.63 151.15 178.43 210.76DPS (INR) 4.01 7.52 10.00 8.00 8.00Source: Company data, Nomura estimates



(%) 1M 3M 12M

Absolute (INR) 1.3 -0.4 -13.4

Absolute (USD) -0.3 -7.9 -26.2




52-week range (INR) 525.83/358.25


11.01


Shiv Nadar 65.2


Notes

We expect USD revenue growth of

19%/16% in FY12/13F.

350

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Jul 1

1

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11

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11

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11

PriceRel MSCI India(INR)


49

Cashflow (INRmn) Year-end 30 Jun FY10 FY11 FY12F FY13F FY14FEBITDA 24,802 26,221 35,798 39,311 44,137Change in working capital -3,156 -5,335 -8,536 -662 -2,471Other operating cashflow -3,757 -5,482 -10,079 -9,263 -11,731Cashflow from operations 17,889 15,404 17,184 29,386 29,935Capital expenditure -7,633 -8,598 -10,911 -10,450 -11,040Free cashflow 10,256 6,806 6,273 18,936 18,895Reduction in investments -5,278 449 1,563 0 0Net acquisitions 2,203 1,244 -2,769 0 0Reduction in other LT assets 0 0 0 0 0Addition in other LT liabilities 0 0 0 0 0Adjustments

Cashflow after investing acts 7,181 8,499 5,067 18,936 18,895Cash dividends -3,153 -6,000 -8,071 -6,478 -6,499Equity issue 4,524 3,949 5,953 36 0Debt issue -3,139 -5,392 -351 -4,015 -3,000Convertible debt issue

Others -4,930 -544 -526 677 1,430Cashflow from financial acts -6,698 -7,987 -2,995 -9,781 -8,068Net cashflow 483 512 2,072 9,155 10,826Beginning cash 4,203 4,686 5,198 7,270 16,425Ending cash 4,686 5,198 7,270 16,425 27,252Ending net debt 21,946 16,042 13,619 449 -13,377Source: Company data, Nomura estimates

Balance sheet (INRmn) As at 30 Jun FY10 FY11 FY12F FY13F FY14FCash & equivalents 4,686 5,198 7,270 16,425 27,252Marketable securities 19,733 17,211 15,604 15,604 15,604Accounts receivable 30,496 34,065 48,951 55,350 63,447Inventories 0 0 0 0 0Other current assets 8,845 12,546 14,942 16,523 19,692Total current assets 63,760 69,020 86,767 103,902 125,994LT investments 707 2,780 2,824 2,824 2,824Fixed assets 18,486 22,165 27,371 31,432 35,158Goodwill 43,122 41,878 44,647 44,647 44,647Other intangible assets

Other LT assets 9,640 10,392 12,928 14,295 17,037Total assets 135,715 146,235 174,537 197,100 225,660Short-term debt

Accounts payable 31,329 33,763 41,543 46,002 53,452Other current liabilities 7,386 6,887 7,853 10,712 12,057Total current liabilities 38,715 40,650 49,396 56,714 65,509Long-term debt 26,632 21,240 20,890 16,875 13,875Convertible debt

Other LT liabilities 0 0 0 0 0Total liabilities 65,347 61,890 70,286 73,589 79,384Minority interest 0 0 0 0 0Preferred stock 0 0 0 0 0Common stock

Retained earnings 70,368 84,345 104,251 123,512 146,276Proposed dividends

Other equity and reserves

Total shareholders' equity 70,368 84,345 104,251 123,512 146,276Total equity & liabilities 135,715 146,235 174,537 197,100 225,660

Liquidity (x)

Current ratio 1.65 1.70 1.76 1.83 1.92Interest cover na na 29.0 28.5 38.9

Leverage

Net debt/EBITDA (x) 0.88 0.61 0.38 0.01 net cashNet debt/equity (%) 31.2 19.0 13.1 0.4 net cash

Activity (days)

Days receivable 83.6 74.3 73.9 81.9 81.4Days inventory 0.0 0.0 0.0 0.0 0.0Days payable 133.7 104.8 95.0 96.5 95.0Cash cycle -50.0 -30.5 -21.1 -14.6 -13.7Source: Company data, Nomura estimates

Notes


Notes

Cash levels are increasing


50

Revenue outperformance likely from 4QFY12F onwards, margin stability not a concern; Reiterate top pick status HCL Tech remains our top pick among Tier-1 IT as: 1) it straddles both market share gains in run-the-business (RTB) spend on strength in infrastructure management and upside from a revival in change-the-business (CTB) spend given its large engineering services practice and strong SAP consulting capabilities; 2) its market-share gain focus against MNC players and historically high deal pipeline in the Dec-11 quarter provide comfort on near-term growth; and 3) we find greater comfort in its stability of margins, coupled with inexpensive valuations on its best-in-class earnings growth across the tier-1 IT universe. Reaffirm Buy and TP of INR530.

What did not work versus our previous expectations

We believe HCL Tech has underperformed its peers over the past six months, despite being among the two best-performing Tier-1 IT stocks over the past year, on two concerns: 1) positive demand commentary not being reflected in revenue growth outperformance vs. peers, and 2) investor/Street expectations of margin improvement not likely to materialise with management commenting about reinvesting excess margins and using rupee depreciation benefits to drive higher growth. In addition, the reduction of HCL Tech’s MSCI weightage has also resulted in liquidity-related pressure on the stock performance.

We remain confident on revenue surety and margin stability

Revenue surety We maintain our core view on high revenue surety at HCL Tech and its ability to gain market share vs. MNC players, especially in the area of infrastructure management services (~25% of its revenues). HCL Tech is one of the six vendors to feature among the top-15 rankings by total contract value of deals won over the past three quarters as per TPI (largest third party IT deals advisor) and it has reported a higher-than-historical pipeline in Dec-11. Also, the company has indicated in-line-with-expectations progress on deal signings in this quarter, which makes us confident on HCL Tech’s revenue surety.

The results of this, however, are likely to be witnessed with a lag from 4QFY12F onwards as these deals ramp-up. The timing mismatch on growth acceleration has disappointed the Street, in our view, resulting in the likelihood of near-term underperformance. We expect this situation to correct and expect HCL Tech to perform better than Tier-1 Indian IT companies on revenue growth in FY13F, with ~16.5% growth vs. 11-15% at its Indian peers.

We also find HCL Tech better placed in a rebound scenario on account of its strong engineering services and SAP consulting capabilities, as under-penetration in engineering services and increased productisation trends start to play out from FY13F.


51

Fig. 72: HCL Tech – revenue mix by service line The company has indicated that 76% of its deal pipeline is run from the business spend areas; hence, it is not likely to see delays In decision making

Service line outlook

Infrastructure services: Fastest growing and second largest in terms of size (~USD1bn in quarterly annualised revenue) among tier-1 peers. Positions it well for significant deal rebid opportunities and share shifts vs. MNCs.

Engineering and R&D services: Industry leader with around USD750mn in quarterly annualised revenue. BPO: Growth expected to be slow; however, segment to return to profitability from 3QFY12F.

Custom application: Transformational project wins signed in the recent past to fuel growth.

Enterprise application services: Growth likely to be slow given a weak discretionary demand outlook; however, Axon consulting capability is a plus in a rebound scenario.


Margin stability HCL Tech is our preferred pick – not for its margin-increase possibilities (which is also not the stated intention of management), but for its higher growth potential. We continue to believe that the company has levers to maintain margin stability at its stated levels of 14% EBIT margin over a longer term. Our expectations build in flattish margins over FY11-13F, with limited benefits from rupee depreciation baked into our numbers. Any benefits accruing from rupee depreciation could provide upside triggers to our estimates.

Fig. 73: Operational scope comparison: HCL Tech better utilisation than peers


Fig. 74: Lateral hiring proportion trend (%) Wage moderation benefit higher at HCL Tech given higher lateral hiring


Enterprise application

services19.8%

Custom Application

32.4%

Engineering and R&D Services18.6%

BPO4.6%

Infrastructure Services24.6%


Infosys 70.2% 69.7% 74.3% 4.1% 37.7% -2.2% 50.1% 0.3%

TCS 76.4% 74.6% 77.7% 1.3% 46.8% -2.2% 54.8% -1.3%

Wipro 76.1% 77.3% 80.7% 4.6% 45.2% 1.2% 45.7% -2.6%

HCLT 69.7% 73.5% 76.4% 6.7% 44.0% 2.9% 42.3% 0.6%

Offshore revenue mix (%)Fixed price proportion(%)Utilization (incl. trainees)

16% 15%

20%

40%

83%

55%

0%

20%

40%

60%

80%

100%

Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11

Infosys TCS HCL Tech


52

Higher earnings estimates on rupee depreciation

We have marginally lowered our FY12/FY13F USD revenue estimates to reflect delays in revenue ramp-up vs our earlier expectations. Our margin estimates are marginally up for FY12F on the back of upward revisions to our USD/INR rate assumptions. Over FY11-13F, we look for ~18% CAGR in revenue growth, an 80bp improvement in EBIT margin, and a 26% CAGR in revenue growth.



Inexpensive valuations, given best-in-class earnings growth

Revenue growth ahead of Tier-1 IT peers (excluding CTSH) and flattish margins would translate into earnings growth of 26% (vs. 8-19% at peers) over FY11-13F, in our view. The stock trades at 10.7x FY13F earnings, a 35-45% discount to Infosys and TCS. We believe the valuations are inexpensive, compared with its earnings growth potential and reiterate our Buy rating and TP of INR530 (unchanged) based on 14x one-year earnings roll-forward (vs. 15x earlier).

Our valuation multiples have been cut on: 1) near-term softness on revenue growth and 2) stability in margin guidance despite significant rupee depreciation.

Fig. 76: HCLT – P/E and average P/E trend HCLT is trading at ~25% discount to average P/E


Valuation methodology and risks Our TP of INR530 is based on 14x our one-year rolled-forward earnings forecast of INR38, which is in line with its historical average valuation.

Key risks include: 1) worse-than-expected slowdown and breakage of pricing discipline; 2) failure to exhibit stability in margins; and 3) client-specific issues.


Revenue (US$ mn) 4,217 4,897 4,292 4,917 -1.8 -0.4

US$/INR rate 48.8 47.5 46.2 45.0 5.6 5.5

Revenue (Rs bn) 205.6 232.5 198.3 221.2 3.7 5.1

EBITDA margin (%) 17.4 16.9 17.0 17.2 40 bps -20 bps

Tax Rate (%) 25.5 23.5 24.9 23.5 60 bps 0 bps

Diluted EPS (Rs) 31.5 36.6 30.2 35.3 4.3 3.6

New Old Change (%)

23.3

5.4

11.4

15.4

4

8

12

16

20

24

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

P/E avg P/E(x)


iGATE IGTE.O IGTE US

SOFTWARE & SERVICES

EQUITY RESEARCH

Great operating leverage story

A leveraged buyout script with integration challenges behind and a smoother cruise ahead

January 3, 2012

Rating Remains

Buy

Target price Increased from 19.00

USD 20.00


USD 15.79


Action: Reiterate BUY and top tier 2 IT pick iGATE post-acquisition of Patni – a company ~3x its size in revenues – has successfully integrated the sales force, minimized client/employee attrition and realized initial operational synergies. At Patni, we see iGATE replicating its formula for high margins by plugging inefficiencies at the delivery end and deriving scale benefits on SGA. This operational leverage, in our view, would lead to non-GAAP EBITDA margins expanding by 400bps (to 25%) over the next five quarters and a 43% EPS CAGR over FY11-13F. We find iGATE’s valuation attractive at P/E of 12.6/10.3x on FY12/13F and expect the stock to trade at a premium to its tier 2 peers.

Strong FCF and access to Patni cash to ease debt overhang The overhang on restricted access to Patni cash (~USD370mn vs overall cash of USD430mn) would likely ease as iGATE delists Patni, in our view. We believe this, combined with strong FCF generation of ~USD400mn over FY11-13F (~50% of debt), would lead to iGATE turning net cash positive over the next 2 years.

Catalysts: Higher revenue growth trajectory, Patni delisting Ingredients exist for revenue growth upside from 1) a larger addressable market and 2) replication of iGATE’s client mining successes at Patni.

Valuation: TP of USD20 based on 13x one-year rolling forward P/E We value iGATE at a ~20% premium to its mid-cap peers, on account of what we view as its best-in-class earnings growth and margin profiles.

31 Dec FY10 FY11F FY12F FY13F

Currency (USD) Actual Old New Old New Old New

Revenue (mn) 281 780 780 1,143 1,137 1,275 1,263

Reported net profit (mn) 52 60 55 94 98 125 125

Normalised net profit (mn) 52 60 55 94 98 125 125

Normalised EPS 92.33c 82.58c 76.11c 1.22 1.27 1.55 1.56

Norm. EPS growth (%) 78.1 -10.6 -17.6 47.6 67.5 27.5 22.1

Norm. P/E (x) 17.5 N/A 21.0 N/A 12.6 N/A 10.3

EV/EBITDA (x) 12.1 10.9 11.2 5.4 5.5 4.2 4.5


Dividend yield (%) 1.6 N/A na N/A na N/A na

ROE (%) 23.6 15.7 15.0 16.0 17.6 17.3 18.1

Net debt/equity (%) net cash 399.4 496.3 181.0 207.1 99.0 110.3


Anchor themes


Nomura vs consensus

Our target price is in line with Bloomberg consensus. However we expect margin improvements to happen earlier than management has guided.

Research analysts





Nomura | iGATE January 3, 2012

54

Key data on iGATE Income statement (USDmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FRevenue 193 281 780 1,137 1,263Cost of goods sold -124 -175 -517 -731 -815Gross profit 69 105 263 406 448SG&A -37 -52 -164 -204 -219Employee share expense

Operating profit 32 53 100 202 229

EBITDA 40 62 139 258 285Depreciation -8 -9 -39 -56 -56Amortisation

EBIT 32 53 100 202 229Net interest expense 0 0 -51 -71 -71Associates & JCEs

Other income -3 5 23 26 35Earnings before tax 29 58 72 157 193Income tax -1 -6 -11 -44 -52Net profit after tax 29 52 62 113 142Minority interests 0 0 -7 -15 -16Other items

Preferred dividends

Normalised NPAT 29 52 55 98 125Extraordinary items 0 0 0 0 0Reported NPAT 29 52 55 98 125Dividends -6 -15 0 0 0Transfer to reserves 23 37 55 98 125


FD normalised P/E (x) 30.9 17.5 21.0 12.6 10.3FD normalised P/E at price target (x) 35.2 20.0 24.0 14.4 11.8Reported P/E (x) 30.5 17.1 20.7 12.4 10.1Dividend yield (%) 0.7 1.6 na na naPrice/cashflow (x) 23.5 16.8 15.3 6.4 6.2Price/book (x) 4.5 3.6 8.5 4.8 3.7EV/EBITDA (x) 19.9 12.1 11.2 5.5 4.5EV/EBIT (x) 24.6 14.2 15.6 7.0 5.5Gross margin (%) 35.9 37.6 33.8 35.7 35.5EBITDA margin (%) 20.7 22.1 17.8 22.7 22.6EBIT margin (%) 16.8 18.9 12.8 17.8 18.1Net margin (%) 14.8 18.4 7.0 8.6 9.9Effective tax rate (%) 2.0 10.3 14.9 27.8 26.7Dividend payout (%) 20.9 28.0 0.0 0.0 0.0Capex to sales (%) 8.2 6.9 2.1 2.4 2.1Capex to depreciation (x) 2.1 2.1 0.4 0.5 0.5ROE (%) 16.9 23.6 15.0 17.6 18.1ROA (pretax %) na 35.7 13.0 14.7 16.6

Growth (%)

Revenue 45.3 178.1 45.8 11.1EBITDA 55.2 123.3 86.1 10.6EBIT 63.7 88.3 102.5 13.4Normalised EPS 78.1 -17.6 67.5 22.1Normalised FDEPS 76.6 -16.8 67.0 22.2

Per share

Reported EPS (USD) 51.85c 92.33c 76.11c 1.27 1.56Norm EPS (USD) 51.85c 92.33c 76.11c 1.27 1.56Fully diluted norm EPS (USD) 51.07c 90.17c 75.03c 1.25 1.53Book value per share (USD) 3.47 4.43 1.85 3.27 4.27DPS (USD) 0.11 0.26 0.00 0.00 0.00Source: Company data, Nomura estimates



(%) 1M 3M 12M

Absolute (USD) 13.5 28.5 -22.1

Absolute (USD) 13.5 28.5 -22.1


Market cap (USDmn) 893.4


52-week range (USD) 20.85/9.32


3.38


Ashok Trivedi 22.1

Sunil Wadhwani 21.2


Notes

We expect pro forma revenue growth of 9% CAGR over FY11-13F.

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PriceRel MSCI India(USD)


55

Cashflow (USDmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FEBITDA 40 62 139 258 285Change in working capital 2 5 15 -6 -8Other operating cashflow -4 -13 -78 -59 -68Cashflow from operations 38 54 76 192 209Capital expenditure -16 -19 -16 -27 -27Free cashflow 22 35 59 165 182Reduction in investments 0 -1 -126 0 0Net acquisitions

Reduction in other LT assets

Addition in other LT liabilities 0 0 -159 0 0Adjustments -1 -1 -689 -14 13Cashflow after investing acts 21 33 -915 151 195Cash dividends -6 -15 0 0 0Equity issue 23 19 398 64 14Debt issue -3 0 862 0 0Convertible debt issue

Others -3 5 -27 -45 -36Cashflow from financial acts 10 10 1,232 19 -22Net cashflow 31 43 317 170 174Beginning cash 65 97 140 457 628Ending cash 97 140 457 628 801Ending net debt -140 662 520 378Source: Company data, Nomura estimates

Balance sheet (USDmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash & equivalents 97 140 457 628 801Marketable securities

Accounts receivable 34 52 230 253 281Inventories

Other current assets 9 6 23 25 28Total current assets 140 198 710 906 1,110LT investments 4 5 132 132 132Fixed assets 43 53 190 161 132Goodwill 33 33 722 736 724Other intangible assets 9 16 76 76 76Other LT assets

Total assets 228 305 1,829 2,011 2,173Short-term debt

Accounts payable 36 56 265 284 307Other current liabilities

Total current liabilities 36 56 265 284 307Long-term debt 0 0 770 770 770Convertible debt 0 0 349 378 409Other LT liabilities 1 1 93 93 93Total liabilities 37 57 1,478 1,525 1,580Minority interest 0 0 219 234 250Preferred stock

Common stock 1 1 1 1 1Retained earnings 191 247 133 251 342Proposed dividends


Total shareholders' equity 191 248 133 251 343Total equity & liabilities 228 305 1,829 2,011 2,173

Liquidity (x)

Current ratio 3.91 3.55 2.68 3.19 3.61Interest cover na na 2.0 2.9 3.2

Leverage

Net debt/EBITDA (x) net cash net cash 4.78 2.02 1.33Net debt/equity (%) net cash net cash 496.3 207.1 110.3

Activity (days)

Days receivable 55.9 65.9 77.7 77.2Days inventory 0.0 0.0 0.0 0.0Days payable 95.4 113.4 137.6 132.4Cash cycle 0.0 -39.5 -47.5 -59.9 -55.3Source: Company data, Nomura estimates

Notes


Notes



56

Great operating leverage story

25% margin guidance achievable two quarters early

iGATE has significant potential to increase EBITDA margins though a combination of gross margin expansion and SGA leverage. Non-GAAP EBITDA margin (which excludes stock compensation) as of 3QFY11 was 21%, and management has a target of taking it up to 25% by June 2013, which assumes 40-41% gross margin and SGA levels of 15%. We think iGATE could reach up to 25% non-GAAP EBITDA margin two quarters earlier by increasing efficiency of the delivery model at Patni and by exploiting scale benefits in SGA spending. Since these margin gains are mostly efficiency and scale related, they would accrue to iGATE even in a low revenue growth scenario. Our estimates are based on USD-INR of 48.5/46.5 over FY12/13F; we believe that if the rupee were to remain higher than these levels (currently at 52 to the USD), margin guidance could be achieved even earlier.

Fig. 77: iGATE: Operating leverage to drive 37% CAGR in EPS over FY11-13F


Key operating margin levers

1. Fixed price mix iGATE (before the Patni acquisition) had been able to achieve gross margins higher than its mid-cap peers and closer to that of tier-1 IT firms despite having lower realizations partly on account of the high share of fixed-price projects (FPP) in its mix, we expect this high FPP proportion to be replicated in the consolidated entity.

Fig. 78: FPP mix comparison iGATE operates at a much higher FPP mix compared to Patni


Fig. 79: iGATE fixed price mix comparison with tier-1 IT IGATE FP mix before Patni higher than tier-1 IT (as per 1QFY11 data)


20.7%

22.1%

17.8%

22.7% 22.6%

16%

19%

22%

25%

FY09 FY10 FY11F FY12F FY13F

EBITDA margin (%)

0.51

0.90

0.75

1.25

1.53

FY09 FY10 FY11F FY12F FY13F

Adj. EPS (USD)

43% EPS growth over FY11-13F

36%41%

45%

72%

0%

10%

20%

30%

40%

50%

60%

70%

80%

FY08 FY09 FY10

Patni iGATE 1QFY11 level 72%

41%

50% 48%42%

iGATE Infosys TCS Wipro HCL Tech


57

2. Cost per employee reduction from 1) better employee pyramid structure and 2) higher offshore effort mix • Patni has a significantly higher share of lateral employees (employees with more than

2-3 years of experience), as reflected in the difference in average years of experience at Patni compared to iGATE. According to iGATE management, the average years of experience at Patni is 7 compared to 3.5 at iGATE.

• iGATE’s offshore effort mix dropped from 80% in December 2010 to 76.6% currently as a result of the Patni acquisition. iGATE has been consistently operating at between 79-81% offshore effort over FY08-10, and we see scope of this ratio improving.

3. SGA leverage Over the past two quarters, we believe iGATE has realized a significant portion of these savings – which resulted in SGA spend as a percentage of revenue improving from 24% in 2QFY11 to 17.6% in 3Q. Management forecasts that SGA spending would be in the region of USD46-48mn quarterly (similar to 3Q levels) in the near term – this would lead to SGA as a percentage of revenue coming down as revenue increases, in our view.

Fig. 80: iGATE SGA spending and % of revenue estimates SGA percentage of revenue likely to decline as absolute SGA is kept within a narrow band


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Strong free cash flow generation to aid in leverage related balance sheet risks iGATE from FY08-10 generated ~80-110% of its net income as free cash flow. Its ratio of cash flow from operations to revenue has also been stable for the past three years at 21-23%, which is comparable to what Infosys generated (21-30%) over the same period. We expect iGATE to generate free cash flow of ~USD400mn over FY11-13F which would be ~50% of the senior debt it has raised (USD770mn). We believe this is achievable given the historical cash flow generation trends at Patni and iGATE.

Fig. 81: iGATE free cash flow (USDmn) estimates


Change of estimates

We have revised our USD/INR rate assumptions higher on the back of the recent ~15% depreciation of the rupee against the USD (in the current quarter). Our margin assumptions have move up marginally as a result of our assumption of more significant rupee depreciation.

Fig. 82: Earnings revision


Reiterate BUY and top tier-2 IT pick status

We like iGATE primarily for five reasons: 1) its early success in the Patni integration makes for a smoother ride ahead, in our view; 2) high operating leverage can be achieved even at moderate revenue growth by removing inefficiencies in Patni’s delivery model and exploiting scale benefits on SGA; 3) an expanded addressable market post the Patni acquisition combined with replication of iGATE’s client mining success increases the chances for revenue growth to move to a higher level; 4) strong free cash flow generation and access to Patni cash could assist in debt reduction by at least 50% by FY13F; and 5) valuations are undemanding, in our view, given ~43% EPS CAGR achievable over FY11-13F.

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Revenue (US$ mn) 780 1,137 1,263 780 1,143 1,275 0.0 -0.5 -0.9

US$/INR rate 46.8 48.5 46.5 46.4 46.4 45.3 0.9 4.6 2.8

EBITDA margin (%) 17.8 22.7 22.6 17.4 21.6 22.3 30 bps 100 bps 30 bps

Tax Rate (%) 13.5 28.0 27.0 13.6 28.0 27.0 -10 bps 0 bps 0 bps

Diluted EPS (Rs) 0.75 1.25 1.53 0.81 1.20 1.53 -7.8 4.6 0.2

New Old Change (%)


59

We have raised our PT from USD 19 to USD20 with the rolling forward of earnings and slightly higher earnings estimates. Our TP is 13x one-year forward earnings of USD1.53, which is at a ~20% premium to our target multiples for the company's mid cap peers (valuation methodology unchanged).

We find the stock valuation of 10.3x FY13F earnings and 4.5x FY13F EV/EBITDA, which is a discount of 30% and 60% to tier-1 peers such as Infosys and TCS, attractive. Key upside triggers for the stock are 1) delisting of Patni, which could free up cash and aid in completing the integration of the two companies; 2) signs of revenue synergies of the iGATE-Patni combination playing out; and 3) USD-INR above our assumed rates of 48.5/46.5 for FY12/13F.

Valuation methodology We value iGATE at a 13x one-year forward P/E, which is at a ~20% premium to our target multiples for its mid cap peers, on account of what we view as its best-in class earnings growth and margin profile.

Risks that may impede the achievement of the target price Downside risks include 1) the inability to ramp up at non-top 5 clients; 2) limited investments into the front end, which could lead to below-par revenue growth; and 3) failure to delist Patni, which could mean less efficient operating structure.


Infosys INFY.NS INFO IN

SOFTWARE & SERVICES

EQUITY RESEARCH

Near-term safety with rebound possibilities

No near-term lag vs. peers; a better rebound candidate and low expectations in valuations

January 3, 2012

Rating Remains

Buy

Target price Increased from 3100

INR 3300


INR 2759


Action: Better positioned for a rebound, troubles not structural; Buy We believe Infosys is best positioned for a rebound as productisation revival, shift in client spending towards change-the-business and regulation-related spending start playing out from 2HFY13F onwards. Contrary to consensus, we believe Infosys’ troubles are not structural, but more environment-led. In the near term, too, we believe Infosys will post on-par growth compared to peers such as TCS (which have been more upbeat on commentary). This coupled with bigger potential gains from rupee depreciation and low expectations built into valuations makes us positive on the stock. We reaffirm Buy.

Catalysts: Pricing stability; revival in package implementation

We like the longer-term strategy of sustaining margins/multiples We believe Infosys’ strategy of deriving two-thirds of revenue from high realization/high margin/non-linear services is the right approach to counter wage cost increases, competitive pressure and longer-term deterioration in valuation multiples. Infosys has the highest exposure to such services (~40% of revenue) and is the best placed in tier 1 IT to succeed with this strategy, in our view.

Valuations already build in concerns; Buy with a new TP of INR3,300 We reiterate Buy on Infosys on: 1) better positioning for a rebound, 2) near-term upside triggers from bigger INR depreciation benefits, and 3) valuation discount of 10% to TCS and its own historical average, pricing in management’s cautious demand commentary. Our TP increases to INR3,300 (from INR3,100) on changes to our USD-INR assumptions.

31 Mar FY11 FY12F FY13F FY14F


Revenue (mn) 275,010 329,802 340,691 363,747 385,667 429,039 435,279



Normalised EPS 119.45 139.16 147.09 159.09 167.43 184.12 186.64

Norm. EPS growth (%) 11.1 16.5 23.1 14.3 13.8 15.7 11.5

Norm. P/E (x) 23.1 N/A 18.8 N/A 16.5 N/A 14.8

EV/EBITDA (x) 15.8 12.9 12.8 11.1 10.9 9.3 9.5



ROE (%) 27.1 27.1 28.4 26.3 27.2 25.2 25.2



Anchor themes


Nomura vs consensus

Our target price is 10% ahead of Bloomberg consensus on higher margin expectations.

Research analysts





Nomura | Infosys January 3, 2012

61

Key data on Infosys Income statement (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FRevenue 227,420 275,010 340,691 385,667 435,279Cost of goods sold -128,855 -158,298 -197,059 -223,535 -255,690Gross profit 98,565 116,712 143,632 162,131 179,589SG&A -29,005 -35,692 -44,822 -50,888 -56,548Employee share expense



EBIT 69,560 81,020 98,810 111,244 123,041Net interest expense

Associates & JCEs

Other income 9,430 12,110 18,111 19,311 21,053Earnings before tax 78,990 93,130 116,921 130,555 144,094Income tax -17,650 -24,900 -32,912 -34,909 -37,465Net profit after tax 61,340 68,230 84,010 95,646 106,630Minority interests 0 0 0 0 0Other items

Preferred dividends

Normalised NPAT 61,340 68,230 84,010 95,646 106,630Extraordinary items 1,320 0 0 0 0Reported NPAT 62,660 68,230 84,010 95,646 106,630Dividends -16,724 -40,096 -26,738 -28,075 -32,086Transfer to reserves 45,936 28,134 57,271 67,570 74,544



Growth (%)


Per share




(%) 1M 3M 12M

Absolute (INR) 6.1 12.9 -18.3

Absolute (USD) 4.5 4.4 -30.4



Estimated free float (%)

52-week range (INR) 3499/2161.5


80.95


N R Narayana Murthy 4.5

Nandan M Nilekani 3.4


Notes

We expect USD revenue growth of 17.4%/13.3% in FY12/13F

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Cashflow (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FEBITDA 78,610 89,640 108,333 121,604 133,772Change in working capital -1,470 -11,490 -5,512 -9,562 -12,861Other operating cashflow -17,070 -26,680 -33,192 -34,909 -37,465Cashflow from operations 60,070 51,470 69,629 77,133 83,446Capital expenditure -9,060 -12,240 -15,200 -12,000 -14,000Free cashflow 51,010 39,230 54,429 65,133 69,446Reduction in investments -37,120 35,450 890 0 0Net acquisitions

Reduction in other LT assets 0 0Addition in other LT liabilities 0 0 0 0 0Adjustments 90 0 0 0

Cashflow after investing acts 13,980 74,680 55,319 65,133 69,446Cash dividends -16,724 -40,096 -26,738 -28,075 -32,086Equity issue 2,014 14,406 -12,730 0 0Debt issue

Convertible debt issue

Others 9,340 12,110 18,111 19,311 21,053Cashflow from financial acts -5,370 -13,580 -21,357 -8,765 -11,033Net cashflow 8,610 61,100 33,961 56,368 58,413Beginning cash 96,950 105,560 166,660 200,621 256,990Ending cash 105,560 166,660 200,621 256,990 315,403Ending net debt -105,560 -166,660 -200,621 -256,990 -315,403Source: Company data, Nomura estimates

Balance sheet (INRmn) As at 31 Mar FY10 FY11 FY12F FY13F FY14FCash & equivalents 105,560 166,660 200,621 256,990 315,403Marketable securities 37,120 1,670 780 780 780Accounts receivable 34,940 58,960 74,672 84,530 95,404Inventories 0 0 0 0 0Other current assets 41,870 24,390 26,994 30,811 39,073Total current assets 219,490 251,680 303,067 373,111 450,660LT investments 0 0 0 0 0Fixed assets 53,550 57,170 62,848 64,487 67,756Goodwill

Other intangible assets


Accounts payable 23,430 18,600 25,464 28,938 33,042Other current liabilities 21,120 21,000 26,939 27,578 29,749Total current liabilities 44,550 39,600 52,403 56,517 62,791Long-term debt

Convertible debt

Other LT liabilities 0 0 0 0 0Total liabilities 44,550 39,600 52,403 56,517 62,791Minority interest 0 0 0 0 0Preferred stock 0 0 0 0 0Common stock 2,860 2,860 2,860 2,860 2,860Retained earnings 227,630 270,170 314,711 382,282 456,825Proposed dividends



Liquidity (x)


Leverage


Activity (days)

Days receivable 57.5 62.3 71.8 75.3 75.4Days inventory 0.0 0.0 0.0 0.0 0.0Days payable 61.6 48.5 40.9 44.4 44.2Cash cycle -4.1 13.9 30.9 30.9 31.2Source: Company data, Nomura estimates

Notes

The strong cash flow generation to continue

Notes

Cash and equivalents continue to rise


63

Portfolio mix makes Infosys a better rebound candidate We believe Infosys is best positioned for a rebound as productisation revival, shift in client spending patterns towards change-the-business and regulation-related spends start playing out from 2HFY13F onwards. Infosys with its portfolio mix skewed towards package implementation (PI) and products (39% of revenue as of 2QFY12), and better utilization scope relative to peers will be able to record a sharper rebound when demand improves, in our view. We model for a rebound in revenue growth to ~18% in FY14F vs. ~13% in FY13F.

Compared to application development and maintenance (ADM) where Indian IT penetration has reached ~30%, PI, system integration (SI) and consulting are 1.5x the ADM market and still underpenetrated with Indian IT names cornering only 5%-8% of global IT spends, according to Nasscom’s estimates for FY11. In our opinion, Infosys’ strategy of deriving two-thirds of its revenue from products/platforms and PI is better placed relative to peers to take advantage of the potential to scale up presence in these high realization services.

Fig. 83: High realization service line exposure (% of revenue) Infosys has the highest exposure towards high realization service lines among tier 1 IT

Service lines include package implementation + consulting + SI + product


On-par performance likely in the near-term despite cautious commentary

Infosys has announced that 3Q revenue growth would be closer to the lower end of its 3.2-5.4% q-q guidance. Consequently, revenue growth for the full-year would also be at the lower end of its full-year growth guidance of 17-19%, according to management.

Infosys’ 3Q guidance assumed sustainability of the sharp pickup in client activity witnessed in August-September 2011, which management now indicates has not materialized as:

• Decision making delays have elongated, with no cancellations as of yet,

• Large programs are going through a second level of scrutiny,

• Pace of project ramp-ups have been slower than contractually agreed upon, as clients reduce cash burn rates, possibly due to: 1) year-end cash conservation strategy; and 2) uncertainty on the macro front.

Contrary to consensus, we believe Infosys’ troubles are not structural, but more environment-led. Despite the cautious commentary, we believe Infosys will post on-par revenue growth compared with peers such as TCS (which has been more upbeat on commentary). IT companies across the board will likely be impacted in 3QFY12 by seasonal weakness (due to holiday-related client shutdowns) and cross currency movements, in our view. We model for ~3.5% q-q growth for both Infosys and TCS in 3QFY12F.

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Infosys TCS HCL Tech Cognizant


64

Good operational scope to tide over near-term demand slowdown

Infosys has a good utilization buffer of 400bps to take advantage of any rebound in demand in the near term. Clients have been holding back on decision making in several large projects, according to Infosys, and if the macro environment improves, this could result in a flush of IT spending. Infosys is, thus, well positioned to take advantage of any rebound, in our view. Similarly, in offshore mix and fixed price mix, we believe Infosys has a sufficient runway to improve margins/structure contracts so as to meet client demand of doing more with less.

Fig. 84: Operational scope comparison of Tier 1 IT names Infosys has good operational scope with a 400bps utilization buffer and sufficient headroom to perk up offshoring and fixed price mix

Source: Company, Nomura research estimates

Infosys likely to benefit the most from rupee depreciation due to low hedging

Infosys is likely to see major benefits of rupee depreciation due to its relatively low level of hedging compared with peers. While the entire rupee depreciation benefit is unlikely to be taken into margins, as some of the benefits would be channelled into reinvestments, we see potential upside to margins given our assumption of a USD-INR rate of 48 (vs. current levels of ~53) in FY13F. Infosys would gain 40-50bp on margins and 1.5% on earnings for each 1% rupee depreciation, on our estimates.

Fig. 85: A comparison of hedging levels (USD mn) among tier 1 IT names Infosys has the lowest hedging level among tier 1 IT

Source: Company data, Nomura research estimates

We like Infosys’ strategy of sustaining industry-leading margins

In a scenario where commoditized services are likely to face pricing pressure, we believe Infosys’ strategy of targeting two-thirds of its revenue from high realization/high margin/non-linear services is the right approach to counter wage cost increases, competitive pressure and longer term deterioration in valuation multiples. We find Infosys best placed within tier 1 IT companies to succeed with this strategy.

Adjusting estimates for rupee depreciation

We marginally lower our USD revenue growth estimates for FY12F/13F to take into account cross currency impacts and near-term softness in discretionary demand. Our rupee revenue estimates are higher based on higher USD/INR forecasts in a backdrop of ~15% depreciation in the rupee in the current quarter. On margins, we slightly raise our FY12F margin estimate due to potential benefits from the rupee’s depreciation.


Infosys 70.2% 69.7% 74.3% 4.1% 37.7% -2.2% 50.1% 0.3%

TCS 76.4% 74.6% 77.7% 1.3% 46.8% -2.2% 54.8% -1.3%

Wipro 76.1% 77.3% 80.7% 4.6% 45.2% 1.2% 45.7% -2.6%

HCLT 69.7% 73.5% 76.4% 6.7% 44.0% 2.9% 42.3% 0.6%


Equivalent USD hedge % of FY12F revenues

Infosys 734 10%

Wipro 1,887 32%

TCS 4,593 45%

HCL Tech 713 17%


65

Fig. 86: Earnings estimate revisions


Valuation

We reiterate our Buy rating with a new TP of INR3,300 (from INR3,100) based on 18x one-year rolling forward earnings of INR183. We increase our TP due to roll forward of earnings and potential benefits from INR depreciation. We like Infosys on account of: 1) the valuation discount of 10% to TCS and to its own historical average, which we think already reflects the cautious demand commentary by management; 2) better positioning for a rebound, and 3) near-term upside trigger on bigger benefits from INR depreciation. We raise both our FY12F/13F EPS estimates by ~5% due to the change in our INR assumptions.

Fig. 87: TCS valuation discount/(premium) to Infosys TCS trades at a ~10% premium to Infosys vs. a historical 10% discount


Valuation methodology We value Infosys at 18x one-year rolling-forward earnings of INR183, which is at a 10% discount to its long-term average valuation. We believe the discount is justified on heightened economic uncertainties, increased risk aversion in the market and an impending slowdown.

Risks to our valuation Key risks are: 1) a worse-than-expected slowdown and breakage of pricing discipline in the industry; 2) client-specific issues; and 3) an adverse ruling in its pending B1 visa violation case in the US.


Revenue (USDmn) 7,092 8,035 7,139 8,083 -0.7 -0.6

USD/INR rate 48.0 48.0 46.2 45.0 4.0 6.7

Revenue (INRbn) 340.7 385.7 329.8 363.7 3.3 6.0

EBITDA margin (%) 31.8 31.5 31.3 31.6 50 bps 0 bps

Tax rate (%) 28.1 26.7 28.2 26.7 0 bps 0 bps

Diluted EPS (INR) 147.0 167.4 139.1 159.1 5.7 5.2

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Tata Consultancy Services TCS.NS TCS IN

SOFTWARE & SERVICES

EQUITY RESEARCH

Heightened expectations keep us cautious

Premium valuations and optimised operations make for limited upside triggers

January 3, 2012

Rating Remains

Neutral

Target price Increased from 1100

INR 1230


INR 1179


Action: Heightened expectations a concern; reaffirm Neutral While we like TCS for its potential to drive market share gains helped by the widest verticals, service lines and geographical presence across tier-1 IT companies, we believe disappointments are likely in the interim on any commentary moderation, given: 1) high Street expectations built into valuations; 2) higher exposure to Europe and BFSI – two segments most susceptible to a slowdown; and 3) limited operational scope to counter cost pressure. We would wait for more valuation comfort given these risks and hence reaffirm our Neutral rating. We prefer CTSH/INFO over TCS.

Upbeat commentary unlikely to manifest in material differentials We expect TCS to post similar q-q revenue growth rates, compared with Infosys over the next two quarters, despite giving more upbeat commentary. On margins, we expect Infosys is likely to widen the gap over TCS in FY13F on account of TCS’ limited margin levers to offset pressure from: 1) wage inflation and 2) potential cost pressure in the commoditised parts of the business, given the highly optimised operations.

Catalysts: A moderation of management commentary on demand

Valuation: TP raised to INR1,230 on roll forward and USD-INR change We expect a USD revenue CAGR of 20% and EPS CAGR of 19% over FY11-13F. Our estimates are higher primarily due to our assumption of better USD-INR rates. We raise our TP to INR1,230 (from INR1,100) based on 18x one-year-forward earnings (methodology unchanged).



Revenue (mn) 373,245 472,295 491,445 520,204 565,856 600,757 634,414



Normalised EPS 44.54 52.55 54.35 59.24 62.98 67.09 69.80

Norm. EPS growth (%) 27.0 18.0 22.0 12.7 15.9 13.3 10.8

Norm. P/E (x) 26.5 N/A 21.7 N/A 18.7 N/A 16.9

EV/EBITDA (x) 20.5 15.5 15.4 13.8 13.7 12.1 12.2



ROE (%) 37.6 36.9 37.9 34.1 35.5 31.3 31.5



Anchor themes

Shift in IT spend allocations and and simple economics should help power tier-1 IT growth closer to the trend line. Within tier-1, we favour companies better equipped for a rebound scenario and those that have greater Street pessimism built in.

Nomura vs consensus

Our FY13F earnings forecast is in line with Bloomberg consensus. However, we are less optimistic than consensus on FY13F revenue growth.

Research analysts





Nomura | Tata Consultancy Services January 3, 2012

67

Key data on Tata Consultancy Services Income statement (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FRevenue 300,289 373,245 491,445 565,856 634,414Cost of goods sold -163,805 -205,865 -269,028 -318,671 -363,473Gross profit 136,484 167,380 222,417 247,186 270,941SG&A -56,975 -62,609 -84,434 -95,997 -107,008Employee share expense



EBIT 79,509 104,771 137,983 151,189 163,933Net interest expense

Associates & JCEs

Other income 2,255 5,324 2,877 10,137 14,731Earnings before tax 81,764 110,095 140,860 161,326 178,664Income tax -12,088 -21,739 -33,497 -37,105 -41,093Net profit after tax 69,676 88,356 107,362 124,221 137,571Minority interests -1,019 -1,190 -992 -948 -948Other items -10 0 0 0 0Preferred dividends




Growth (%)


Per share




(%) 1M 3M 12M

Absolute (INR) 10.9 13.3 3.4

Absolute (USD) 9.1 4.8 -11.9




52-week range (INR) 1247/902


39.28


Tata Sons Ltd 73.8


Notes

We expect USD revenue growth of 25.2%/15% for FY12/13F

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Cashflow (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FEBITDA 86,800 111,985 147,459 162,229 175,736Change in working capital -44,271 27,556 -23,840 -6,488 -8,861Other operating cashflow -13,035 -22,929 -34,489 -38,053 -42,041Cashflow from operations 29,494 116,612 89,129 117,688 124,834Capital expenditure -10,932 -16,934 -18,243 -19,200 -20,000Free cashflow 18,561 99,678 70,886 98,488 104,834Reduction in investments -20,546 -53,005 -2,577 0 0Net acquisitions

Reduction in other LT assets 5,706 -3,266 -4,956 -6,870 -7,987Addition in other LT liabilities 0 0 0 0 0Adjustments 1,160 -1,946 -1,006 -570 -570Cashflow after investing acts 4,882 41,461 62,347 91,049 96,278Cash dividends -45,797 -32,058 -38,927 -43,507 -43,507Equity issue 30,864 -11,354 -12,722 0 0Debt issue 4,605 1,919 2,170 1,404 1,705Convertible debt issue 0 0 0 0 0Others 2,255 5,322 2,877 10,137 14,731Cashflow from financial acts -8,073 -36,171 -46,602 -31,966 -27,072Net cashflow -3,191 5,290 15,744 59,083 69,206Beginning cash 13,440 10,249 15,539 31,283 90,366Ending cash 10,249 15,539 31,283 90,366 159,573Ending net debt -10,249 -15,539 -31,283 -90,366 -159,573Source: Company data, Nomura estimates

Balance sheet (INRmn) As at 31 Mar FY10 FY11 FY12F FY13F FY14FCash & equivalents 10,249 15,539 31,283 90,366 159,573Marketable securities 37,799 90,821 93,398 93,398 93,398Accounts receivable 70,109 95,497 141,266 156,340 174,634Inventories 0 0 0 0 0Other current assets 59,762 14,485 17,250 19,091 21,325Total current assets 177,919 216,342 283,198 359,195 448,929LT investments 17 0 0 0 0Fixed assets 41,706 51,996 61,333 70,062 78,829Goodwill 32,415 33,791 34,227 34,227 34,227Other intangible assets 0 0 0 0 0Other LT assets 22,488 25,754 30,710 37,580 45,566Total assets 274,546 327,883 409,468 501,064 607,552Short-term debt

Accounts payable 50,996 58,663 83,357 93,783 105,450Other current liabilities

Total current liabilities 50,996 58,663 83,357 93,783 105,450Long-term debt

Convertible debt

Other LT liabilities 9,110 11,029 13,199 14,603 16,308Total liabilities 60,106 69,692 96,556 108,387 121,758Minority interest 4,056 3,147 4,581 4,581 4,581Preferred stock 1,000 1,000 1,000 1,000 1,000Common stock 1,957 1,957 1,957 1,957 1,957Retained earnings 207,427 252,087 305,374 385,139 478,255Proposed dividends



Liquidity (x)


Leverage


Activity (days)

Days receivable 88.4 81.0 88.2 96.0 95.2Days inventory 0.0 0.0 0.0 0.0 0.0Days payable 125.6 97.2 96.6 101.4 100.0Cash cycle -37.2 -16.2 -8.4 -5.5 -4.8Source: Company data, Nomura estimates

Notes

Cash flow generation remains strong

Notes

Cash levels are on the rise


69

Upbeat commentary may not translate into material outperformance We expect TCS to post similar sequential USD revenue growth rates as Infosys over the next two quarters, despite TCS management giving more upbeat commentary on demand. This is likely on account of a slowdown in client decision making, coupled with seasonal weakness in the third and fourth quarters, in our view. Revenue growth for the two companies will likely equalise over the next two years – from the 8pp outperformance that TCS will likely achieve over Infosys in FY12F, according to our estimates.

On margins, Infosys is likely to widen the gap over TCS in FY13F on account of TCS’ limited margin levers to offset pressure from: 1) wage inflation; and 2) potential cost pressure in the commoditised parts of the business such as infrastructure management services (IMS), BPO and application maintenance (AM), given its highly optimised operations.

Key risks, in our view, that the Street is not factoring for TCS include:

Higher BFSI/Europe exposure and client concentration: BFSI and Europe remain the segments most likely to be hit first in a slowdown, in our view. This was the case in the previous downturn (in 2008), and we expect history to repeat itself.

With TCS having the sector’s highest BFSI exposure (44% of its revenue), as well as relatively high Europe exposure (26% of its revenue), we see potential risk here. Furthermore, we remain cautious on the stock, given that it has the highest client concentration (~28% of revenue vs 19-25% at peers) among the tier-1 IT companies from a top-10 client perspective, thus raising concerns over the potential impact of client-specific issues.

Fig. 88: BFSI/Europe exposure among tier-1 IT TCS has the highest exposure to BFSI, while also having a large exposure to Europe

Note: Based on last reported quarter


Highly optimised operations TCS has limited incremental margin levers to offset pressure from possible wage inflation and potential cost pressure in the commoditised parts of the business, in our view. Across operating metrics, TCS is near the peak values at which it has operated – thus leaving very little room for improvement.

44%41%

35%

27%25%26%

18%21%

29%27%

TCS Cognizant Infosys Wipro HCL Tech

BFSI Europe


70

Fig. 89: Operational scope comparison TCS operates at highly optimised utilisation levels and offshore revenue mix


No room for disappointment given valuation premiums We believe the Street is likely to be disappointed on any commentary moderation given expectations of continued revenue outperformance over Infosys. The risk of disappointment is higher at TCS, in our view, given the premium valuations at which the stock trades. TCS trades at a 10% premium to Infosys in terms of one-year forward P/E multiple and given the par revenue growth likely over the next two years, this premium might not be sustained.

Adjusting our estimates for rupee depreciation

We raise our EPS estimates for FY12/13F by 3.4%/6.3% largely on an upward revision in INR/USD rates from 46/45 to 48 for both FY12F and FY13F. Our USD revenue growth assumptions are marginally higher for FY13F to account for the Friends deal that TCS recently won (revenue of USD146mn per annum over 15 years, ~1.5% of TCS’ FY12F revenue). We are more negative on EBTIDA margins for FY13F despite benefits from a weaker rupee on account of TCS’ limited margin levers to offset the impact from wage hikes and realisation pressure arising from a greater skew of growth towards the lower-realisation commoditised businesses. Our FY12F margin estimates have inched up primarily due to our higher rupee rate assumptions.

Over FY11-13F, we expect a USD revenue CAGR of 20%, EBITDA margin decline of 130bps and EPS CAGR of 19%.




Infosys 70.2% 69.7% 74.3% 4.1% 37.7% -2.2% 50.1% 0.3%

TCS 76.4% 74.6% 77.7% 1.3% 46.8% -2.2% 54.8% -1.3%

Wipro 76.1% 77.3% 80.7% 4.6% 45.2% 1.2% 45.7% -2.6%

HCLT 69.7% 73.5% 76.4% 6.7% 44.0% 2.9% 42.3% 0.6%



Revenue (USD mn) 10,248 11,789 10,242 11,560 0.1 2.0

USD/INR rate 48.0 48.0 46.1 45.0 4.0 6.7

Revenue (INR bn) 491.4 565.9 472.3 520.2 4.1 8.8

EBITDA margin (%) 30.0 28.7 29.4 29.3 60 bps -60 bps

Tax Rate (%) 23.8 23.0 23.8 23.0 0 bps 0 bps

Diluted EPS (INR) 54.3 63.0 52.6 59.2 3.4 6.3

New Old Change (%)


71

Upside triggers limited; reaffirm Neutral

We believe disappointments are likely in the interim on any commentary moderation, given: 1) higher Street optimism built into valuations; 2) higher exposure to Europe and BFSI – the two segments most susceptible to a slowdown; and 3) limited operational scope to counter cost pressures. We await more valuation comfort given these risks and hence maintain our Neutral rating. We prefer CTSH/INFO over TCS.

Valuation methodology Our TP of INR1,230 (INR1,100 earlier) is based on 18x our one-year rolling forward earnings forecast of INR68.2. Our target multiple is in line with the stock’s historical average, reflecting heightened economic uncertainty and risks on its high BFSI and Europe exposure.

Risks to our valuation Risks on the upside include a recovery in global macro leading to demand rebound faster than we anticipate, while downside risks include: 1) faster-than-anticipated slowdown and breakage of pricing discipline in the industry; 2) client-specific issues; and 3) deterioration in management commentary from the current position of no issues on demand.


Wipro WIPR.NS WPRO IN

SOFTWARE & SERVICES

EQUITY RESEARCH

Revival to be slower than Street expectations

Recent outperformance builds high hopes of a speedy revival; unlikely in our view

January 3, 2012

Rating Remains

Neutral

Target price Increased from 350 INR 390

Closing price December 27, 2011 INR 407

Potential downside -4.2%

Action: Speed of revival likely to disappoint; Reaffirm Neutral Wipro has been the best performing Tier-1 IT stock (22% outperformance vs. the Nifty) over the past three months, driven by market expectations of a speedy revival in revenue growth. However, we believe the Street might be disappointed on this front with Wipro likely to continue losing market share vs. peers and lagging in earnings growth over the next two years. This, coupled with 1) higher-than-peer group margin declines over FY11-13F and 2) no immediate improvement in ROCE/working capital deterioration trends, could lead to valuations staying depressed in our view. Reaffirm Neutral.

Catalyst: Pricing pressure and continued loss of market share

Wipro’s early revival hopes premature, in our view We remain non-consensus in our view that revival signs are yet to emerge definitively with 1) continued growth issues in the US (two consecutive quarters of declines on an organic basis) 2) loss of growth momentum might be difficult to arrest without being disruptive on pricing/increasing investments in sales/ acquisitions, which could lead to P&L or balance sheet deterioration 3) operational scope might not be utilised as the company builds buffer for growth – exerting pressure on margins. We believe near-term results might not underpin revival hopes.

Valuation: Raise TP to INR390 (from INR350) on INR assumption We remain Neutral on Wipro with a new TP of INR390, based on 14x 1-yr forward earnings (20% discount to TCS/Infosys) on earnings lag and inferior return ratios. Our TP change is driven by our INR assumption changes and rolling-forward of earnings.



Revenue (mn) 310,542 365,649 370,053 398,438 415,350 451,054 460,654



Normalised EPS 21.52 23.21 22.88 24.40 25.53 26.78 28.41

Norm. EPS growth (%) 13.1 7.8 6.3 5.1 11.6 9.8 11.3

Norm. P/E (x) 19.0 N/A 17.9 N/A 16.0 N/A 14.4

EV/EBITDA (x) 15.1 12.6 13.6 11.3 11.8 10.0 10.7



ROE (%) 24.3 22.3 22.1 20.6 21.5 19.6 20.5

Net debt/equity (%) net cash 0.1 1.2 net cash net cash net cash net cash


Anchor themes

Shift in IT spend allocations and and simple economics should help power Tier-1 IT growth closer to the trend line. Within Tier-1, we favour companies better equipped for a rebound scenario and those that have greater Street pessimism built in.

Nomura vs consensus

We are 3% lower than the Bloomberg consensus earnings estimate for FY13F; we expect Street estimates to be cut as margin expectations get reset lower.

Research analysts





Nomura | Wipro January 3, 2012

73

Key data on Wipro Income statement (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FRevenue 271,957 310,542 370,053 415,350 460,654Cost of goods sold -186,430 -212,930 -260,786 -291,885 -328,118Gross profit 85,527 97,612 109,267 123,465 132,536SG&A -33,299 -40,389 -45,679 -51,141 -55,828Employee share expense


EBITDA 60,059 65,434 73,564 82,707 88,224Depreciation -7,831 -8,211 -9,977 -10,384 -11,516Amortisation 0 0 0 0 0EBIT 52,228 57,223 63,588 72,324 76,708Net interest expense

Associates & JCEs

Other income 2,986 5,164 4,948 4,964 9,353Earnings before tax 55,214 62,387 68,535 77,287 86,060Income tax -9,294 -10,256 -13,122 -15,457 -17,212Net profit after tax 45,920 52,131 55,413 61,830 68,848Minority interests -185 -344 -19 40 40Other items 530 648 407 396 396Preferred dividends




Growth (%)


Per share




(%) 1M 3M 12M

Absolute (INR) 10.0 16.8 -16.1

Absolute (USD) 8.2 8.0 -28.5




52-week range (INR) 496.8/310.2


13.85


Azim H Premji 79.2


Notes

We estimate FY12F and FY13F USD revenue growth of 14% and 10%, respectively, in the IT services division

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Cashflow (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FEBITDA 60,059 65,434 73,564 82,707 88,224Change in working capital -25,743 -7,066 -25,386 -7,897 -9,095Other operating cashflow -8,949 -9,952 -12,734 -15,021 -16,776Cashflow from operations 25,367 48,416 35,444 59,789 62,353Capital expenditure -11,495 -9,847 -16,270 -16,384 -17,516Free cashflow 13,872 38,569 19,174 43,405 44,836Reduction in investments -14,552 -19,510 8,557 0 0Net acquisitions 1,823 -556 -11,308 0

Reduction in other LT assets -13 -11,875 -4,682 -3,066 -3,413Addition in other LT liabilities

Adjustments 0 542 0 0

Cashflow after investing acts 1,130 7,170 11,741 40,339 41,423Cash dividends -10,092 -17,118 -17,139 -17,139 -17,139Equity issue 12,995 7,963 -11,975 0 0Debt issue 8,742 -6,916 5,308 -940 -940Convertible debt issue

Others 2,986 5,164 4,948 4,964 9,353Cashflow from financial acts 14,631 -10,907 -18,858 -13,115 -8,726Net cashflow 15,761 -3,737 -7,117 27,224 32,697Beginning cash 49,117 64,878 61,141 54,024 81,248Ending cash 64,878 61,141 54,024 81,248 113,945Ending net debt -2,367 -8,339 3,278 -24,886 -58,523Source: Company data, Nomura estimates

Balance sheet (INRmn) As at 31 Mar FY10 FY11 FY12F FY13F FY14FCash & equivalents 64,878 61,141 54,024 81,248 113,945Marketable securities 30,420 49,282 40,563 40,563 40,563Accounts receivable 67,636 85,776 112,040 125,755 139,471Inventories 7,926 9,707 11,152 12,517 13,883Other current assets 34,654 26,408 37,040 42,056 47,641Total current assets 205,514 232,314 254,819 302,139 355,502LT investments 2,345 2,993 3,155 3,155 3,155Fixed assets 53,458 55,094 61,387 67,387 73,387Goodwill 57,813 58,369 69,677 69,677 69,677Other intangible assets


Accounts payable 62,966 67,575 80,530 92,729 104,299Other current liabilities 0 0 0 0 0Total current liabilities 62,966 67,575 80,530 92,729 104,299Long-term debt 62,511 52,802 57,302 56,362 55,422Convertible debt

Other LT liabilities 7,902 10,695 11,503 11,503 11,503Total liabilities 133,379 131,072 149,335 160,594 171,225Minority interest 437 691 640 640 640Preferred stock 0 0 0 0 0Common stock 2,936 4,908 4,915 4,915 4,915Retained earnings 193,176 234,772 261,503 306,630 358,775Proposed dividends



Liquidity (x)


Leverage

Net debt/EBITDA (x) net cash net cash 0.04 net cash net cashNet debt/equity (%) net cash net cash 1.2 net cash net cash

Activity (days)

Days receivable 87.5 90.2 97.8 104.5 105.1Days inventory 15.2 15.1 14.6 14.8 14.7Days payable 135.1 111.9 103.9 108.3 109.6Cash cycle -32.5 -6.6 8.5 11.0 10.2Source: Company data, Nomura estimates

Notes


Notes



75

Why we are not convinced of a speedy revival We believe the Street is drawing signs from Wipro’s slightly ahead-of-expectations revenue growth in 2QFY12 driven by possibly higher contractor/third-party revenue and comparable guidance to Infosys and Cognizant for 3QFY12F (2-4% growth vs. 3.2-5.4% at Infosys and 3.7% at Cognizant). The Street also seems excited about the company indicating an improvement in pipeline and in client mining. We, however, believe the optimism has been much more than justified, with the stock outperforming its peer group and outperforming the Nifty by 22% over the past three months. We expect the Street to be disappointed on the speed of revival on account of the following key reasons:

• US geography is still a problem, and is unlikely to improve in the near term on unfavorable business exposure. This is reflected in the share of the US declining on an organic basis over the past two quarters. The US accounts for ~60% of the company’s revenue and the company has a higher skew towards technology and telecom OEM clients, which are likely to stay sluggish, in our view. In Europe too, Wipro has exposure to two of the largest Swiss banks, where the company has indicated sluggishness in terms of revenue.

• Loss of momentum on demand might require Wipro to implement measures such as being disruptive on pricing/ acquiring for relationships and investing more into sales. We believe that any of these measures could have negative margin and balance sheet implications in the interim. Some key possibilities being:

– In BFSI, which is one of the focused verticals for reviving growth, Wipro is much less penetrated compared with competition and might have to acquire for getting relationships or expanding domain capabilities, in our view. Wipro’s past acquisitions have been dilutive to its return ratios – the overall ROCE as well as IT services ROCE has seen a marked deterioration over the past few years. Incidentally, Wipro’s ROCE is now lower than that of HCL Tech.

Fig. 91: Wipro – ROCE trend (IT services and overall company) ROCE of the IT services business has contracted from 45-46% In FY09 to 34% in 2QFY12


– Wipro spends the least among competition on S&M expenses and, we believe, it might have to raise its S&M expenditure to push for higher growth, which could impact margins, in our view. Also, although the company has indicated that it is not likely to be disruptive on pricing, but given competition from players like HCL Tech (especially in IMS – 22% of Wipro revenues), which are more price competitive and have shown greater flexibility in taking over client staff in deal situations, Wipro might have to make choices. This could also lead to further deterioration in working capital – DSO days have increased from 85 days to 110 days over a period of two years.

44%

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IT Services and Products Overall company


76

Fig. 92: SG&A spend comparison (last quarter annualised) Wipro's SGA spend is the lowest among Tier-1 IT, in percentage terms

Note: For TCS, SG & A expense includes trainee and unallocated employee salaries also. Last quarter is Sep-2011 for

Infosys, TCS and HCL Tech, and Nov-2011 for Accenture.


Fig. 93: DSO days (accounts receivable + unbilled revenue) trend Wipro has seen substantial deterioration in receivables over the past four years

Note: DSO days calculation is based on quarterly annualized revenues


– We also believe that companies such as HCL Tech and TCS have moved ahead in terms of deal-signings over the past 12 months. With Wipro’s participation falling short and that too in a scenario of an impending demand slowdown in FY13F, might put Wipro at a disadvantage in terms of revenue growth, we believe.

• Near-term results might not fuel hopes of a speedy revival, as we believe Wipro will continue to lag peers such as Infosys/TCS and Cognizant on revenue growth in 3QFY12F and might guide cautiously for 4QFY12F. We expect Wipro will post 2.5% q-q growth in 3QFY12 and guide for 2-3% growth in 4QFY12F.

• Operational scope might not be fully utilised: We believe that despite Wipro having a scope of ~450bps on utilisation (including trainees), it might not be able to utilise this lever materially as management has indicated that it would like to maintain current utilisation levels in order to keep sufficient buffer for growth. This, we believe, is given its experience during the past downturn when Wipro was caught in a tight spot because of its high utilisation, when it had to forego growth when demand rebounded. Utilisation, including trainees, at 76.1% in 2QFY12 was ~260bps lower on a y-y basis.

Adjusting revenue and margins for rupee depreciation

We have marginally reduced our USD revenue growth estimates for Wipro in FY12F post factoring in cross currency impacts and near-term slowness in client decision making. We now look for FY12F and FY13F USD revenue growth of 14% and 10%, respectively. Our rupee revenue estimates are higher on account of USD/INR depreciation. We are slightly more positive on margins again on account of rupee depreciation. Over FY11-13F, we expect revenue CAGR of 12%, IT services EBIT margin dilution of 150bps, and EPS CAGR of 8%.

Revenues SG&A expense SG&A as a % of revenue

Accenture 28,298 5,080 18.0

Cognizant 6,404 1,331 20.8

HCL Tech 4,009 577 14.4

TCS 10,100 1,768 17.5

Infosys 6,984 926 13.3

Wipro 5,890 649 11.0

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77



Limited upside triggers; reaffirm Neutral

We raise our TP to INR390 (from INR350) primarily due to the rolling-forward of earnings and upward revision to EPS estimates on rupee depreciation. Our TP is based on 14x 1-year forward earnings of INR28. The 14x multiple, at ~20% discount to our target multiple for Infosys and TCS, is justified, in our view, given the deteriorating return ratios and our expectation of sustained underperformance vs. peers.

We maintain our Neutral rating on the stock, as we expect Wipro will grow more slowly than peers on its unfavourable vertical mix and under-investment in sales. Wipro remains our least-preferred stock among Tier-1 IT. We prefer Cognizant, Infosys and HCLT among the Tier-1 IT companies.

Valuation methodology We value Wipro at 14x 1-year forward earnings of INR28, which is at ~20% discount to our target multiple for Infosys and TCS. We think the discount is justified given the lag in revenue revival and below-par earnings growth. Our target price is INR390.

Risks that may impede the achievement of the target price The key downside risks include: 1) worse-than-anticipated demand slowdown and breakage of pricing discipline and 2) client-specific issues, while upside risks include recovery in global macro leading to demand rebound faster than we anticipate.


IT services revenue (USD mn) 5,945 6,560 5,987 6,658 -0.7 -1.5

IT services revenue (INR bn) 281.7 314.9 277.6 299.6 1.5 5.1

IT services EBIT margin (%) 21.4 21.2 21.0 20.7 40 bps 50 bps

Cons. revenue (INR bn) 370.1 415.4 365.6 398.4 1.2 4.2

Tax Rate (%) 19.1 20.0 19.2 20.0 0 bps 0 bps

Diluted EPS (INR) 22.7 25.4 23.1 24.2 -1.4 4.6

New Old Change (%)


78

Appendix A-1

Analyst Certification

We, Ashwin Mehta and Pinku Pappan, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures Mentioned companies Issuer name Ticker Price Price date Stock rating Sector rating Disclosures Cognizant CTSH US USD 65.48 16-Dec-2011 Neutral Not rated 123 HCL Technologies HCLT IN INR 412 16-Dec-2011 Buy Not rated iGATE IGTE US USD 16.38 16-Dec-2011 Buy Not rated Infosys INFO IN INR 2724 16-Dec-2011 Buy Not rated 123 Tata Consultancy Services TCS IN INR 1146 16-Dec-2011 Neutral Not rated Wipro WPRO IN INR 403 16-Dec-2011 Reduce Not rated 49

Disclosures required in the U.S.

49 Possible IB related compensation in the next 3 months Nomura Securities International, Inc. and/or its affiliates expects to receive or intends to seek compensation for investment banking services from the company in the next three months.

123 Market Maker - NSI Nomura Securities International Inc. makes a market in securities of the company.

Previous Rating Issuer name Previous Rating Date of change Cognizant Buy 02-Nov-2010 HCL Technologies Neutral 10-Sep-2009 iGATE Not Rated 23-Nov-2011 Infosys Neutral 21-Jan-2011 Tata Consultancy Services Buy 22-Dec-2009 Wipro Neutral 03-Jan-2012

Rating and target price changes

Ticker Old stock rating New stock rating Old target price New target price

Wipro WPRO IN Neutral Reduce INR 350 INR 350


79

Wipro (WPRO IN) INR 403 (16-Dec-2011) Rating and target price chart (three year history)

Reduce (Sector rating: Not rated)

Date Rating Target price Closing price 31-Oct-11 350.00 366.60 04-Oct-11 340.00 333.55 05-Sep-11 330.00 321.75 20-Jul-11 410.00 398.95 27-Apr-11 450.00 451.10 21-Jan-11 480.00 455.95 05-Jan-11 460.00 485.65 22-Oct-10 450.00 448.90 13-Oct-10 Neutral 483.40 13-Oct-10 470.00 483.40 23-Jul-10 480.00 412.45 06-Jul-10 490.00 397.35 16-Jun-10 470.00 408.80 25-May-10 Buy 380.19 06-Apr-10 780.00 429.12 20-Jan-10 790.00 435.93 30-Dec-09 740.00 408.81 27-Oct-09 677.00 363.39 10-Sep-09 Neutral 326.13 10-Sep-09 625.00 326.13 06-Jul-09 357.00 223.32 22-Apr-09 257.00 168.63 21-Jan-09 Reduce 131.82 21-Jan-09 217.00 131.82

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology We value Wipro at 14x 1-year forward earnings of INR28, which is at a ~20% discount to our target multiple for Infosys and TCS. The discount, in our view, is justified given the lag in revenue revival and below par earnings growth. Our target price is INR380. Risks that may impede the achievement of the target price The key risks include: 1) worse-than-anticipated demand slowdown and breakage of pricing discipline; 2) rupee appreciation; and 3) client-specific issues.

Cognizant (CTSH US) USD 65.48 (16-Dec-2011) Rating and target price chart (three year history)

Neutral (Sector rating: Not rated)

Date Rating Target price Closing price 03-Nov-11 75.00 71.23 05-Sep-11 68.00 61.10 08-Apr-11 83.00 80.26 21-Jan-11 82.00 73.05 05-Jan-11 77.00 76.19 02-Nov-10 Neutral 65.55 02-Nov-10 68.00 65.55 04-Aug-10 67.00 61.57 29-Jun-10 63.00 50.55 06-May-10 60.00 48.75 10-Feb-10 52.00 46.34 03-Nov-09 48.00 41.97 18-Sep-09 45.00 38.49 05-Aug-09 36.75 34.59 22-Jun-09 Buy 24.90 22-Jun-09 32.00 24.90


Valuation Methodology We value Cognizant at 20x our one-year forward earnings per share estimate of USD4.1, which is at a 10% discount to its long-term average to reflect higher risk in the macro environment and risks related to higher BFSI exposure. Our target price is USD82. Risks that may impede the achievement of the target price The key downside risks include: 1) a faster-than-anticipated demand slowdown and 2) deviance from pricing discipline in the industry.


80

HCL Technologies (HCLT IN) INR 412 (16-Dec-2011) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 05-Sep-11 530.00 384.05 27-Jul-11 630.00 504.00 20-Apr-11 620.00 522.85 08-Apr-11 580.00 484.75 21-Jan-11 600.00 499.55 05-Jan-11 540.00 472.35 13-Oct-10 510.00 444.25 07-Jul-10 450.00 356.15 22-Apr-10 435.00 382.45 31-Mar-10 425.00 358.40 26-Jan-10 430.00 361.20 28-Oct-09 397.00 313.35 10-Sep-09 Buy 309.45 10-Sep-09 389.00 309.45 06-Jul-09 Neutral 187.45 06-Jul-09 187.00 187.45 28-Apr-09 Buy 126.05 28-Apr-09 152.00 126.05 23-Jan-09 Reduce 107.00 23-Jan-09 130.00 107.00


Valuation Methodology Our TP of INR530 is based on 14x one-year rolling forward earnings forecast of INR38, which is in line with its historical average valuation. Risks that may impede the achievement of the target price The key risks include: 1) worse-than-expected slowdown and breakage of pricing discipline; 2) failure to exhibit stability in margins; and; 3) client-specific issues.

Infosys (INFO IN) INR 2724 (16-Dec-2011) Rating and target price chart (three year history)


Date Rating Target price Closing price 12-Oct-11 3,100.00 2,679.35 04-Oct-11 2,900.00 2,438.50 05-Sep-11 2,800.00 2,265.10 12-Jul-11 3,400.00 2,791.55 17-Apr-11 3,450.00 2,989.50 21-Jan-11 Buy 3,243.85 21-Jan-11 3,800.00 3,243.85 05-Jan-11 3,580.00 3,459.60 18-Oct-10 3,200.00 3,107.05 14-Jul-10 3,040.00 2,742.90 06-Jul-10 3,000.00 2,785.10 25-Mar-10 2,780.00 2,813.95 12-Jan-10 2,740.00 2,586.95 09-Dec-09 2,600.00 2,456.55 09-Oct-09 2,300.00 2,177.60 10-Sep-09 Neutral 2,240.30 10-Sep-09 2,271.00 2,240.30 10-Jul-09 1,598.00 1,721.15 17-Jun-09 1,458.00 1,711.45 15-Apr-09 1,283.00 1,370.60 13-Jan-09 1,049.00 1,228.15


Valuation Methodology We value Infosys at 18x 1-yr forward earnings of INR183, which is at a 10% discount to its long-term average valuation. We believe the discount is justified on heightened economic uncertainties, increased risk aversion and an impending slowdown. Our target price is INR3,300. Risks that may impede the achievement of the target price The key risks are: 1) worse-than-expected slowdown and breakage of pricing discipline in the industry; 2) client-specific issues; and 3) an adverse ruling in its pending B1 visa violation case in the US.


81

Tata Consultancy Services (TCS IN) INR 1146 (16-Dec-2011) Rating and target price chart (three year history)

Neutral (Sector rating: Not rated)

Date Rating Target price Closing price 18-Oct-11 1,100.00 1,033.55 04-Oct-11 1,070.00 1,045.95 05-Sep-11 1,050.00 1,027.70 14-Jul-11 1,260.00 1,123.70 20-Apr-11 1,240.00 1,218.70 08-Apr-11 1,230.00 1,196.00 21-Jan-11 1,200.00 1,211.65 05-Jan-11 1,140.00 1,158.95 22-Oct-10 1,000.00 1,040.20 16-Jul-10 890.00 833.65 08-Jul-10 860.00 776.80 20-Apr-10 830.00 789.50 25-Mar-10 850.00 829.80 15-Jan-10 810.00 791.40 22-Dec-09 Neutral 724.05 22-Dec-09 785.00 724.05 17-Oct-09 700.00 598.30 10-Sep-09 Buy 556.55 10-Sep-09 640.00 556.55 20-Jul-09 383.00 500.55 06-Jul-09 349.00 380.70 20-Apr-09 517.00 278.90 15-Jan-09 Reduce 252.06 15-Jan-09 469.00 252.06


Valuation Methodology Our target price of INR1,230 is based on 18x 1-yr rolling forward earnings forecast of INR68.2. Our target multiple is in line with the stock’s historical average, reflecting heightened economic uncertainties and risk on its high BFSI and Europe exposure. Risks that may impede the achievement of the target price Risks on the upside include recovery in global macro leading to demand rebound faster than we anticipate, while downside risks include: 1) faster-than-anticipated slowdown and breakage of pricing discipline in the industry; 2) client-specific issues; and 3) deterioration in management commentary from the current position of no issues on demand.

iGATE (IGTE US) USD 16.38 (16-Dec-2011) Rating and target price chart (three year history)


Date Rating Target price Closing price 23-Nov-11 Buy 13.91 23-Nov-11 19.00 13.91


Valuation Methodology Our TP of US$20 is based on 13x one-year rolling forward EPS. We value iGATE at a ~20% premium to its mid-cap peers, on account of what we view as its best-in-class earnings growth and margin profiles. Risks that may impede the achievement of the target price Downside risks include 1) the inability to ramp up at non-top 5 clients; 2) limited investments into the front end, which could lead to below-par revenue growth; and 3) failure to delist Patni, which could mean less efficient operating structure.


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