The Indian software industry needs to disclose more
Goutam Das March 4, 2013On January 18, towards the end of a 61-minute analyst call at Wipro to discuss the company's December quarter results, Kawaljeet Saluja, an analyst with Kotak Institutional Equities, stirred up a hornet's nest. "How should I think about the complete disconnect between volumes and realisation," he asked CEO T.K. Kurien. "Should we just continue to look at these metrics the way we have been historically, or are there changes that you are trying to drive in the business, which are reducing the utility of disclosed metrics?"
Analysts evaluating the Indian information technology (IT) services industry, break up a company's revenue growth into volumes, a measure of billed hours that is linked to people growth as well as price realisations.
Historically, both volumes and pricing have moved in tandem but in the December quarter, Wipro's volumes were down one per cent while price realisations had jumped more than two per cent. "I think the only measure that matters is how the top-line is growing. There are only two measures that frankly we worry about. One is top-line growth, the other one is gross margin," Kurien replied.
When Saluja pressed further, company veteran and Executive Director Suresh Senapaty agreed some of the older metrics like headcount addition were becoming less relevant. "Theoretically, it (the older metrics) has lost its utility. But because traditionally all of us have been giving and you guys have been deliberating on it, we are engaged on it but at the end of the day it is losing relevance," he said.
Saluja is a respected name in financial markets; he first shot to fame when he questioned the Satyam management about $500 million lying idle in a current account in October 2008. Two months later, then-Chairman B. Ramalinga Raju, initially jailed and now out on bail, admitted he had cooked the company's books. Today, Saluja is the most vocal about additional disclosures IT services companies need to make as business models change in the industry: from a linear model where more revenues came with a proportional expansion of headcount to revenue streams that are independent of people growth.
Earlier in January, Saluja sent a note to investors, arguing why the Street's line of questioning to companies should change. "From volumes, pricing, sequential growth rates, attrition, utilisation and wages, we believe the discussion needs to shift to order backlog, new bookings, execution time frame, employee productivity, year on yeargrowth rates, return on invested capital of contracts, execution capabilities and quality of attrition.
Companies do not make disclosures on these lines, at this point. However, constructive discussions on them will ensure a new set of 'relevant metrics' are shared with investors," he wrote.
Of the 13 analysts BT spoke with, seven agreed with Saluja and said that IT companies need to disclose more for the analyst community to be able to accurately model and forecast revenue and profitability growth. While the rest said that the older metrics like headcount were still sufficient given that 50 to 60 per cent of the industry's billings are made on a "time and materials" (T&M) basis, everybody agreed that it is becoming increasingly difficult to model a company's financials. T&M pricing involves charging a dollar rate per hour per person.
Analysts point to the December quarter results of Infosys to illustrate the frailty of the current set of disclosures. Most analysts tracking the company failed to predict the 4.2 per cent quarter over quarter growth in revenues and had expected the topline to inch up by just 1.5 per cent. In the past, upticks in volume and price successfully offset the impact of salary inflation in companies.
However, in the September quarter, TCS, the country's largest IT exporter, reported a decline in operating margins despite healthy volume, pricing and currency benefits. "Infosys provides all the metrics, but those are now becoming redundant to predict its performance.
Earlier, it was very easy to predict the revenues for most IT companies. And that's why they used to get a big premium to the market,"says Sanjeev Hota, an analyst with Mumbai brokerage Sharekhan. What were the metrics that aided easy forecast? To arrive at a revenue projection, analysts typically multiply the number of billable people in a company to the dollar per hour rate charged from clients, factoring in the number of working hours in a particular month. The tabulation is separately done for offshore and onsite workforce because employees abroad have a higher billing. Companies, therefore, disclose headcount and utilisation (bench utilisation in the IT industry indicates the number of employees a company can bill), onshore-offshore mix of employees, and indicate price movements.
This model is facing limitations because companies are selling more fixed priced projects, intellectual property-based solutions, automation and infrastructure management services. iGate's CFO Sujit Sircar said that by automating an outsourced accounts payable process at different levels, a company can potentially reduce 20 per cent of the workforce it would otherwise need to execute.
If a company's business model is based on outcomes rather than the dollar per hour model, it can potentially earn more with fewer people. The wishlist from analysts is long (see What May Be In) and ticking the boxes on all items is not possible. For instance, K.K. Raman, a partner at audit and consultancy company KPMG, notes that the percentage of work done for top clients on a non-T&M basis would be a good indicator of client confidence in a service provider.
Rajeev Sawhney, former chief of HCL Technologies' Europe operations, says companies should disclose to investors a metric they track very closely internally - the ratio of Existing Accounts Existing Business to Existing Accounts New Business to Net New Business. "It is a good indicator of where a company's challenges are," he says. Companies, however, may be hesitant to disclose metrics at this granular level.
But there are also suggestions that are easy to implement. "What could become more relevant is the order book. The orders you are sitting on and which are executable in the future would demonstrate visibility in the business," says a Wipro executive, who did not want to be named. Though his company has not taken a decision to disclose its order book, he predicts companies would come out with it in two years.
Similarly, total contract value (TCV) or even the annualised contract value (ACV) of a company will become increasingly relevant given the number of multi-year deals being signed. Cognizant, for instance, announced a seven-year $330 million deal with ING Group in 2012 and a five-year deal with Rabobank earlier this year. If ACVs of a few big deals are known, investors can easily predict if a company will match, beat or miss industry growth rates in a year.
Another metric being demanded is the quality of attrition. Analysts want companies to qualify attrition at different levels rather than just giving out an annualised number, since in outcome-based projects, mid-level and senior level employees have a significant role to play. "If the industry demands it, people will report it. But there are no common industry standards of reporting many metrics," Mindtree's CEO Krishnakumar Natarajan says. In calculating attrition, for example, some companies exclude subsidiaries while others exclude the number of people they have sacked.
Still, the time may have come for better quality disclosures by IT companies.