Mid-size IT companies’ shares continue to fall while TCS, Infosys and HCL show robust growth

With declining margins and attrition challenges, mid-cap IT companies’ shares are being beaten down, even as their large peers continue their northward journey

Noted British economist, EF Schumacher, wrote a book called, Small is Beautiful. The falling stocks of mid-cap IT (information technology) companies and the rising stocks of large companies from the same sector, has proven the phrase wrong. It perhaps indicates that, "Small is (not) beautiful." Big is, indeed!

Stocks of mid-sized IT companies have been falling, even as their large peers continue their northward journey.

In the period from 4 January 2010 till today's trading session on 7 March 2011, the stocks of mid-sized IT companies have wilted by more than 50%. During the same period, the Sensexafter hitting a high of 21,004.96 points on 5 November 2010has moved up 4%. The BSE IT index, the benchmark index of IT companies, has inched up by 18% in the same period. It closed at 6,168.82 on Monday (7th March).
In the period considered above, the share price of Firstsource Solutions Ltd fell by 52%, MindTree Ltd dropped by 46%, MphasiS Ltd was down by 37%, Tech Mahindra plunged by 33%, Patni Computer Systems Ltd fell by 7%. On the other hand, Tata Consultancy Services (TCS) Ltd has moved up by 48%, HCL Technologies has climbed up by 22%, Infosys inched up 16% and Wipro grew by 7%.  

What are the reasons for this sluggish growth? Analysts tracking these stocks say that mid-sized IT companies are caught in attrition challenges, which is pressurising their margins. Other factors like excessive focus on horizontals and vendor consolidation are leading to sluggish growth and the subsequent impact is being seen on their stocks.

According to Abhishek Kumar, associate, Centrum Broking, "There are lot of attrition challenges in mid-size IT companies. Such companies have to pay more to retain their employees, which is not the case for bigger IT companies, as they can afford lower wages due to their brand name."

Elaborating on this trend, Rohit Anand, senior research analyst at PINC Research, told Moneylife, "They (mid-cap IT firms) have not exhibited good financials in a few recent quarterly results, they are bogged down by sluggish revenue growth and pressure on margins due to increase in salary costs because of rising attrition in the industry. Broader markets are not well suited for mid-caps at this point of time. Investors prefer to stay invested in blue-chip stocks, which have a long history of good returns to investors."

On company-specific details, Mr Anand said, "Mid-cap firms haven't announced big deals. There was one big deal announced by Patni, but that couldn't help increase the revenue momentum and it even lagged behind its mid-cap peers in revenue growth. Patni is expected to be muted in terms of share price performance due to lack of revenue growth, much below the industry average. MindTree announced two deals worth $70 million last week, but the exit of the chairman and the lack of leadership at the senior level is putting the company at risk."

The latest quarterly results of mid-cap IT companies were disappointing, as operating profits were down. Again, the operating profit of the large caps inched up. Firstsource Solutions' operating profit for the December 2010 quarter came down toRs20.74crore from Rs30.63 a quarter earlier. Similarly, for MindTree, for the third quarter, it stood at Rs44.96 crore-down by 17% as compared to the second quarter. The operating profit for the latest quarter of the mid-caps as compared to a quarter ago fell by 11% for Mphasis; 10% for Tech Mahindra and 55% for Hexaware. While for Patni, the operating profit for the fourth quarter stood at Rs188.75 crore, an increase of just 1% as against a quarter ago.

Meanwhile, the operating profit on a quarter-on-quarter basis for large-cap companies increased. It grew by 32% for HCL; 9% for TCS and 8% for Wipro. However, for Infosys, growth remained flat.

Despite the stumbling revival of the US economy, mid-cap IT companies have been unable to win contractors and projects due to the current vendor-consolidation process that is going on. Again, the projects are being grabbed by the major IT giants.

"There is vendor consolidation going on in the US and Europe. So contracts are given to one large company instead of many mid-cap companies," said Srishti Anand, an analyst tracking IT stocks at Angel Broking.

Mr Kumar echoed her views, "If mid-cap IT companies have to win a project and compete with the bigger companies, they have to lower their prices. Because of this, they don't enjoy the economies of scale, which leads to higher costs."

Large-cap IT companies, due to their vertical offerings, are able grow with healthy financial results as compared to the mid-sized firms, which only have horizontal concentration. This directly affects the revenues in case clients decide to downsize. "Mid-cap IT companies are skewed in terms of vertical exposure as compared to larger peers having a diversified basket," added Ms Anand.

Going beyond, there is a concern for these companies-as margins are expected to come down even more. Mr Kumar said, "Diversified offering and foraying into domains like banking and manufacturing can enable growth. Otherwise, the pressure on margins will continue from both the supply and demand side."
Mr Anand said, "Revenue growth (of mid-cap firms) will lag, compared to large-cap firms and the margins will be under pressure due to further salary costs, already high utilisation and currency headwinds." He added, "Share price performance of mid-cap IT firms will lag that of large-cap firms at a generic level. A few mid-cap IT firms, due to their USP (unique selling proposition), positioning and margin levers might post relatively better results."


LIC new business premium collection up 37% in April-January FY11

LIC's premium collections from new business rose to Rs67,135.32 crore from Rs49,019.49 crore during the first ten months of FY11.

New Delhi: The country's largest insurer Life Insurance Corp of India (LIC) has recorded about 37% growth in its new business premium to Rs67,135.32 crore during the April-January period this fiscal, reports PTI.

In comparison, during the 10-months period ending 31st January of the previous fiscal (2009-10), LIC's premium collections from new business stood at Rs49,019.49 crore, the data from sectoral regulator Insurance Regulatory and Development Authority (IRDA) said.

Overall, the 23 life insurers in the country collectively mopped up Rs95,000 crore as new first-year premium during the period, a 26% increase from Rs75,347 crore in the year-ago period.

Out of this, the 22 private life insurers together accounted for Rs27,864.73 crore worth of new business in the April-January period, compared to Rs26,327.81 crore in the year-ago period, a growth of about 6%.

Among the private life insurance players, SBI Life saw its premium collections from new business grow by 9% to Rs5,274.97 crore during the period, while Reliance Life saw an dip of 10% to Rs2,171.38 crore.

ICICI Life's premium collections from new business grew to Rs5,130.23 crore in April-January 2011, from Rs4,290 crore during the same period last year.Meanwhile, the non-life insurance industry witnessed a 24.57% growth in premium collections in the April-January period to Rs14,394.69 crore.

The segment had registered a gross premium income of Rs11,555.89 crore in the April-January period of 2009-10, as per the IRDA data. Nearly 70% of the gross premium income in the non-life insurance sector was accounted for by public sector units (PSUs).

In the April-January period, the four public sector general insurers collected Rs20,112.59 crore, compared to Rs 16,606.08 crore during the corresponding period last year. The maximum premium was mopped up by New India Insurance, which saw a 18% growth in collections to Rs5,850.54 crore.

Among the private players, ICICI Lombard's premium collections grew 29% to Rs3,511.35 crore during the first four months of the current fiscal.


Kotak Realty sells Peepul Tree to Tata Realty for Rs525 cr

Deal between Kotak India Real Estate Fund I and Tata Realty Initiatives Fund 1 is the largest exit by a real estate fund 

Mumbai: Kotak India Real Estate Fund I has announced the sale of Peepul Tree Properties, a wholly-owned undertaking, to Tata Realty Initiatives Fund 1 for an enterprise value of Rs525 crore ($117 million).

Peepul Tree Properties owns an IT park in Goregaon, in suburban Mumbai, which is leased to marquee tenants such as Accenture, HP, BNP, Tata AIG, BOB Legal and General, Integron and Prana Studios.

On an initial equity investment of Rs95 crore, Kotak India Real Estate Fund I has received over Rs 400-crore from the exit including internal accruals, the company said in a statement, reports PTI.

The exit has scored many firsts. In addition to being the largest real estate exit in the Indian market by a fund, Peepul Tree Properties is the first office property to be divested by a property fund in the country and one of the first foreign direct investments in an income producing asset, the company stated.

Kotak India Real Estate Fund I is the inaugural Rs457 crore domestic fund ($100 million) of Kotak Realty Fund. With the sale, Kotak Realty Fund will also become the first property fund in India to return the entire corpus of the fund back to its investors. The Fund has other notable investments such as Lemon Tree Hotels, Pride Hotels, 3C Green Boulevard and Clover Golf community.  

Kotak Realty Fund director, V Hari Krishna, said, "This has been a highly successful investment for the Fund. It was a control investment, which we have been able to lease, operate and exit profitably. A $117 million exit of an office property in India demonstrates that the market is getting deeper and signals the return of institutional capital."

Kotak Realty Fund chief executive officer, S Sriniwasan, said, "Our investment in Peepul Tree Properties and subsequent exit is a classic example of our approach to real estate investing and fund management. By making these investment decisions, we have helped build quality assets in partnership with leading Indian developers and have created enduring value for our investors."

"We are actively pursuing exit opportunities in our first fund, even while we continue to deploy capital from our subsequent funds. We have so far contracted exits aggregating $177 million, underlining our credentials as one of India's leading property fund managers. We will continue to focus on scaling up the business further with new fund offerings."

Kotak Realty Fund, a division of Kotak Investment Advisors Ltd, was established in 2005 and is one of the country's first realty funds with an opportunistic investment strategy.

The core investment team includes S Sriniwasan and V Hari Krishna, the founding members, and Vikas Chimakurthy. Kotak Realty has aggregate funds under management/advisory of $700 million across three funds: Kotak India Real Estate Fund I, a Rs457 crore domestic fund; Kotak Alternate Opportunities India Fund, a Rs1,491 crore domestic fund; and Kotak India Realty Fund, an offshore fund of $265 million.


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