Companies & Sectors
US immigration bill would disrupt the Indian IT business model
According to Nomura, the US immigration bill, if passed, would place the Indian IT business model at competitive disadvantage compared with MNCs and depress margins irrevocably
 
The overriding factor in the information technology (IT) sector currently remains the overhang due to the US immigration bill, which has damaging provisions for Indian IT. These provisions have the potential to flatten sector earnings over FY13-16F or take them to negative territory as well in certain cases if one of the clauses related to outplacement debarment of H1B employees passes, says Nomura in a research paper.
 
This is a bipartisan bill (backed by four Democrat and four Republican senators) and was tabled in the US Senate recently. The bill focuses on comprehensive immigration reform encompassing a wide range of issues like border security, immigrant/non-immigrant visas, and citizenship paths for illegal immigrants and employment verification. The bigger pieces of the bill are focused on what happens to the 11 million illegal immigrants in the US, while H-1B reform is a smaller part of the bill, although more relevant from an Indian IT perspective.
 
According to Nomura, there are four key proposals in the bill that are most damaging for Indian IT companies. These are outplacement debarment of H1-B workers at client sites, increase in visa fees, increase in local proportions to 50% by 2016 and increase in H1B mandated salary levels. 
 
Outplacement debarment of H-1B resources on client sites by H-1B-dependent 
employers 
According to the bill, “an H-1B-dependent employer may not place, outsource, lease, or otherwise contract for the services or placement of an H-1B non-immigrant employee”. 
 
Nomura says, this means that employees on H-1B visas will be restricted from working at the customer sites, although they can work from global delivery centres. Since all Indian IT companies are classified as H-1B-dependent employers, this provision would restrict them from placing their staff on H-1B visas (work visas) at customer sites. H-1B dependent employers are those companies, which have at least 15% of their US staff on H-1B visas. 
 
Typically, Indian IT companies place people onsite for interfacing with clients, coordinating with the offshore teams and for critical development/support related work at client sites. Majority of IT services staff in the US are typically posted at customer sites. Therefore, the debarment provision would disrupt this arrangement and would mandate placing only local employees at client sites. 
 
“We believe it is difficult to quantify the impact of the severest of all provisions in the US immigration bill, which is ‘Debarment of outplacement of H-1B employees at customer sites’, as it will hit existing business, existing margins, business models and future growth. This provision will impact all tier-1 IT companies severely if passed in its current form. TCS could have lower disruption initially as it has historically been more dependent on L1 visas (company transfers), compared to peers who have been more H-1B dependent, but nevertheless the troubles would be industry-wide,” Nomura said.
 
Increase in visa fees 
If a company has between 30-50% of its US staff on H-1B or L1 visas, the bill proposes to charge $5,000 extra for additional people above the 30% norm. If, on the other hand, a company has more than 50% of its US staff on H-1B or L1 visas, the bill proposes to charge $10,000 extra for every additional person above the 50% norm. 
 
Local headcount proportions of 50% by 2016 
The bill mandates that companies should have at least 25% of staff as locals by 2014, 35% by 2015 and 50% by 2016. If these conditions are not met, the companies would not be able to apply for further visas (H-1B and L1). 
 
Increase in H-1B mandated salaries 
Currently, H-1B visa salaries are mandated by USCIS, depending on the geographical area, skill or experience level that a person has, with which companies need to comply with by paying at least the same or higher salaries. What the bill proposes to do is to increase mandated salaries for H-1B visa holders, given the view held by the framers of this bill that H-1B visas are being used by Indian IT companies to undercut American employees. The quantum of the increase to the mandated salaries has not been mentioned.
 

“We expect 150-400 basis point impact on margins for tier-1 IT companies on account of three of the four provisions (ie, excluding the outplacement debarment of H1B clause). This essentially has the potential to flatten sector earnings with a reduction in earnings per share (EPS) compounded annual growth rates (CAGRs) by 4-9% across companies under various scenarios. Though some of the cost escalation could be passed to clients, we believe the impact is still likely to be substantial. The impact is likely to be severest for TCS and Cognizant Technology Solutions Corp, followed by Infosys, Wipro and HCL Technologies,” said Nomura. 

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COMMENTS

Kiran R Bhagwat

4 years ago

I don't think it will be easy for the US to meet the objective of increasing local employment for the following reasons:
1. The talent availability in the US is a major problem. Even with the Indian companies placing their people on site, there are thousands of positions open in large IT companies in the US even today! The problem would be worse after restrictions are put in place!
2. The pressure on off-shoring the work will increase - and that may in fact indirectly benefit the Indian companies and take even more work away from the US!
3. There will be some shifting of local workforce across IT services companies and also movement of people on H1 back to India in order to get the balance right. This may mean that the increase in new employment will not be to the extent the numbers suggest!

Indraprastha Gas reports in-line 4Q; SC decision key for re-rating, says Nomura
Price hikes of CNG and domestic PNG enabled blended EBITDA margins to remain resilient for Indraprastha Gas, says Nomura Equity Research in its Quick Note. A favourable Supreme Court decision on the PNGRB’s appeal against the Delhi High Court order is a must for restoring investor confidence again
 
Indraprastha Gas ( IGL) reported PAT (profit after tax) of Rs835 million (up 4% y-o-y, down 3% q-o-q), was in line with Nomura’s estimate of Rs841 million, but 4.5% below Bloomberg’s consensus estimates, said Nomura Equity Research in its Quick Note on the company’s performance. Similar to 3Q, volumes were expectedly weak. Price hikes (CNG - 4% in early January, 7% for domestic PNG in February) enabled blended EBITDA margins to remain resilient Rs5.5/scm (up 1% q-o-q, 5% y-o-y). Despite weak 2H, FY13 EPS at Rs25.3 increased 16% y-o-y.
Similar to 3Q, both CNG (down 1% q-o-q, up 4% y-o-y) and PNG (up 8% q-o-q, 14% y-o-y) were weak compared to historical trends. CNG weakness was due to reduced city bus consumption (several buses were grounded for mandatory checks; and new bus additions were delayed) and PNG growth was affected due to higher spot LNG prices leading to reduced competiveness with liquid fuels. The management indicated that double-digit growth rates are likely to resume from 1QFY14.
 
According to Nomura, a favourable Supreme Court decision (on the PNGRB’s appeal against the Delhi High Court order) is a must for restoring investor confidence again. The dispute is ongoing for over a year (tariff order 9 April 2012), and has seen fast track hearings in Supreme Court over last few weeks. The hearings are to commence from 16th July once court resumes after summer vacations. IGL has a strong case, and an early positive decision could lead to re-rating, said Nomura.
 
Nomura favours IGL for its secular city gas business in Delhi (India’s largest metro) and its ability to pass on costs (CNG prices up by around 90% over three years). With continued strong earnings growth (four-year CAGR 20%, 16% for FY13F) valuations, at 10.1x/9.1x FY14/15F P/E (EPS of Rs27.7 and Rs30.8, respectively), remain compelling, said Nomura. On expectations of an early decision by the Supreme Court, the stock had seen a decent run recently and was up 26% YTD until early May. However, with the hearing being postponed to July, the stock has seen correction of nearly 10% over the last two weeks. The recent correction provides investors with an opportunity to accumulate the shares, believes Nomura.
 

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Dish TV beats market expectations but ARPU remains subdued
Dish TV now is clearly focusing on profitability and cash flow over immediate market share, says Nomura Equity Research in its Quick Note
 
Dish TV’s standalone results were ahead of expectations but missed consensus expectations at the operating level, said Nomura Equity Research in its Quick Note on the company’s performance in 4QFY13. While ARPU (average revenue per user) came in lower than expectations, trends were significantly positive on all other metrics as SAC and churn trended down, content cost surprised on the upside and this turned out to be the first free cash flow positive year for the market. 
 
Dish now is clearly focusing on profitability and cash flow over immediate market share. The brokerage expects that high-single-digit percentage increase in ARPU will be visible in FY14 on the back of recent price increases and competition becoming more rational. “We would use any weakness in the stock price on the back of these results to accumulate the stock,” added Nomura.
 
Analysing the company’s results, Nomura Equity Research said that Q4FY13 consolidated sales came in at Rs5.54 billion (5.8% y-o-y growth) in line with its expectation of Rs5.65 billion but around 5% below consensus expectations of Rs5.82 billion owing largely to a subdued ARPU.
 
EBITDA came in at Rs1.2 billion, which was around 15% ahead of Nomura’s Rs1.04 billion estimate but nearly 9% below consensus expectation. The brokerage sees a 12% y-o-y increase in content cost as guided by the company, especially as part of the incremental cost from media pro negotiation was expected this quarter; however, the actual increase was around 5.1%, which was a positive surprise, said Nomura.
 
Profit after tax (PAT) came in at Rs436 million of loss compared to Nomura’s expectations of Rs875 million of loss. The lower loss versus Nomura’s expectation was on account of higher other income (Rs157 million against Nomura’s expectation of Rs90 million) and lower depreciation (Rs1.45 billion versus its expectation of Rs1.71 billion) due to a higher write-off of set-top box (STB) for subscribers who were inactive for more than 500 days. Adjusted for these, PAT would have been Rs760 million of loss compared to Nomura’s expectations of Rs875 million loss and consensus expectations of Rs530 million of loss.
 
Subscriber acquisition cost (SAC) decreased from Rs2,201 in Q3 to Rs1,996 in Q4 due to STB price increase in February 2013 for which the complete impact will be visible in Q1 of FY14, said Nomura.
 
The company has guided for an increase in content cost by 8%-10% y-o-y in FY14F against Nomura’s current expectations of 15%. The brokerage expects content and other cost growth of around 15% y-o-y in FY13 based on the management’s guidance of 12%-15% that was later reduced to 12%. But actual growth in content and other cost was around 7.5%, leading to lower base versus Nomura’s expectations. Thus, these two combined would lead to an around Rs 94 million reduction in content cost expectations for FY14F, said Nomura.
 
Company churn declined to around 0.8% in Q4 from 1% in Q3. While it’s too early to extrapolate 0.8% churn rate to subsequent quarters, decline in churn rate can be attributed to following reasons:
Set up box price increase by DTH players as well as some cable operators such as Den Networks in February 2013, which has increased subscriber switching cost. This can also been seen from the fact that Airtel DTH churn rate came down from 1.3% in Q3 to 1.1% in Q4.
Dish TV’s offer of 70 basic free channels (most Free to Air) for subscribers as a part of existing base package. This was a churn management strategy that became evident in Q4, said Nomura.
 
The company generated around Rs650 million of FCF (free cash flow) in FY13 and has guided for Rs2 billion of FCF in FY14. Nomura believes that this improvement in free cash flow trajectory is possible as:
Increase in STB price—the company intends to bring down subsidy from the current Rs1,450 to zero in the next 12–18 months, which would mean the company would reduce subsidy in FY14. Also, the full impact of STB price increase taken in February 2013 was not completely captured in Q4 but will be visible in FY14.
Improvement in operation performance led by subscriber addition, increase in package price that would lead to better EBITDA and cash flow from negative working capital days.
 
The company added around 0.4 million subscribers in Q4 (against Nomura’s expectation of 0.35 million). This expectedly, trended down as Dish TV, in particular (and the entire DTH industry in general), focused on “value focused customers”.  MSOs have seeded 4.45 million STBs compared to 0.38 million STBs seeded by DTH between 1 March 2013 and 12 April 2013 post STB price increase taken by DTH players. This can also be understood by the fact that Airtel also added around 0.21 million in Q4 (versus 0.44 million in Q3). Also, a few inactive subscribers, particularly in phase 2, became active in Q4.
 
Dish TV reported ARPU of Rs157 against Nomura’s expectations of Rs161.8 and Rs160 in Q3. As per company, this was on account of the lower number of days in Q4, down trading (% of subscribers on base pack has increased from run rate of 54% to 58% in Q4), increase time gap between package subscription getting over and recharge, lower churn rate that effectively means higher base, inactivity by some subscribers due to children exams, and Q3 having better ARPU due to festival season. Even Airtel DTH ARPU decreased from Rs186 in Q3 to Rs184 in Q4.
 
The company seems confident of high-single-digit increase (Rs12-Rs14) in ARPU in FY14F post 10% price hike taken in April 2013 and will be looking at further price increases in the next fiscal.
 
While digitization is mostly done in phase I & II and MSOs have seeded set up boxes, they have not started billing as per the digital package which is significantly higher than current prices they are charging subscribers. Once the billing as per the digital package starts, DTH players including Dish TV would have more headroom to increase ARPUs, says Nomura.
Additionally, given that one of the MSO’s revenue streams of carriage fees is trending down with the onset of digitization, they will have a bigger incentive to behave rationally on the ARPU front.
 
Dish TV’s gross and net debt increased by around Rs 1.5 billion in FY13, which Nomura expects to come down in FY14F on account of increased FCF generation as mentioned above. Also, short-term loans and advances increased from Rs1.98 billion to Rs3.06 billion on account of increases in advanced payment towards purchase of STBs.
 
On the back of Q4 numbers and the company’s guidance, Nomura’s FY14F estimates and price target are under review. The brokerage will be looking at a lower subscriber addition (as the DTH industry focuses on profitability rather than market share), lower content cost guidance, and lower subscriber addition cost.
 

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