Looking for tech companies that can grow even in a downturn? Go East, Far East.
Three information technology service vendors with ties to India are performing well despite the fumbling economy. Their secret weapon is a large pool of programming talent in India that allows them to cut prices while maintaining profit margins.
The fourth-quarter performance of Indian IT services companies shows sequential average revenue growth of 17 percent, a remarkable achievement compared to a decline of 16 percent for their U.S. peers.
What's their secret? Cognizant (Nasdaq: CTSH), Wipro (NYSE: WIT) and Infosys Technologies (Nasdaq: INFY) have a lot of financial flexibility because much of their operations are based in India. A programmer in India can be hired for a fraction of the cost of his peer in the U.S. That fact allows these IT companies to pass along savings to major corporate customers, which are becoming increasingly worried about cutting expenses as revenue growth slows.
Cognizant, which is based in Teaneck, N.J., but has eight software development centers in India; and Wipro and Infosys, both based in India's "Silicon City" of Bangalore, are analysts' top picks for investors seeking offshore havens. These three companies are in a sweet spot. They're small enough to stay out of the way of services giants IBM (NYSE: IBM), Computer Sciences Corp. (NYSE: CSC) and Keane (NYSE: KEA), but large enough to outpace new-age services companies that have struggled as dot-com customers implode.
Cognizant and Infosys are similar companies. Both offer applications management, development services and re-engineering for enterprise customers. Wipro gets the bulk of its revenue from global support services, consulting and IT outsourcing. It also has a consumer care and lighting unit that sells cooking oil, soaps and light bulbs.
In the event of a U.S. recession "the offshore services industry offers an ideal opportunity," said Banc of America Securities analyst Bob Austrian. So bullish is Banc of America on the Indian opportunity, the firm has organized a bus trip for its clients to witness the "technology oasis unlike any in the world."
Investors have noticed.
Just the path of these companies' stocks, especially in relation to the Nasdaq average, speaks volumes. The stocks have held up relatively well.
Cognizant: Ups growth targets
In its most recent earnings report, Cognizant topped estimates and reiterated a strong outlook for the next few quarters.
CFO Gordon Coburn said Cognizant's customers are looking to cut costs and the company can help. Seventy percent of the work Cognizant does is in India, giving the company a cost advantage it can pass on to its customers.
"A recession would hurt everyone, but a mild recession could help us," Coburn said. In an economic downturn, companies need to save money, he added, so they outsource the work to where it can be done cheapest. "That's why the other offshore plays are doing well."
But there's more than just offshore outsourcing behind the company's success. Cognizant's applications management business, which keeps the code running behind the scenes, is not an area that customers would target for cost cutting.
Forty-seven percent of the company's business comes from its application management segment, a service that's "just not discretionary," Coburn said. Cognizant manages code for applications and provides e-business integration services better return on investments. That's just what corporate clients are hungry for in a slowdown.
The budgets of Cognizant's clients are locked for applications management, and companies are integrating e-business applications to save money. That's why Cognizant could actually raise estimates in its latest quarter. Coburn said 2001 sales are expected to jump 40 percent, up from previous expectations of a 35 percent increase. Earnings for fiscal 2001 are projected to be $1.20 a share, up from the previous expectation of $1.16 a share.
And 95 percent of the company's first-quarter revenue is already in the pipeline, as is 85 percent in the second quarter and 75 percent in the third, said Coburn.
Infosys: Strong revenue growth
Infosys is in a similar situation; the company topped estimates in its most recent quarterly report, and has been getting accolades from analysts.
The company grew revenue 120 percent year-over-year in the third quarter, and operating margins improved despite a ferocious hiring spree.
And things are about to get better as the U.S. economy gets worse. The company conducted a survey of its customers in late December, and most said they planned to raise IT budgets 7 percent to 8 percent over last year's budget, and expand their relationship with Infosys.
"This is consistent with our thesis that the 'value for money' that Infosys provides is superior to other U.S.-based IT service providers," said Austrian, who reiterated a "buy" rating on the stock Jan. 10.
Austrian also hiked his revenue target for fiscal 2001 to $404 million from $383 million, and his earnings estimate to 99 cents a share from 96 cents a share. He added that the targets are "conservative" and the company will most likely top them, as it has in past quarters.
Wipro: Best of the bunch?
Wipro also announced stellar results in its most recent quarter, with global IT services revenue showing especially strong growth.
The fact that the company was able to grow its American business (which made up 65 percent of its revenue in the last quarter) in the face of a slowing economy is evidence of the value of its services.
"Even in the face of the ongoing slowdown and dot-com layoffs, Wipro can continue to grow at a +50 percent rate," Austrian wrote. He believes that a small market share--Wipro makes up less than 1 percent of the global IT outsourcing market--and the company's ability to constantly shift its services focus to higher-value services will allow it to keep growing at a swift pace.
Some analysts suggested that Wipro could even be the best pick of the bunch.
"Unlike other Indian companies...Wipro's margins hold considerable upside in the medium term given the company's low billing rates and offshore component," wrote Rahul Dhruv in a Salomon Smith Barney report.
The company is also best poised to take advantage of the wireless and broadband evolution, Dhruv noted. Its work with Cisco Systems (Nasdaq: CSCO), Nortel Networks (NYSE: NT) and Lucent Technologies (NYSE: LU) have proven it is best equipped to provide research and development services to communications equipment makers, a business that amounts to almost a third of all global IT services revenue, Dhruv said.
The Nortel factor
Although all three companies are doing well, there could be a few worries on the horizon. Nortel could be the weak link for two of the three Indian software players.
Shares of Infosys and Wipro were down considerably last week on speculation that Nortel's slowing growth could impact Indian software companies. Nortel recently warned that business would be slow through 2001 and that it would cut 10,000 jobs.
Wipro was hit hardest. Nortel was Wipro's largest customer in its fiscal third quarter, and is among Infosys' Top 10 customers, constituting around 4 percent of its fiscal 2000 revenue.
Shares bounced back quickly with the reassurance of analysts, however. "While we believe Wipro could be affected more than Infosys...we do not expect any significant impact to earnings for either," said Merrill Lynch analyst Girish Pai in a research note.