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March - 2005 - issue > Personal Finance
Picking Tech Shares
Priya Pradeep
Tuesday, March 1, 2005
Over the last few months Sanjeev Kapoor, Research Analyst for retail securities and equities solutions provider Sharekhan, has been engrossed in his world of technology stocks and figures. There are various permutations and combinations for him to consider in the tech stocks sphere. He recommends Geometric Software, Infosys and Satyam as strong buys in the technology space.

Geometric Software, with a market Capitalisation of Rs 446.2 crore, is a niche player focusing on the Product Lifecycle Management (PLM) space. Globally, the PLM space has been faring quite well. Geometric provides R&D services to OEMs and now has grown to offer implementation and engineering services in addition to product integration.

Infosys and Satyam possess classic features of business success, and are attractive due to their large recruitment exercises, volume growth and high billing rates. Top line volume growth has been in the double digits for the last two to three quarters for these companies. Offshore business, which is soaring, is the reason for the above volume growth. According to Sharekhan, Satyam has unnerved it because of over dependence of Satyam on its client GE. If GE backed out of Satyam’s client chain, it would be akin to the rug being pulled under Satyam’s feet. Fortunately, this dependency is gradually sobering. Satyam’s client influence is spreading over to other verticals so Sharekhan is giving it high marks for future potential.

How to choose a Tech Stock?
Comparison between tier-1 players like TCS, Infosys, Satyam and Wipro is done in terms of volume growth and pressure on margins. Rupee-Dollar fluctuations and attrition rates are also measures by which tech stocks are selected. Sharekhan recommends Infosys because it has shown in the past its ability to manage its margins despite depreciation of U.S dollar against the Indian Rupee and the hike in salaries. Second-tier companies like Zensar and KPIT are evaluated on their client dependency, especially if the number of clients is few. Tier-1 companies due to its size attract clients on the basis of their strength alone but this is not the case for tier-2 IT players. Hence tier-2 companies should be niche players famous for their business visibility due to the exclusive niche status.

Robust volume growth that Indian IT companies witnessed in FY2005’s second and third quarter demonstrates increased momentum towards offshoring. Going forward the expectation is that the Indian IT sector can end FY2005 with a volume growth of 35-40 percent. Some of the Tier I IT companies have witnessed higher billing rates in Q2FY2005. Although the impact of the hike in the billing rates would not be visible in FY2005 yet we could see the effect of the same couple of years down the line. The U.S dollar has depreciated 5.6 percent against the Indian Rupee since the announcement of the second quarter results. Given the hedging position of the IT companies, the risk is not very high but if the U.S dollar falls below the 43 rupee mark it would definitely have a negative impact on the Indian IT companies. The Indian IT sector at $12.5 billion is still at a very nascent stage when considering the U.S’s $550 billion IT services market. Given that Indian offshoring enjoys a cost advantage of 40 percent, we believe that the wage differential will slowly narrow down. Until that happens, Indian IT companies will continue to increase their market share in the global IT market.

The Downside of some Tech Stocks
During the slowdown of the IT Industry the supply was more and billing rates were under pressure. The Rupee-Dollar factor is also a key component in this game. If the dollar falls further against the rupee, there will be negative repercussions like losing competitiveness to other countries because we won’t be cheaper anymore for foreign companies to do offshore business here on our soil.

India is presently the source for cheap manpower for the BPO business and if it has to remain so then the dollar might as well not fall further. Kapoor is concerned about investment in companies like KPIT. Cummins outsources $35 million of IT out of which $13 million goes to the $27.7 million revenue earning KPIT. A large company like Cummins outsources work to three to four vendors in order to spread its risks. So there is no sign of Cummins expanding its engagement with KPIT. At the same time, if Cummins decides to stop its business dealings to KPIT then it could mean the shocking loss of $13 Million to KPIT, which could send its stock spiraling down. Tech professionals should be aware of such background business realities.

Sharekhan’s view
Geometric, Infosys and Satyam are the top-rated stocks, which can be invested in presently. Geometric, a young company, is likely to domineer its chosen niche and is an emerging star. Niches have all the potential to balloon into full-blown markets. It can give you ten-fold returns if you are patient. Universally anything that goes up has to come down, hence what is the right time to exit these stars later? Well it is when the volume growth, valuation and billing rate comes down and there is an increase in attrition, which calls for increase in salaries. Come to think of it: large-scale recruitments prove to be double-edged swords.

If there is an increase in hiring it would mean that the company is doing well or it could mean increased attrition leading to increased salaries, as a bait resulting in higher costs incurred. So, the advice is to look at the net addition in manpower. In other words, hiring and attrition rate should be looked at simultaneously. It works in two ways! Isn’t that food for thought?

Sanjeev Kapoor is Research Analyst for SSKI Investor Services Pvt Ltd. (Sharekhan). All comments or statements made herein are the analyst's personal view and do not reflect those of siliconindia. Holdings of the analyst are None in any of the stocks mentioned.

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