Outsourcers Look To China, As Obama Goes To India

Currency volatility, rising costs, growing near-shore demand, increasing rural outsourcing capacity, and political and protectionist measures are troubling the Indian outsourcing sector. The Indian rupee has been one of the best performing currencies this year and has appreciated over 5.6% with the dollar since January. The U.S Senate may have vetoed the outsourcing bill, but the country which accounts for over 70 percent of Indian outsourcing revenues has levied higher visa costs which amount to an additional spending of an estimated $200 million by Indian IT outsourcers. A state ban by Ohio passed to stop outsourcing of government work has added to protectionist policies. Yet amid such pressures, the leading players in the sector continued to deliver strong quarterly results.

TCS’s Financials
Tata Consultancy Services’ (NSE:TCS) Q2 revenues grew 30% over the year and 12% over the quarter to $2 billion. EPS rose 10% over the year and 35% over the quarter to $0.23.

TCS’s Operating Metrics
TCS continued to expand their utilization rates and reported 83.8% utilization excluding trainees compared with 82.6% a quarter ago. Including trainees, utilization grew to 77.7% from 74.8%. However, attrition grew to 14.1% from 13.1% a quarter ago. Driven by the growing market demand, the company added 10,229 employees – the highest quarterly number added to date.

TCS’s Global Network Delivery Model
During the quarter, TCS management noticed two trends in the market. First, customers are focusing on becoming more efficient and are consolidating their systems, and second, businesses are trying to grow globally. To address their customers’ need for geographic expansion, TCS is also growing their global footprint. They have 107 delivery centers in more than 20 countries. They are focusing on China, where they currently have over 1,200 employees.

China’s outsourcing sector is currently valued at $10 billion and is expected to grow to $30 billion in the next three years. TCS plans to shift nearly 10% of their new projects to China and hire five times the number of current employees in the next few years. A recent report by Goldman Sachs estimates TCS’s Chinese region revenues to be nearly $100 million a year and expects to rise to $250 million in the next three years.

Their stock is trading at Rs 1,053.40 (~$23.40) after having touched a 52-week high of Rs 1072.95 (~$23.92) earlier last month.

Infosys’s Financials
Infosys (NASDAQ:INFY) saw Q2 revenues grow 30% over the year and 10% over the quarter to $1.5 billion and exceeded the market’s expectations of $1.4 billion. EPS grew 16% over the year and 14% over the quarter to $0. 65.

For the current quarter, Infosys expects revenues to be $1.55 billion–$1.56 billion with EPS of $0.66–$0.67. They expect to end the year with revenues of $5.95 billion–$6.00 billion with EPS of $2.54-$2.58.

Infosys’s Operating Metrics
Infosys saw significant growth in utilization during the quarter. Q3 utilization including trainees was 74.3% compared with 73.0% a quarter ago and 67.3% a year ago. However, attrition continued to increase and reached 17.1% in the quarter compared with 15.8% in the previous quarter and 10.9% a year ago. Despite higher attrition, the company added nearly 7,650 employees during the quarter, making this the largest addition of employees since December 2007.

Infosys’s Global Footprint
Infosys too is working on opening a campus in China. Their Shanghai campus is expected to accommodate over 20,000 employees from their current base of 2,700 employees in the country. Goldman Sachs’s report pegs Infosys’s China revenues for the year to grow to over $200 million from the present $100 million. Besides China, Infosys is also growing in Europe and has already invested $100 million in expanding their set-up on the continent.

Infosys projects full-year sales of $5.72 billion–$5.81 billion with EPS of $2.42–$2.52. The market was looking for revenues of $5.67 billion with EPS of $2.47. For the current quarter, Infosys projects revenues of $1.41 million–$1.43 million with EPS of $0.59–$0.60 compared with the Street’s estimates of revenues of $1.38 billion with EPS of $0.60.

The stock is trading at $67.16, taking the market capitalization to $38.4 billion. It touched a 52-week high of $71.99 earlier last month.

Wipro’s Financials
Wipro’s (NYSE: WIT) revenues grew 19.5% over the year and 5.7% over the quarter to $1.27 billion. EBIT for the segment of $286 million for the quarter grew 7% over the year.

For the current quarter, they expect revenues from IT Services to be $1.32 billion–$1.34 billion.

Wipro’s Operating Metrics
Wipro too managed to increase their utilization rates even as they continued to struggle with higher attrition. Utilization excluding trainees grew from previous quarter’s 81.6% to 82.4%. A year ago, utilization stood at 80.5%. Attrition grew to 23.5% from 23% a quarter ago and a mere 10.5% a year ago.

Wipro’s Global Expansion
China is a priority in Wipro’s delivery map as well. Like its peers, the company is looking at servicing at least 10% of their revenues from new outsourcing projects from their China centers. They project a workforce of nearly 1,000 people within a year in China.

The stock is trading at $14.57, taking its market capitalization to $35.5 billion. The stock reached a 52-week high of $16.81 earlier last month.

The leading Indian IT players seem to strongly believe in growing delivery centers outside India. With the growing demand, and because of the Chinese education systems and infrastructure, China will attract investement from the sector. However, these players should be looking at other regions as well. In fact, President Obama’s upcoming visit to India will certainly put the agenda on the table: Indian companies need to hire Americans in America.

As I said earlier, growing internationally will help these companies address the concerns of time zone management and meet the growing near-shore demand.  For instance, to address the visa fee increase, these companies could look at expanding operations in Mexico or Canada, where TN visa fees have remained unchanged. Most of these players already have a presence in Latin America. TCS already has more than 7,000 people generating 4%–5% of their annual revenues in Latin America.

But expanding within the low-cost regions of the United States is another opportunity that these players should take advantage of, and that is the one that President Obama should negotiate, put incentive structures around, and create a serious strategy for.

In California, the unemployment rate is 12.4%, much higher than the national average of 9.6%. The other day, CBS’s 60 Minutes did a show on engineers with PhDs and master’s degrees in California who are out of work in droves. Perhaps if the Indian outsourcers were offered incentives to set up shop in places such as Morgan Hill and Gilroy, and hire large numbers of these highly intelligent, extremely well-trained people – a happy compromise could be accomplished.

Instead of looking at China, perhaps the outsourcers would look at America instead.

President Obama, think carrot, not stick. Think incentives to attract investment, not penalties to enforce protectionism.