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IT and BPO Services
2009 Outlook, Prefer Defensive Names, Publishing
2011 Estimates
Computer Services and IT
Consulting
Tien-tsin Huang, CFAAC
(1-212) 622-6632
tien-tsin.huang@jpmorgan.com
David E Cohen, CFA
(1-212) 622-5338
david.e.cohen@jpmorgan.com
Puneet Jain
(1-212) 622-1436
puneet.x.jain@jpmchase.com
J.P. Morgan Securities Inc.
See page 27 for analyst certification and important disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision. Customers of J.P. Morgan in the United States can receive independent, third-party research on the company or companies
covered in this report, at no cost to them, where such research is available. Customers can access this independent research at
www.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research.
Demand uncertainty remains a key theme going into 2009. In anticipation of a
subdued IT Services revenue/earnings outlook in 2009, IT Services stocks declined an
average of 41% in 2008 vs. S&P 500 down 38%. Slower growth expectations could
provide some relative support for IT Services stocks this year, but we expect overall
performance to be particularly dictated by macro expectations. For investors expecting
the economy to worsen through 2009, ACN is our top pick. For investors expecting a
rebound in 2009, CTSH is our top pick. Our favorite small-cap idea is G. This report
includes key themes, our 2009 outlook and stock ideas.
• Recession/Recovery stocks – top picks. Given the uncertainty over the length and
magnitude of the ongoing global recession, we prefer ACN for its relative
defensiveness in a slowing demand environment and what we see as its ability and
willingness to defend EPS growth even if top-line growth slows. We consider
CTSH as a leader in the eventual recovery as 1) it experienced the most multiple
contraction in 2008 and, 2) in our view, has the highest growth acceleration
potential, among our IT and BPO services coverage.
• IT budgets flat to down in 2009, but outsourcing share of IT labor spend should
rise. We would not be surprised to see IT spending (including IT services) decline in
2009, as companies adjust to a difficult economy. But we expect clients to increase
outsourcing, especially offshoring, to cut costs and adopt a more variable-cost model
in 2009. We see this offsetting at least some of the growth impact from declining
overall budgets. We expect outsourcing budgets to increase in the low mid-singledigit
range in 2009 while offshore budgets may rise by at least a high single digit.
Ranking 2009 revenue growth, the fastest growers should be G (14%) and CTSH
(11%), while the laggards being EXLS (-7%) and WNS (-4% on organic basis).
• Key themes – Pricing pressure, offshore push, and cost cutting. We expect
clients to push vendors to lower bill rates, but this could force a shift to fixed fee or
outcome-based pricing. We think ACN is likely to be the least impacted firm from
potential price wars and VRTU to be the most exposed. We also think clients will
push vendors to increase offshore leverage on their accounts (likely win-win), which
should help the growth rates of offshore firms under our coverage. We think the
trend of vendor consolidation should favor the larger firms like ACN and CTSH.
Finally, we think vendors will increasingly look to cut their internal costs in order to
expand (or protect) margins.
• Premium for discipline and long-term strategies – warning signs for rising
risks. We think management teams that can remain disciplined and focus on LT
shareholder value-enhancing strategies deserve a premium multiple in 2009. As the
year unfolds, we will watch closely for more short-term oriented actions, such as: 1)
pursuing acquisitions for growth, instead of strategic motives, 2) offering irrational
price discount to customers, 3) aggressively cutting back internal costs to the point
that resulting margins are not likely sustainable, and 4) failure to continue to invest
to improve a company’s long-term business profile. We like CTSH for the continued
reinvestments that improve its long-term business profile, and G for its disciplined
hedging policies.
Premium multiple for defensible EPS, relative to current expectations. We think
the market will reward companies with defensible earnings, even in the face of slowing
top-line growth. We prefer companies that can expand margins or buy back stocks to
protect earnings growth in 2009. A potential extension of India-based STPI tax benefits
this year may help EPS growth rate of offshore sector in 2010. We think ACN and G
have the most potential (and willingness) to protect their EPS growth (relative to our
current expectations), if the sector’s revenue growth were to slow significantly.
• Updating 2009 estimates, Introducing 2011 estimates. We are updating our estimates
for several of our companies. Our new 2009 estimates assume more than previously
anticipated economic deterioration in FY09. We are also introducing our 2011
estimates representing normalized revenue growth and margin levels.
Table of Contents
PM Summary.............................................................................5
Key 2009 Themes .....................................................................8
Premium for Discipline and Long-term Strategies ......................................................8
Pricing Pressure ...........................................................................................................8
Buyers market – Vendors hungrier for growth ............................................................9
Increase in offshore leverage .......................................................................................9
Margin Expansion Measures........................................................................................9
Possible STPI Tax Benefits Extension.......................................................................10
Revenue Growth Outlook in 2009 .........................................11
Growth expectations have come down ......................................................................12
Satyam’s woes may be offshore’s gains ....................................................................13
European operations do not provide a relative safe growth haven.............................13
EPS growth likely the key driver in 2009 ..............................14
Margin Expansion......................................................................................................14
Share Repurchases .....................................................................................................15
We Prefer Strong Balance Sheets.........................................15
Liquidity Issues..........................................................................................................15
DSO ...........................................................................................................................16
Cash for Growth.........................................................................................................16
Currency Impact .....................................................................17
Revenue Growth Impact ............................................................................................17
EPS impact.................................................................................................................17
Company Outlook in 2009 .....................................................18
Introducing 2011 Estimates...................................................19
Revising 2009 Estimates........................................................19
Valuation Summary................................................................20
Investment Risks....................................................................23
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