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September 26, 2008 For Private Circulation only 1

US financial crisis and its impact on Indian IT firms

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Deepak TiwariResearch Analyst

[email protected]

T: + 91 22 4063 3032

IT Update

Background

First we talked about US slowdown then US slipping in recession and then wewere taken aback by financial hurricane. We witnessed the fall of US financialgiants like Bear Stearns, Fannie Mae & Freddie Mac, Lehman Brothers, MerrillLynch, AIG and Washington Mutual. Still, we are clueless what has been storedin the future and who is going to be the next victim of this notorious sub-primemess. As US President Bush says that US financial stability is under threat. Theoptimists envisage that the current crisis will be over in two three quarters fromnow. But you never know like we did not know what had been cooking in last sixmonths just to wake up one fine morning to learn US financial giants that ruledthe world economy for decades, are desperately seeking funds to salvage thembut hardly there is any taker. Moreover, several banks worldwide are eschewing

to lend them. Some recent developments in US economy further aggravate thesituation. For instance, orders for costly US manufactured goods plunged inAugust, new-home sales hit a 17-year low, while new claims for jobless benefitsshot up last week. Top US industrial conglomerate General Electric Co, widelyseen as a bellwether of the US economy, issued a profit warning, citing"unprecedented weakness and volatility" in the financial services market.German Finance Minister Peer Steinbrueck says such crisis would lead up toless dominant role for the United States in the global financial system as it willlose its superpower status in the world financial system making world financialsystem more multi-polar.

The impact on Indian IT companies

We don’t gainsay that troubles in the US will not impact Indian IT titans. Thereare people who think it will create opportunities for them whereas there arepeople who deride such views. In its recent report, research firm, Gartnerexpected higher opportunities for Indian IT companies and for off shoring. ButMr. John McCarthy of US research firm Forrester believes otherwise. Heridicules that US slowdown is good for IT firms because cost-cutting will lead tohigher off shoring. He says this is no longer a recession, rather a re-structuringof financial services that is taking place. We are of the opinion that it will impactIT firms particularly Indians players in following manner:

M&A and the conversion of large investment banks into commercialbanks will result in fewer employees, fewer vendors and lessextravagant IT budgets.

Financial services, the most aggressive buyers of technology would cutdown on their IT spend and the growth will go back to 25% and staythat way for some time.

Margins of Indian IT firms will continue to drift down to 15% and therewill be real pressure on the top line.

Indian IT providers are unlikely to repeat their historical growth in profitmargin rates and will eventually move closer to that of their globalpeers.

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Opportunities and challenges

The only consolation for IT companies is that the recent Forrester’s report had found 40% of large businesses had slashedIT budgets, but a subset, 90% of enterprises in media, entertainment and leisure, were not cutting back on IT spends. Butneedless to say these sectors cannot match the IT spends of financial services.

Who will be hit the most?

We have analyzed which IT firms will be hit the most due to this perilous situation. Most of the IT companies are reportingslowdown in quarterly revenues across the industry. A significant part of their revenues come from America which is facingworst financial crisis since Great depression in 1930. This is followed by Europe region which is witnessing early sign ofslowdown. Many IT firms have been trying to diversify in order to de-risk and zeroing on new and emerging regions likeMiddle East, Asia Pacific and India. Further, they are also trying to diversify their verticals. Given the fact that a significantpart of revenues flow from BFSI segment which is plagued with uncertainties, their top line as well margins will take a hugehit. As of now, it is difficult to estimate the impact because of various factors such as economic slowdown, rupee volatility,inflation and liquidity crunch. But it is certain that profitability of IT companies will be impacted. It also depends on whatstrategies they are going to adapt and how they are going to cope up with bad phase. Moreover, we believe this situation willremain until first quarter of 2010.

America contributes a significant part of IT firms’ revenues

Close to 59% of EBIDTA of both TCS and Infosys is contributed by America region followed 30% by European countries.

TCS and Infosys will take a big hit as BFSI segment faltering

BFSI segment contributes 35% in EBIDTA of Infosys. TCS does not report vertical wise results.

55%

62%

44%

60%57%

29%28%

24%21%

29%

9%

1%

24%

3%

14%

7%9% 8%

16%

0%0%

10%

20%

30%

40%

50%

60%

70%

TCS Infosys Wipro Satyam HCL Tech

America

Europe

India

Others

58%

12% 9%

21%

0%0%

20%

40%

60%

80%

BFSI Mfg Retail Telecom Others

TCS

36%

15%12%

22%16%

0%

10%

20%

30%

40%


Infosys

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Wipro and HCL Tech has lesser exposure to BFSI segment

Note: Satyam does not report vertical wise results. The other segment in case of Wipro includes Product Engineering 24%, Energy Uti lities10% and TMTS 11%.

Revenues from offshore business

The margin from offshore business is always higher than that from onsite business. US financial turbulence is likely to affect this margin aswell which will impact Infosys and HCL Tech more than their peers.

Disclaimer: This document has been prepared by Arthaeon Financial Services and is meant for sole use by the recipient and not for circulation. This document is not tobe reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The informationcontained herein is from sources believed to be reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. Arthaeon FinancialServices and/or its affiliates or employees shall not be liable for loss or damage that may arise from any error in this document. Arthaeon Financial Services may havefrom time to time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or otherservices for, any company mentioned in this document.

41.9%

49.1%

45.6%

50.2%

36.0%

38.0%

40.0%

42.0%

44.0%

46.0%

48.0%

50.0%

52.0%

TCS Infosys Wipro HCL Tech

25%

9% 10% 8%

48%

0%

20%

40%

60%


Wipro

27%31%

9%

16% 17%

0%

10%

20%

30%

40%


HCL Tech

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