Upside Gets Outsourced for Indian IT

For several weeks last spring, it looked like India's information technology outsourcing giants were about to be swamped by the political tsunami that swept the left-leaning Congress Party into power. Fearing a reversal of long-standing pro-development policies, investors pulled billions of rupees out of the Bombay stock market, sending the widely watched BSE 100 index plunging more than 21%.

In response, U.S.-based investors pulled the plug on three of the largest so-called offshore outsourcers traded on Wall Street, knocking American depositary shares of Wipro(WIT), Infosys Technologies(INFY) and Satyam Computer(SAY) down about 16%.

Six months later, the picture couldn't have changed more. The BSE has rebounded by 31%, and the outsourcers have soared far above their May 17 trough: Infosys by 94%, Wipro by 85% and Satyam by 66%.

It Was a Very Good Half-Year Political realities have boosted Indian IT shares

What brought about the run-up? Investors began to realize that the Congress Party, which actually initiated economic reforms in 1991, and its communist allies are very pro-development, as long as those policies don't hurt labor, said Rafiq Dossani of the Asia-Pacific Research Center at Stanford University. "They strongly support tax benefits and other incentives [for the outsourcers] because they increase employment. Likewise, they are in favor of multinationals investing in new companies that don't affect state-owned sectors such as airlines," he said.

Meanwhile, demand for offshore expertise has continued to rise, and increased productivity has easily offset a modest rise in wages. The result: big boosts to top- and bottom-line performance.

In the quarter ended in September, Infosys posted a 49% increase in profit, its largest quarterly jump in three years, and revenue was up 52% from a year earlier. Second-quarter earnings for Wipro were up 79% on sales that increased by 44%. And driven largely by increased business from General Electric(GE), Satyam said its profit in the quarter was up 28% as revenue increased by 42%.

Although India has a huge educated work force, graduating about 800,000 engineers a year, there has been some upward pressure on wages as demand for labor increases. In the software industry, salaries have jumped by as much as 20% (less for call-center workers), said Stanford's Dossani.

Even so, operating margins have not suffered significantly, said Ashish Thadhani, who follows offshoring for Gilford Securities. Wipro, for example, posted an operating margin of 18.7% for fiscal 2004, and is expected to increase that to 20.7% in fiscal 2005.

Along with better productivity, the companies have defended their margins by passing some of the increased costs on to customers. "A boost of 1% or 2% in costs is essentially insignificant to a customer, but is a huge deal to Wipro and others," Thadhani said.

All three companies gave solid guidance, and now that the U.S. election is over, whatever fears there were that a new administration might penalize companies sending work overseas have vanished. "Those concerns were never enormous, but there probably was some business that was delayed," said analyst Sameer Nadkarni of WR Hambrecht.