INSTITUTIONAL EQUITY RESEARCH

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IT Services

Management speak – Reconfirms scary future !

INDIA | IT SERVICES | Sector Update

5 January 2017

Over the last two months, the Chairman/CEO/ex-CEO of four of the top-five Indian IT companies

warned their employees, investors, and the media about disruptive forces at work in the sector.

Infosys’ CEO, Dr Vishal Sikka, and Wipro’s Chairman, Mr Azim Premji, addressed their employees

on New Year’s Eve, cautioning them about the global technology environment. A month back,

Tech Mahindra’s CEO, Mr CP Gurnani, had expressed similar concerns in a media interview.

Around the same time, Mr Vineet Nayar, ex-CEO, HCL Tech, asked the most important question in

a blog – is this Indian IT’s “Kodak moment”?

Infosys CEO, Dr. Vishal Sikka’s New-year address to employees – key statement

“By all indications, the future promises to be even more disruptive, especially for our own

business, which is impacted by the multiple factors of technological and geo-political disruption.

We will not survive if we remain in the constricted space of doing as we are told, depending solely

on cost-arbitrage, and working as reactive problem-solvers. By "standing still" instead of moving

forward decisively, we will face the brunt of these disruptive forces, as our industry has already

started to see. A lot of the work that came to us and to others in our industry, can already be done

with AI systems.”

This is exactly in line with the hypothesis of our December 2015 report, where we had argued

that technology changes and inefficient capital allocation policies of Indian IT companies will

hamper their growth over the next few years.

Wipro Chairman, Mr. Azim Premji’s New-year address to employees – key statement

On the eve of the coming New Year, I must say that the year 2016, seems to have raised questions

and obstacles, on the path to a better world, which cannot be ignored. These questions have

arisen from developments in the political arena, from the fast unfolding environmental crisis and

from forces that want to shape the world in to a place of exclusion, conflict and suspicion.

In our August 2016 report, we had argued that the rise of right-wing populism across the world,

would lead to higher business uncertainty, directly impacting the demand environment of Indian

IT companies over the next few years.

HCL Tech Ex-CEO, Mr Vineet Nayar’s blog on India IT industry – key statement Disruptive change can make a deceptively slow approach. If a company is not alert or quick to respond or – even worse – if it responds with feeble incremental change, the damage can be fatal. HP and IBM, for example, had seen the offshoring wave coming but their inertia and obsession with status quo eventually led to their losing significant markets to Indian IT. I call this the “Kodak moment”. So is Indian IT facing a Kodak moment now?

We had raised this point in our December 2016 report, where we had compared the current

disruption in the IT industry to the disruptions that led to the fall of leading companies like

Kodak, Nokia, and Blackberry.

Tech Mahindra CEO, Mr C.P.Gurnani’s interview with Mint – key statement

So, even now, the focus for Tech Mahindra, and I believe other Indian heritage IT firms, is that you

need to make sure we remain relevant. Technology is changing industries around us. My priority

No. 1 (is) to make ourselves remain relevant.

Maintain our Underweight call on the sector

We see these letters/opinions as a testimony of the large disruptive forces at work against the

Indian IT services industry – something that we have been cautioning for over eighteen months

now. These just reinstate our belief that the transformation of the industry landscape over the

next 2-3 years will cause these companies to underperform significantly, as they reinvent

themselves to remain relevant. We maintain our negative stance on the sector as we see revenue

growth decelerating over the next three years. Despite seemingly inexpensive valuations, it is

NOT YET time to buy the sector.

We maintain Sell on TCS and Wipro, Neutral on HCL Tech and Tech Mahindra, and BUY on

Infosys. In the mid-cap space, NIIT Tech is our only BUY.

Vibhor Singhal (+ 9122 6667 9949) vsinghal@phillipcapital.in Shyamal Dhruve (+ 9122 6667 9992) sdhruve@phillipcapital.in

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IT SERVICES SECTOR UPDATE

Infosys CEO, Dr. Vishal Sikka’s New-year address to employees Date: 31- December 2016 Hi Friends, The time around the end and beginning of a year, while a passage of our own construction, offers us valuable time for reflection, introspection and resolution. Sitting here in the Singapore Airlines lounge at Changi Airport, I've been looking back on the strange year gone by: Brexit, the American Presidential Election, demonetization, cyber security, the refugee and terrorism situation, and many others. There were events that seriously changed the way we viewed the world, but perhaps that biggest disruption is the one that has been proceeding irreversibly and unstoppably in our times - the accelerating force of technology and digitization. So, it is no surprise that I am surrounded by at least 5 magazines that have AI cover stories! By all indications, the future promises to be even more disruptive, especially for our own business, which is impacted by the multiple factors of technological and geo-political disruption. We will not survive if we remain in the constricted space of doing as we are told, depending solely on cost-arbitrage, and working as reactive problem-solvers. By "standing still" instead of moving forward decisively, we will face the brunt of these disruptive forces, as our industry has already started to see. A lot of the work that came to us and to others in our industry, can already be done with AI systems. So as I think about all this, and as I've said to you often, our path forward is very clear - we need to harness the dual forces of automation and innovation. We must embrace automation to become more productive in the work that we do, and with the resulting capacity, focus our attention upwards towards innovation, both for ourselves and our clients. The foundation for all of this is our culture, our values and especially our infrastructure for life-long learning. I am often asked, how do we do this? On automation: Mastering automation. We must bring it into everything we do. In addition to doing our job, we must work on building a tool that helps us do the job faster/better/cheaper. "There is an automation for that": Preserving the sanctity of our "human-ness" requires that we must strive to do a routine/mechanizable activity only one time, and build automation to take care of the activity the next time around. We must see automation, and the amalgamation of our human work with automation, as an opportunity to transcend the assumptions of the present, not a threat to our future, and we must help everyone else see this as well. We must understand Mana deeply, now deployed at 20+ clients, and learn to deliver value using it. Take the classes on Mana and machine learning on Digital Tutor and the Infosys Learning Platform. For hands-on experience on Mana 2.0, we have created a seven day course weaving in real-world examples. To create a culture of 'Machine Learning First', you could opt for the two-day exploratory training on machine learning, provided by ETA. On innovation: The Zero Distance culture of innovation, now almost two years old in the company is very encouraging. But often, it is very small in terms of the innovation delivered. And in chasing small improvements, sometimes we can miss the point of the big thing, the larger picture of potential greater value. Also, often we don't have visibility beyond the silos that we've been given to work on/in by our clients, and sometimes (although

We had highlighted this in our Dec-15 report ‘First law of thermodynamics – QED!’ report here

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IT SERVICES SECTOR UPDATE

we are removing this one through collaboration) even silos of our own making. Often, our clients just aren't ready for what we bring to the table, they don't see us as innovators. So how do we break these presumptions and live as innovators? Martin Luther King, Jr. said: "If you can't fly then run, if you can't run then walk, if you can't walk then crawl, but whatever you do you have to keep moving forward." He was, of course, talking about freedom. But it applies equally to us. To our freedom, from the tyranny of the mundane, of the cost-driven value delivery, our freedom to think, to innovate, to create. So as I met our teams over the last two weeks, I've asked them to do what I'll ask you, first try and fly. See if you can find an opportunity to fly. Fly in this case means a total digital transformation of our clients' business processes that we happen to be involved in. We have a select few examples that come close to "Fly". If we can't fly, we must run. Run here is a new process, refurbished apps. Walk is a new process, with the same apps. Crawl is with the same process, same apps, but accelerated using automation, using implementation excellence, using tools like AssistEdge, and others. And this is not limited to teams in delivery or consulting or BPO. This applies to all of us! The work our Finance and BEF teams have done in rethinking OTR is a great example of transformation; as is the work some of our AssistEdge teams did in bringing conversational interfaces to the product to completely reimagine its experience; or the work our HR team has done in identifying and nurturing talent using data science, just three great examples... And the all-important base of learning & education: Learnability - we will advance in automation and innovation by learning about these topics: An immersive training capsule called "Automation - A Way of Life" is being rolled out for all fresh hires in Mysore. An updated module on Design Thinking will also include concrete examples, and Infosys success stories. We must remember that operational excellence is an imperative for each one of us. We must focus on delivering the best solutions in the smartest, fastest way possible, and not give up or give in to weaker instincts. Often, teams deliver only what is told, without going beyond the given scope, and with a lackadaisical attitude towards greater value creation. This can no longer be the case. Many teams that I have met recently have begun to understand and execute on the duality of automation and innovation, and to bring value to clients, not just mechanically execute the jobs we are handed. I've had some incredible meetings with clients from Australia to India and beyond and a very encouraging floorwalk at IBPO in Jaipur too, where we have begun seeing the effects of automation. Our clients have collectively rewarded us for this by giving us the best client survey results in over a decade, as well as in other forums. But there is a long way to go. The road ahead is long and not easy. The mountains ahead are tall ones. But there is no other way but to get there and go beyond. If we don't, we will be made obsolete by the tidal wave of automation and technology-fuelled transformation that is almost upon us. On the other hand, if we do achieve all that we set out to do, we can be that one great force powering the purposeful evolution of our world. A world where our AIs may make us more successful, but also more human. Where our ability to learn, and to deliver the purposeful fruits of those learnings, helps us all be mode. Let us do this, together. Wishing you a Happy New Year. Best, V Source: http://profit.ndtv.com/news/tech-media-telecom/article-road-ahead-not-easy-infosys-ceo-sikka-tells-employees-1644317

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Wipro Chairman, Mr. Azim Premji’s New-year address to employees Date: 31- December 2016 Dear Wiproite, Four weeks ago in the gentle morning winter sun, I watched the assembly proceedings, of a school which serves a severely disadvantaged community, in Sirohi in Rajasthan. It was deeply engaging for me, because the children were completely and meaningfully engaged. After the assembly, a confident young girl - probably no more than 11 years old - talked with genuine joy, about how good and satisfied she felt. This child was talking about the fulfillment that comes from something well done. Then, she posed a question to me: what was it that I have done, that makes me feel really happy and fulfilled? It is not as though this question has not been asked of me before. But that moment and the question, was suffused with the child's genuine curiosity and pure heart, and so became a moment of great clarity and insight for me. The greatest fulfilment is in knowing that the work that we are doing at the Foundation has some role in shaping confident, thinking, caring and ethical human beings like her. For five decades, I have been completely invested in Wipro and its people. Wipro makes a real difference to its clients across the world, and this is what powers its success. It is your commitment and hard work, and that of every Wiproite, that actually makes this happen. I have the greatest pride in this. The importance of this success of Wipro has become manifold more, because it's the success of Wipro that enables the possibility of making a difference to some of the most disadvantaged people in the world. This is because almost 40% of Wipro is owned by a philanthropic trust, which is completely focused on trying to contribute to developing a better world, including helping children like the girl that I met in Sirohi. On the eve of the coming New Year, I must say that the year 2016, seems to have raised questions and obstacles, on the path to a better world, which cannot be ignored. These questions have arisen from developments in the political arena, from the fast unfolding environmental crisis and from forces that want to shape the world in to a place of exclusion, conflict and suspicion. Once we start addressing these issues head on rather than ignoring them, I am confident that we will continue to make progress. It's not that only people in public life can play a part, but each one of us in our own roles can make a difference, and we as a company can make a substantial difference. For this, I feel that if we use four principles to guide our actions, we can be constructive without yielding on the quest for a better world. These four principles are: * Finding Common ground: We must find common ground, rather than focusing on conflicts. The reality of the world is that there will always be disagreement and differences between people, but finding common ground is the only way of moving forward. This is as true in business as in politics and social issues, and as true in personal as in public life.

We had highlighted this in our Aug-16 report ‘Second law of thermodynamics – In play!’ report here

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* Concern for others: We must have genuine concern for others. We must respect all human beings equally and we must have the same respect for nature. This respect must manifest in action. If we have concern, then finding common ground becomes possible. * Connectedness: We must recognize that societies, economies, and the environment are all deeply connected. Individual human beings and peoples find meaning in this connectedness, not in separation and isolation. Our problems and solutions are deeply connected. So every effort of ours to find solutions and to find meaning, must strengthen this connectedness. * Commitment to Values: The bedrock of everything must be an unflinching commitment to Values, at the core of which is Integrity. Integrity is certainly about honesty and honoring commitments, but it is more than that. It is about having the courage to persevere for what is right and what is good The child who asked me that question represents the possibility of the kind of a person who can help make a truly better world. What inspires me and fills me with hope is that that child is not alone. Just in those six days in Rajasthan, in one of the most disadvantaged parts of the world, I met scores of people who have the same spirit, including women who have been victims of trafficking now fighting against it, public school teachers going way beyond the call of duty, NGO workers who have embraced the problems of others and the average farmer citizen who lends a shoulder to the fight for the good. All of them are people battling the most complex of challenges, yet unyielding in their efforts and positivism. This is what I see across the world, from San Francisco to Tokyo, all places that I go to, I meet people with the same spirit and fire. That includes an uncountable number of Wiproites. And that is why I am full of hope for a better world, a more just, equitable, humane and sustainable world. I know that if we persevere, we will prevail. I wish you all a splendid 2017. AZIM PREMJI Source: http://www.gadgetsnow.com/tech-news/wipro-chairman-azim-premjis-letter-to-employees/articleshow/56307201.cms?utm_source=toiweb&utm_medium =referral&utm_campaign=toiweb_hptopnews

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HCL Tech ex-CEO, Mr Vineet Nayar’s blog on Indian IT industry Date: 19- November 2016 Kodak was a great company and most people in my generation have living memories created by Kodak. The company was a huge global brand with enviable talent, yet they failed to spot a big wave of disruption in the form of digital photography that eventually swept them away. Disruptive change can make a deceptively slow approach. If a company is not alert or quick to respond or – even worse – if it responds with feeble incremental change, the damage can be fatal. HP and IBM, for example, had seen the offshoring wave coming but their inertia and obsession with status quo eventually led to their losing significant markets to Indian IT. I call this the “Kodak moment”. So is Indian IT facing a Kodak moment now? It’s not just Trump or Brexit and possible trade barriers put up by them. Change could run far deeper. “Soon we won’t programme computers. We’ll train them like dogs,” said Wired magazine in their May cover story ‘Death of Code’, arguing that artificial intelligence will change the way we write and run software. What they were fundamentally predicting was the death of the coder as we know it. Many others have predicted that in the next decade we will see a net reduction of global IT manpower working on back-end applications, and India will be worst hit by this mega trend. This may be true. However, unlike Kodak, Indian IT still has three key trends playing in its favour. First, global spend on technology is increasing, thus India still has a lot of scope for increasing its share in the growing portfolio by realigning to the new tasks of our customers. Second, right now no one has the digital skills that the world needs. The question is who can build it at scale first and we for sure know how to do that. Third, the world is seeing marginalisation of the role of the CIO and emergence of a new set of business buyers. Just like we did in the case of RIM and BPO, we need to once again find and win new friends. It is difficult for me to imagine that Indian IT is sleeping through this storm. Traditional customers will spend lesser and lesser on traditional services – thus it is just a matter of time before one becomes irrelevant. I believe Indian IT leaders are too smart to let this happen. So, how do we prevent this “Kodak Moment” from sweeping us away? It begins with a rather simple mantra – “If you can believe it, you can achieve it.” First and foremost, we have to accept that this change is not the small wave we see today but an inevitable tsunami that will fundamentally change everything. This change is too big for us to battle with tweaks and tucks; we need instead bigger, bolder moves like acquisitions, structural changes, top leadership realignment, etc. Second, the start of this transformation has to be by cannibalising our own services. Attack what you do and disrupt it with new ways of doing it even if it results in reduced profits in the short term. Lastly, recognise the importance of structures. The organisation structure should be hierarchical and aggregating if you want to work at peak efficiency and improve profits. However if you are looking to build something new, then create independent units with complete control of their destiny from order to cash. Smaller, passionate, focussed teams that learn and grow are the only ones who can truly innovate and break through in a legacy-heavy environment.

We had highlighted this in our Dec-16 report ‘Time to buy the sector? NOT YET!’ report here

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This is how Comnet built the multi-billion dollar remote infrastructure management business and this is the only way Indian IT can prevent its legacy from becoming its noose. And what about Indian IT engineers? I am afraid there are troubled times ahead. Current skills are obsolete and you need to take responsibility to stay relevant, if you are not to fall into the Kodak trap. Is the future of the Indian IT engineer and Indian IT firms uncertain? My response would be yes. But if you are wondering whether Indian IT will be Kodak-ed the answer is most certainly not, as they are too smart to be left holding on to their past, caught on a Kodak film camera. Source: http://blogs.timesofindia.indiatimes.com/toi-edit-page/is-indian-it-awaiting-its-kodak-moment-not-if-it-can-wake-up-to-a-tsunami-of-impending-disruption/

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Tech Mahindra CEO, Mr C.P.Gurnani’s interview with Mint Date: 21- December 2016 Q: Analysts and commentators have started penning obituaries for the Indian IT outsourcing industry. From your perch, what is the future of Indian IT and Tech Mahindra? It will be wrong to write us off. I see the present as exciting times. Remember, Indian IT has seen changes all throughout its life. It all started with Father Kohli (F.C. Kohli, the first CEO of Tata Consultancy Services Ltd). The model then was that companies said, “we have consultants and we will give them to you”. Then the Y2K moment happened, which was like an inflection point. In all these decades, the industry has grown. So, even now, the focus for Tech Mahindra, and I believe other Indian heritage IT firms, is that you need to make sure we remain relevant. Technology is changing industries around us. My priority No. 1 (is) to make ourselves remain relevant. Q: So, how are you making Tech Mahindra stay relevant? Can you also share what are, say, the three big bets for Tech Mahindra? I can tell you not three but five. First is cybersecurity. Second is imaging as a service or say, a service where we use automation platform with radiologist, and run imaging as a service. No. 3 is blockchain. No. 4 is that we want to be the largest system integrator in the Internet of things (IoT). No. 5 is network services, as the world moves towards last-mile connectivity, and focus on software-defined networks (increases). Q: All IT firms are talking about these newer tech. When can we see Tech Mahindra beginning to disclose the business it generates from each of these five big bets? We should be able to do this soon. The way we look at it is that we will take 12-16 months to incubate them. So, out of the five, three will go into production phase. It is possible that not all five will go into production phase. And so, I believe that the three which go into production, it is my duty to report the numbers. I have invested shareholder money and I guess it is the right of the shareholders to know what I have done with their money. So, we should be able to report the revenue or business once it goes into production (phase) after 12-16 months. Q: How different will the Tech Mahindra of 2020 be? Currently, 65% of my business comes from IT while balance comes from engineering services, network services, customer experience, platform and security. I’m taking a forward call and saying 50% will come from IT and 50% will come from different platforms by 2020. So, obviously there will be changes. Q: Your thoughts on the internal goal of becoming a $10 billion firm by 2020, and what percentage of revenue will be called digital by then? Will it be more than half of your revenue, as against the 15-7% currently? Will it mean significant revenue from M&A? I cannot comment on the Internal goals. But on your question of digital revenue, I would say that the way market is moving, getting more than 50% you see is not relevant. Because if I get the topline, I promise you, we will have more than 50% (coming from) digital. Q: One of the things which is often held against Indian heritage IT firms is that they are too conservative. You are talking about blockchain. But if you are serious, then why not launch a service line? Take a more aggressive approach like the one adopted by IBM, which has set up business focused on blockchain technologies. I cannot comment on what approach other companies are taking. I’m not betting my company on any one technology. If you look at my company, 65% of business which comes from traditional IT will change to 50% by 2020. So, I will still get 50% from IT. So, I’m not betting my whole ranch on this. blockchain for all you know will be $200 million practice, say, for us when I’m $8 billion or $9 billion.

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Q: So, are you saying that there is enough in traditional business? I am not saying this. All I am saying is that my company’s focus remains and will be in solving business problems. I will choose the technology. I’m not getting married to one technology. And that is the difference between service and product companies. Q: Tech Mahindra is perceived to be lagging behind in digital technologies. It does not have a strong consultancy arm, for instance. You are wrong when you say I don’t have a strong consultancy arm. I have about 3,000 consultants. I have probably what is the largest IT telecom services firm out of India— being a leader for the last 10 years and I will be the leader for the next 10 years. From the positioning point of view, I have taken a position: I will be largest IT firm in the media, communication and entertainment industry. We have launched DAVID, and the core reason to launch this is to make ourselves future-ready. Source: http://www.livemint.com/Companies/05PcYpZOmBeSeBLoMPqETN/By-2020-50-of-Tech-Mahindras-business-will-come-from-IT.html

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IT SERVICES SECTOR UPDATE

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Sr. no. Particulars Yes/No

1 Whether compensation has been received from the company(ies) covered in the Research report in the past 12 months for investment banking transaction by PCIL

No

2 Whether Research Analyst, PCIL or its associates or relatives of the Research Analyst affiliates collectively hold more than 1% of the company(ies) covered in the Research report

No

3 Whether compensation has been received by PCIL or its associates from the company(ies) covered in the Research report No

4 PCIL or its affiliates have managed or co-managed in the previous twelve months a private or public offering of securities for the company(ies) covered in the Research report

No

5 Research Analyst, his associate, PCIL or its associates have received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in the Research report, in the last twelve months

No

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IT SERVICES SECTOR UPDATE

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