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Will software stocks ever regain their sheen ? - Feb 08, 2004

The recent bull run in the markets have seen an across the board rally in almost all sectors. That is, barring software. The sector has been a market performer - a far cry from being a star out-performer. If one was to accept the beginning of June 2003 as the commencement date of the bull run, the relative appreciation in technology stocks is instantly apparent.

What are the reasons behind this apathy and what lies ahead ? We take a hard look at the factors spooking the tech sector - 

Empirical margins - historically, the tech sector saw stratospheric margins and superlative profits. The business model was particularly strong in the year 1999 and upto 2000. The big boost came from the y2k opportunities, banking applications and insurance. The dotcom boom also helped sentiments. Valuations of technology stocks were un-realistically high. Clearly, the scorching rate of growth could not be sustained and increased competition was bound to lead to margin pressures. The dotcom bust only exacerbated the situation after year 2001. Currently, the business is getting increasingly commoditised and is a numbers game with fixed margins - a fraction of the year 2000 highs.

Geo - political scenario - the terror attacks in Sept 2001 in the USA brought into public domain a simmering issue - outsourcing versus domestic job creation. The US corporates were outsourcing from cheaper asian solutions providers who were aggressive in pricing. This resulted in un-employment amongst the domestic US nationals. Starting with government uniforms for the postal depts, dock workers etc, USA stopped outsourcing. Software services were a logical extension. This saw a re-rating of the sector - downwards. The recession in the US economy also saw a price negotiation by the US clients and lower billing rates - both onshore and offsite.

Treasury considerations - the major hit to the software companies in India came from the surprise appreciation in the Indian Rupee which was hitherto seen depreciating by an average of 6 - 8 % per annum. That put paid to the treasury projections of all major software exporters. Since pricing of the services were fixed with a depreciation factor, the appreciation resulted in turmoil in the bottomlines. It is only now that corporates like Infosys and Wipro have shown the way forward by taking forward positions in the US $ and hedging future risk. That should effectively limit the worries of the sector analysts in the future.

Present scenario - the Indian companies are looking towards the European union ( EU ) and cutting their reliance on the US markets for future growth. The US government is currently going through the motions of a heartless pantomime of banning outsourcing. Corporate America is unlikely to let the situation continue beyond December 2004 ( US general elections ) in it's present form. Profits, not protectionism will govern the decisions in the USA. On the domestic front, the government in it's election run up unleashed the power of the Indian BPO juggernaut by sweeping tax sops. Experts from US & the EU opine that India's achievement in the BPO space is only a tip of the potential iceberg. That the best is yet to come.

Future scenario - the technology sector is undergoing a quiet consolidation as the business re-organises itself. There will be M&A and maybe a few companies might even bite the dust, but the future is promising. Beyond the US elections, the business will pick up and the EU will be the next big market. I can draw only one inference from the recent Microsoft initiative to combat the freeware linux proliferation, which was launched worldwide from India - that microsoft realises the importance of India in it's future plans.

Your call of action - should you be buying software stocks ? In my opinion, yes ! But do not expect miracles overnight. Buy with a medium term perspective with atleast a 6 months time frame in mind. Buy quality stocks like Infosys, Wipro, I-Flex and Polaris.

SEBI disclosure - the author of this article does not have any exposure to the securities mentioned above.

Priyanka Bhambwani is the ITES head at Bsplindia.com and these views are her own. She invites your feedback at priyanka@bsplindia.com 

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