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Sector Update | IT

March 20, 2013 Ankita Somani
022-39357800 Ext: 6819 ankita.somani@angelbroking.com

IT Sector
Indian IT - Long term growth outlook intact
The global economy is set to improve going ahead with global GDP predicted to grow by 3.5% in CY2013 and 4.1% in CY2014. Global IT - business process management (BPM) spend is expected to grow in the range of 5-6% over the next two years and global sourcing is set to grow faster at ~8% during 2013 and 2014. India continues to be the global sourcing leader, but it accounts for only ~10% of the total global IT-BPM spend of US$124-130bn, which implies that the market is huge and presents immense untapped opportunity. Indian IT-BPM firms are well positioned to take advantage of these trends by working towards developing new capabilities, servicing the entire IT services value chain and expanding their focus to new geographies, technologies and industry verticals. Indian companies grabbing market share vs global peers: We expect worldwide IT spending (excluding hardware) to post a three-year CAGR of 4.4% while the total sourcing market is expected to grow by ~7-8% (~2x of worldwide spend). Top IT service players globally have been increasing their market share every year in the overall IT-BPM spending and have gained ~110bp per annum share annually since the last five years. While the worldwide IT services market has posted a five year CAGR of just ~3.5% and global sourcing market having posted a CAGR of ~9% commensurately, Indian software services revenue has posted a 16% CAGR (almost 2x of growth in global sourcing); primary reason for the same being the labor arbitrage or cost savings to clients. The top-5 Indian IT companies have been increasingly gaining market share since last five years in the overall revenues from biggies of IT services sector globally. Indian IT - Large cap companies leading the growth: The top-5 Indian IT services vendors have increased their share of Indian IT exports by ~135bp per annum. This supplements the fact that Indian large-cap players have been surpassing mid-cap companies in terms of grabbing market share. Taking into notice the average market share gains over the past six years (FY2007-12) and 7-8% CAGR in global sourcing spend for the next three years, the top-5 Indian IT companies are likely to grow at ~14% CAGR over the next three years. Valuation: We continue to remain positive on TCS and HCL Tech from a longer term perspective, though current valuations preclude us from taking any considerable upsides from current levels for the next couple of quarters. We expect TCS and HCL Tech to lead the growth in tier-I IT pack by growing higher than the industry average in FY2014. We recommend Accumulate rating on TCS and HCL Tech with target price of `1,624 and `875, respectively. The PE premium commanded by TCS over Infosys has reduced now, given Infosys’ outperformance during 3QFY2013 after six quarters of disappointing results. We maintain Accumulate rating on Infosys as well as Wipro with target price of `3,132 and `473, respectively. Tech Mahindra remains one of our preferred picks in the entire IT space as the company has recently acquired two companies which will give it inorganic boost. Also, post its merger with Mahindra Satyam, the risks which the company is facing right now such as client concentration and industry concentration will be curtailed and the company will be able to reap benefits from Mahindra Satyam’s capability in enterprise services. Along with Tech Mahindra, we like KPIT Cummins among mid-caps at the current level with a target price of `130, owing to recent correction in the stock price despite industry leading revenue growth.
Please refer to important disclosures at the end of this report

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Sector Update | March 2013

The worldwide IT spending grew by 4.8% yoy in CY2012 to US$1.9tn. In line with growth in global IT spend, the global sourcing market also grew to US$124-130bn, ie a growth of 9% over 2011, which is nearly twice the growth in global IT spend.

Worldwide IT spending
On the face of a volatile economic environment, 2012 recorded a steady growth for technology and related services sector, with worldwide spending of US$1.9tn, a growth rate of 4.8% yoy. Of the worldwide technology spend of ~US$1.9tn in CY2012, software products, IT, and BPM services contributed ~US$1.1tn (58%) while hardware accounted for the balance ~US$797bn (42%). Worldwide, hardware spending grew by 7%, IT services spend increased by 3.3%, BPM grew by 4.9% and spend on software products increased by 3.3%. In line with growth in global IT spend, the global sourcing market also grew to US$124-130bn, ie a growth of 9% over 2011, which is nearly twice the growth in global IT spend. As per Nasscom, lingering concerns about global economy also impacted contracts in 2012 as volumes fell by ~13%. However, average contract value remained fairly steady at US$21bn largely on the back of number of mega deals signed in the BPM space. As per Nasscom, accelerated IT spending is likely to be witnessed in 2013 with areas like mobility, cloud, and social media expected to grow much faster, thereby shifting the overall spend in technology.

Exhibit 1: Worldwide technology spend
(USD bn) Worldwide services Worldwide BPO Worldwide software products Worldwide hardware Total
Source: IDC, Angel Research

CY2008 591 130 304 600 1,625

CY2009 566 152 272 563 1,554

CY2010 586 147 293 599 1,625

CY2011 605 153 309 747 1,814

CY2012E 625 160 319 797 1,902

CY2013E 651 169 340 841 2,001

CY2014E 677 176 362 883 2,098

Exhibit 2: Global technology spend (excluding hardware)
1,300 1,200 3.6 4.0 3.5 5.0 4.8 6 5 4 3 2 1 1,000 900 800 (3.3) 2009 2010 2011 2012E 2013E 2014E 0 -1 -2 -3 -4 Global technology spend
Source: Nasscom, Angel Research

(USD bn)

1,100

% growth (yoy)

We expect worldwide IT spending (excluding hardware) to post a three-year CAGR of 4.4% while the total sourcing market is expected to grow by ~7-8%.

We expect worldwide IT spending (excluding hardware) to post a three-year CAGR of 4.4% with growth being led by emerging industry verticals such as retail, energy & utilities and lifesciences & healthcare. Worldwide IT services spends have grown at a CAGR of 3.4% over the past 8 years. New requirements in legal and regulatory work, process improvement and demand for new applications are expected to aid growth in legacy industry verticals – BFSI and manufacturing. The telecom industry vertical is expected to remain sluggish in the near term. The year witnessed a pronounced shift to smaller contracts while mature verticals and segments were the growth drivers for global sourcing deals.

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(%)

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Sector Update | March 2013

India has emerged as the preferred outsourcing destination; Indian IT exports revenues (excluding hardware) are estimated to be at US$75.8bn in FY2013, up 10.2% yoy, and contribute ~80% to the total IT-BPM revenues (excluding hardware).

Indian IT industry
The Indian IT services and BPM industry is an integral part of the global sourcing strategy and has been increasingly contributing to the domestic economy over the years. During FY2013, IT industry in India is estimated to aggregate revenues of US$108bn in FY2013, with the IT software and services sector (excluding hardware) accounting for US$95bn of revenues. Exports revenues (excluding hardware) are estimated to be at US$75.8bn in FY2013, up 10.2% yoy, and contributed ~80% to the total IT-BPM revenues (excluding hardware). Domestic IT-BPM revenue (excluding hardware) is expected to grow at 2% to US$19.3bn in FY2013. As a proportion of national GDP, the sector revenues have grown from 1.2% in FY1998 to ~8% in FY2013. For CY2013, growth for the Indian IT industry exports has been predicted to be in the range of 12-14%.

Exhibit 3: IT-BPM – one of the highest impact sectors for India
contributed ~8% to India's GDP; grew >6x in the last 15 years 23-25% contribution to Indian exports; grew >6x in the last 15 years

US$3.2bn PE/VC investments; accounts for ~37% of the total investments in India

direct employement to ~3mn people; one of the largest private sector employers

India's IT-BPM sector

~7% share in total FDI; sector ranked 4th in contribution to total FDI

~380 cross border acquistions during FY2008-12

Source: Nasscom, Angel Research

March 20, 2013

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Sector Update | March 2013

Exhibit 4: Indian IT industry revenues (domestic + export) – FY2008-13E
(USD mn) IT services BPO Software prdts and ER&D Hardware Total FY2008 22,203 9,915 8,300 500 40,918 FY2009 FY2010 FY2011 FY2012 FY2013E 12,443 3,087 3,788 12,882 32,200 Exports Domestic Exports Domestic Exports Domestic Exports Domestic Exports Domestic Exports Domestic 7,882 25,800 1,576 11,699 2,234 10,293 9,600 395 8,226 27,290 1,932 12,401 2,690 9,006 9,999 395 9,070 33,478 2,304 14,172 2,960 11,385 9,746 395 24,080 59,430 11,004 39,890 2,791 15,915 3,495 12,979 11,732 415 29,022 69,199 12,170 43,853 3,068 17,848 3,721 14,132 12,710 415 31,669 76,248

21,985 47,494

21,854 50,085

Aggregate revenues
Source: Nasscom, Angel Research

62,903

69,348

74,165

88,452

100,868

108,448

The growth rate for the Indian IT sector has moderated in the last couple of years from 40% CAGR (FY2003-07) to ~15.9% CAGR (FY2007-13E). The key reasons for the decline are: 1) increasing revenue base, 2) comparable offshore employee base of MNCs such as IBM, Accenture, Capgemini, 3) weak macro-environment over the past few years and 4) increasing commoditization of services like ADM.

MNCs vs Indian IT companies: Indian companies increasingly capturing market share
The top IT services companies globally have been gaining share by ~110bp per annum annually since the last five years. Top IT services players globally have been increasing their market share every year in the overall IT-BPM spending. These top companies have been gaining share by ~110bp per annum annually since the last five years. We expect this trend to continue going forward with large IT companies taking advantage from scale of operations, diversified presence, strong client mining skills and flexible cost structures.

Exhibit 5: Revenue profile of large IT service players globally
(USD mn) IBM Fujitsu Accenture HP CSC Capgemini Atos Logica TCS Infosys Wipro Cognizant HCL Tech Total FY2007 48,291 31,570 21,453 15,617 14,855 7,700 5,397 4,465 4,131 3,090 2,460 1,424 1,390 161,842 FY2008 54,144 32,722 25,314 15,329 16,500 8,703 5,855 6,149 5,684 4,178 3,647 2,136 1,879 182,240 FY2009 58,891 31,399 23,171 21,745 16,740 8,710 5,624 6,645 6,015 4,663 4,324 2,816 2,180 192,921 FY2010 55,000 33,468 23,094 34,680 15,921 8,371 5,127 5,796 6,339 4,804 4,391 3,279 2,705 202,974 FY2011 56,424 35,293 27,353 35,276 16,042 8,697 5,021 5,714 8,186 6,041 5,221 4,592 3,545 217,405 FY2012 60,613 34,935 29,778 35,702 15,877 9,693 6,813 6,289 10,170 6,994 5,921 6,121 4,152 233,058

Share in total IT-BPM

25.2%

27.1%

26.8%

28.3%

29.7%

30.7%

Source: Company, Angel Research

March 20, 2013

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Sector Update | March 2013

While in the past two decades Indian IT had been a story of market share shift from MNCs like IBM, HP, Capgemini, Accenture, CSC to India based outsourcers Infosys, TCS, Wipro, Cognizant and HCL Tech, driven by labor arbitrage. Although the labor cost advantage has been on a declining trend, there still is a comfortable 20-25% cost saving for clients along with availability of a young workforce. The market share of top 5 Indian IT players – TCS, Infosys, Cognizant, Wipro and HCL Tech – has been increasing since last six years in the overall IT spend from top IT companies globally and we expect this trend to continue going forward. Top-5 Indian IT companies have been increasingly gaining market share since last five years in the overall revenues from biggies of IT services sector globally.

Exhibit 6: Market share of top 5 Indian IT players showing a rising trend
(%) IBM Fujitsu Accenture HP CSC Capgemini Atos Logica MNC's market share TCS Infosys Wipro Cognizant HCL Tech Indian players market share
Source: Company, Angel Research

FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 29.8 19.5 13.3 9.6 9.2 4.8 3.3 2.8 92.3 2.6 1.9 1.5 0.9 0.9 7.7 29.7 18.0 13.9 8.4 9.1 4.8 3.2 3.4 90.4 3.1 2.3 2.0 1.2 1.0 9.6 30.5 16.3 12.0 11.3 8.7 4.5 2.9 3.4 89.6 3.1 2.4 2.2 1.5 1.1 10.4 27.1 16.5 11.4 17.1 7.8 4.1 2.5 2.9 89.4 3.1 2.4 2.2 1.6 1.3 10.6 26.0 16.2 12.6 16.2 7.4 4.0 2.3 2.6 87.3 3.8 2.8 2.4 2.1 1.6 12.7 26.0 15.0 12.8 15.3 6.8 4.2 2.9 2.7 85.7 4.4 3.0 2.5 2.6 1.8 14.3

While the worldwide IT services market has posted a five year CAGR of just ~3.5% and global sourcing market of ~9%, Indian software services revenue has grown at a CAGR of 16%. The primary reason for the same is the benefit accruing out of labor arbitrage, leading to cost savings for clients. Along with large players in the global IT industry, the top-5 Indian IT companies have been increasingly gaining market share since the last five years in overall revenue terms, in some cases cannibalizing into the market share of global IT biggies. Indian IT is becoming competitive in terms of services being offered to the clients globally in addition to cost advantage. During FY2007-12, Indian IT services’ revenue market share has grown at an average of 85bp per annum. The top-5 Indian IT services vendors have increased their share in India’s IT exports by ~135bp per annum over the same period; supplementing the fact that Indian large-cap players have been surpassing mid-cap companies in terms of grabbing market share.

Indian IT-BPM: Large-cap companies to continue to surpass midcaps in revenue market share.
Worldwide, IT services spends have grown at a CAGR of 3.4% over the past six years. During this period, Indian IT services’ revenue market share has grown at an average of 85bp per annum. The top-5 Indian IT services vendors have increased their share in India’s IT exports by ~135bp per annum over the same period. This supplements the fact that Indian large-cap players have been surpassing mid-cap companies in terms of grabbing market share. Also, with midcaps facing issues such as demand pressures, limited pricing power, high client concentration, limited bench, limited margin levers and high revenue base, we expect large-caps to lead in terms of revenue growth and grab incremental market share.

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Sector Update | March 2013

Exhibit 7: Historic market share gains
FY2007 Worldwide spend (USD bn) % growth yoy Indian IT (USD bn) % growth yoy Market share of Indian IT Market share gain (bp) India top tier revenues (USD bn) % growth yoy Top tier as % of Indian IT Top tier market share gain (bp)
Source: Company, Angel Research

FY2008 672 4.8 42 33.8 6.2% 134 18 40.3 42.1 193

FY2009 721 7.3 48 14.6 6.6% 42 20 14.1 42.0 (19)

FY2010 718 (0.4) 51 7.2 7.1% 50 22 7.6 42.1 18

FY2011 733 2.0 61 20.3 8.4% 127 28 28.2 44.9 276

FY2012 758 3.4 71 15.6 9.4% 99 33 20.9 47.0 206

FY2013E 785 3.6 77 8.7 9.8% 46 37 11.8 48.3 131

641 31 4.8% 12 40.2

Assuming the average market share gains over the past six years and 3.4% CAGR in worldwide IT services spend, the top-5 Indian IT companies are likely to grow at ~14% CAGR over the next three years.

Cognizant led the growth in Indian IT market share
Going by data on incremental market share gains over the past five years for Indian players, we believe Cognizant has been a clear outperformer, primarily due to its strong focus and investments in the fastest growing US market. Excluding Cognizant, growth for the top-4 IT companies is lower by 2-3 percentage points.

Exhibit 8: Historic market share – Ex cognizant
FY2007 Market share - Indian IT services Top tier as % of worldwide spends Top tier market share in Indian IT (%) Top tier market share ex-Cognizant (%)
Source: Company, Angel Research

FY2008 6.2 2.6 42.1 37.0

FY2009 6.6 2.8 42.0 36.1

FY2010 7.1 3.0 42.1 35.7

FY2011 8.4 3.8 44.9 37.4

FY2012 9.4 4.4 47.0 38.3

FY2013 9.8 4.7 48.3 38.8

FY2007-13E

4.8 1.9 40.2 35.6

805 312

India IT-BPM industry to continue to maintain its leadership globally
The Indian IT-BPM industry’s value proposition, low development costs, cheap skilled workforce and competitive billing have supported in the country emerging as one of the key outsourcing destinations. Indian IT has been continuously gaining market share in the global IT spend with India being one of the preferred offshoring destination. The India IT-BPM industry’s value proposition, low development costs, cheap skilled workforce and competitive billing has supported the country to emerge as one of the key outsourcing destinations. The IT-BPM industry is at an inflexion point – it has evolved dramatically over the last decade in terms of scale and complexity, key service offerings and the value it provide to its customers – from a legacy service-based solution provider to strategic partner providing end-to end services. Globally, India has been accepted as one of the dominating forces in the IT-BPM market, growing at a CAGR of 25% during FY2000-13, which is four times higher than the global IT-BPM spend during the same period (Source: Nasscom). This was achieved through an India-centric FTE-based delivery model relying primarily on cost arbitrage, tapping labor pool from major Indian cities and offering application development and maintenance

March 20, 2013

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Sector Update | March 2013

support across key verticals of BFSI, manufacturing and telecom to Fortune 500 clients. From a value perspective, the industry is now increasingly aligned to its customer business, providing scale and maximum leverage, as against just offering cost arbitrage and a solution for skill shortage.

Exhibit 9: India – the only country to offer full spectrum of IT-BPM services
Full gamut of services
IT Services, eCommerce BPM, Animation and Gaming ER&D Knowledge Services Software Products OSPD

Ownership Profile

Indian Service Providers

MNCs

GICs

Integrated

Pure-plays

Players Portfolio

Tier I firms

Medium

Emerging

Start-ups/Small

Verticals Portfolio

Aero, Auto, BFSI, Telecom

Hi-Tech, Manufacturing

Government, Auto and Ancillaries

Retail, MPE, FMCG, Energy

TTL, Real Estate, F&B

Pharma, Agri, Healthcare

World Presence

Americas

Europe

Asia

Africa

Australia

Customers

Fortune 500

SMBs

Governments

NGOs

Source: Nasscom, Angel Research

As per industry reports, even after years of outsourcing and rising competition, India continues to maintain its dominant position as a leading outsourcing market as compared to other emerging economies such as China, Philippines and Indonesia. India is the all-round standout with its first mover advantage and deep skill base, and still maintains its lion’s share of the IT-BPM market. India continues to maintain its advantage of cost-efficiency as compared to other key locations worldwide. As per Nasscom, under current macro-economic conditions, global customers continue to value Indian IT companies owing to their strong cost management and highly mature client delivery capabilities across verticals. One of the most critical factors that is enabling India to keep its position as a leading service player in the global outsourcing market is its output of highly qualified talent pool of technical graduates and postgraduates every year. In FY2013, it is expected that India will churn out 4.74mn graduates and postgraduates (Source: Nasscom).

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Sector Update | March 2013

Exhibit 10: Indian IT maintaining cost competitiveness
110 90
79-81 57.5-59.5 57.5-59.5 49.5-51.5 42-44

(USD '000)

70 50 30 10

38-40

31-33

30-32 25-27

21-23

19-21

Buenos Aires

Monterrey

Prague

Beijing

Kuala Lumpur

Operating cost per FTE per annum for IT services: ADM 2012
Source: Everest Research, Nasscom, Angel Research

Offshore employee base of MNCs now comparable to Indian vendors
IBM last reported its India headcount at 74,000 in its 2007 annual report. As per media reports, IBM currently has an employee headcount of ~130,000 (more than one-third of its employee base) in India. From less than 10,000 people in 2002, IBM’s India operations now account for nearly US$3bn in revenue including the business it earns from serving local customers. IBM along with Accenture has come a long way since its IT outsourcing business was challenged by rising Indian rivals Infosys and TCS - in the late 1990s. Back then, Indian tech firms offered to deliver software projects at rates that were one-fourth of that in the US. Both IBM and Accenture have been hiring hundreds of thousands of software engineers since then in order to compete better. Accenture also currently has got ~110,000 employees in India. Offshore delivery led growth, which was a disruptive force over 2000-2005, is no longer a big differentiator. So India continues to remain one of the biggest destinations for offshoring of IT services.

Going ahead, we expect growth to be driven by emerging industry verticals such as retail, healthcare and utilities, even as the traditional industry verticals BFSI and manufacturing record industry average growth rates.

Industry vertical wise growth: New verticals to surpass growth in matured verticals aided by lower base
In line with the past trend, BFSI and manufacturing industry verticals have remained two of the largest verticals in terms of total share in IT spending, with more than ~42% share. Emerging verticals such as retail, healthcare, lifesciences and utilities have contributed ~30% to the total spend in 2012. As per Nasscom, growth during CY2012 was driven by emerging industry verticals such as retail, healthcare and utilities, growing at a consolidated 12%, even as the traditional industry verticals BFSI and manufacturing recorded just an industry average growth rate. We expect this trend to continue going ahead as well.

March 20, 2013

Metro Manila

Bengaluru

Singapore

Bangkok

Pune

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Sector Update | March 2013

The BFSI industry is the most mature in terms of offshoring and IT has permeated across most of the BFSI value chain. This industry accounts for the largest share of more than 41% of Indian IT-BPO exports.

BFSI - Matured vertical, growth driven by market share churn
The BFSI vertical has been one of the earliest adaptors to technology due to high volume of transactions involved, which required more and more applications and systems for improving customer experiences and increased efficiencies. The BFSI industry is the most mature in terms of offshoring and IT has permeated across most of the BFSI value chain. This industry accounts for the largest share of more than 41% of Indian IT-BPO exports. Going forward, technology services spending in the BFSI segment will be driven by the key imperatives of integration, optimization and regulation (Basel III, Dot France etc.) and increasing shift of BPO business on platforms. Key areas of investment in this industry segment include customer service solutions through cloud, smarter analytics, business intelligence, m-commerce, cloud computing and virtualization. In this scenario, IT services providers in India have a huge opportunity, with potential to upsell, upgrade, customize and take advantage of the limited internal expertise within these organizations. Worldwide spend in the BFSI vertical is expected to post a three-year CAGR of 3.1%. India's domestic IT spends are valued at US$30.4bn, out of which the BFSI sector contributes 11.1%; the sector is fast growing in terms of IT investment. Domestic firms made the maximum investment in hardware products, with 53% spend set aside for this category, followed by IT services at 32% and software at 15%.

Going forward, technology services spending in the BFSI segment will be driven by the key imperatives of integration, optimization and regulation. Worldwide spend in BFSI vertical is expected to post a three-year CAGR of 3.1%.

Manufacturing - Matured vertical, limited churn in market share
The manufacturing industry is also one of the mature industries in terms of offshoring. Major drivers of growth within the manufacturing vertical are auto, chemical products, metals and food & beverages. Likewise to BFSI, the manufacturing industry vertical has also been one of the large contributor to worldwide IT spend. The manufacturing industry segment has seen increased uptake of outsourcing last year, resulting its share having shot up from 16.0% in 2011 to 16.6% in 2012. While large and medium organizations have been adopting IT to optimize their supply chain management, inventory control systems, and product/process management among others; smaller players have been adopting it currently to meet compliance requirements, improving quality of their products, aligning to new business developments and for better business flow. Major drivers of growth within the manufacturing vertical are auto, chemical products, metals and food & beverages. IT spend in the manufacturing industry is driven by the needs of staying ahead of competition, better customer satisfaction, informed decision making, globalization and better control of mobile employees. Worldwide spend in the manufacturing vertical is expected to post a three year CAGR of 4.4%. Manufacturing is the biggest spender on IT-BPO products and services in India. This industry segment contributes ~30% to the total domestic ITBPO market spending. A majority of the spend is focused around IT services with significant focus on system integration, custom application development and hardware/software maintenance. Traditionally manufacturing organizations have been very low on outsourcing of IT business activities but this phenomenon is changing fast.

Worldwide IT spend in the manufacturing vertical is expected to post a three year CAGR of 4.4%.

March 20, 2013

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Sector Update | March 2013

Telecom industry has been struggling since recession in FY2009-10, reason being that most of the telecom infrastructure in developed markets has already been built which has resulted in a shift from capex to opex model and hence most work outsourced is in the maintenance space.

Telecom and Media - Laggards in growth due to worsening financials
The telecom industry segment has been struggling since recession in FY2009-10 due to focus of US and European firms on expanding in faster growing economies such as India and China, which resulted in reallocation of budgets in these geographies. The second reason has been that most of the telecom infrastructure in developed markets has already been built which has resulted in a shift from capex model to opex model and hence most work now being outsourced is in the maintenance space rather than high value development space. IT spend from telecom equipment manufacturer companies has been sluggish although there are some signs of improvement seen in spending from telecom services provider companies with 3G and 4G launches happening in many economies. As a result, the share of telecom in IT-BPO exports has declined slightly. Mobility remains the biggest growth opportunity for key players in telecom. While the telecom space has been facing a tough time, the media vertical on the other hand has picked up well due to increased digitization. Social media is seen as a new marketing tool as the platform directly offers access to more than millions of connections, thereby enabling firms to reach their end-customers in almost no time. Social media trends are also enabling forms to respond to market changes faster and tailor their products/services to end user demands. Worldwide IT spend in the telecom industry segment is expected to post a three-year CAGR of 4%. While matured verticals like BFSI, telecom and manufacturing had been major contributors to worldwide IT spends (~US$752bn in FY2013), upcoming verticals like retail, healthcare, travel and utilities; in spite of being one-third of matured verticals size (~US$301bn in FY2013); have started showing more traction. Primary reason for the same has been late adoption of technology and data analytics.

Retail - New technology ties together online and offline stores
Retail is one of the key emerging industry segments. In the retail industry segment, online sales, online platforms, and m-commerce are driving the need to develop smart applications. Worldwide IT spend in retail industry is expected to post a three year CAGR of 5.6%. In the retail industry segment, online sales, online platforms, and m-commerce are driving requirement to develop smart applications which can throw useful insights into customer behavior and patterns. Retail is one of the key emerging industry segments where the growth is driven by mobility and analytics. Currently, retail industry is a hybrid model of online and brick-and mortar; however, rapid advancements in internet and mobile technologies are driving growth of online retail. Other factors driving this growth include 24x7 convenience, improved broadband access, web-enabled services, broad selection of online products that enable comparison of price and features and online payment gateways. Retailers are looking to technology to enhance customer experience, drive customer loyalty, reduce costs, enable more efficient inventor/space/human resource management and manage global supply chains in order to differentiate and stay competitive. Indian IT firms have been developing domain capabilities across the entire spectrum of retail value, chain-marketing, merchandising, supplier collaboration, warehouse and store management. Worldwide IT spend in retail industry segment is expected to post a three year CAGR of 5.6%.

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Sector Update | March 2013

In healthcare, data analytics has started playing a key role with significant increase in clinical trials and processing of patient responses. Worldwide IT spend in this industry segment is expected to post a three year CAGR of 7.0%.

Healthcare - Huge addressable market
In healthcare, data analytics has started playing a key role with significant increase in clinical trials and processing of patient responses. This industry is one of the potential adopters but is still on the maturity curve and is working towards standardization of internal processes. Much of the growth in healthcare spending is expected to come from spending on Electronic Health Record (EHR) systems, mobile health applications and efforts to comply with new government standards. In the US, most of the spending can be attributed to the Healthcare Reform Act, the new ICD-10 coding system, and adoption of EHR systems, which will be mandated by 2015. The technological advancements and keen interest of consumers in the benefits of mobile health technology will be the main drivers for increase in healthcare-related IT spending. Worldwide spend in this industry segment is expected to post a three year CAGR of 7.0%.

Travel and Utilities - Huge addressable market to tap
In these industry segments, volume of data thrown out for processing and converting into information has been growing at an exponential pace. Utilities’ IT investments will continue to be driven by smart metering roll outs, operational excellence, cost reductions and need to comply with energy policies and regulation. We expect worldwide spend in travel and utilities industry segment to post three year CAGR of 5.7% and 6.7%, respectively.

Exhibit 11: Worldwide industry vertical wise spend – emerging verticals to lead the growth
(USD bn) BFSI Manufacturing Retail Healthcare Transportation Communications and media Utilities and Construction Services Government Others Total
Source: IDC, Angel Research

2009 221 238 110 46 37 178 56 98 170 248 1,402

2010 225 245 112 49 38 184 58 101 175 268 1,456

2011 236 259 118 53 40 196 61 107 186 294 1,552

2012 247 273 123 56 42 204 64 113 196 320 1,640

2013 254 283 129 60 44 215 68 118 207 322 1,701

2014 263 296 135 64 47 222 73 124 218 326 1,769

2015 3 year CAGR (%) 271 310 145 69 50 230 78 131 229 327 1,840 3.1% 4.4% 5.6% 7.0% 5.7% 4.0% 6.7% 5.0% 5.3% 0.7% 3.9%

March 20, 2013

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Sector Update | March 2013

Exhibit 12: Industry-wise revenue growth of tier-I Indian IT players
BFSI growth (%) TCS Infosys HCL Tech Wipro Manufacturing growth (%) TCS Infosys HCL Tech Wipro Telecom growth (%) TCS Infosys HCL Tech Wipro Retail growth (%) TCS Infosys HCL Tech Wipro Energy and utilities growth (%) TCS Infosys HCL Tech Wipro
Source: Company, Angel Research

FY2007 45.0 49.2 76.7 47.2

FY2008 42.2 29.0 43.4 59.0

FY2009 2.7 6.0 6.3 26.8

FY2010 10.9 3.3 23.4 1.5

FY2011 FY2012 28.6 32.6 30.4 23.0 20.9 13.3 12.6 13.4

25.0 23.4

14.3 29.3 35.8

41.7 12.7 20.6 25.6

(15.7) 2.4 8.9 4.7

16.8 (6.2) 34.2 20.7

38.4 6.3 23.9 6.2

67.5 69.5 0.5 26.6

40.9 51.3 37.0 (14.3)

(12.4) (6.5) 7.6 8.3

(10.7) (8.4) 2.0 (1.8)

28.1 0.8 11.8 16.2

7.8 (8.5) (3.3) 4.7

53.4 40.9

49.3 59.5 89.0

41.6 19.2 30.0

23.8 8.7 31.3 (10.4)

17.4 34.3 45.8 22.1

37.8 28.0 17.9 10.5

36.0 61.0 27.5

54.9 32.6 42.5

9.7 22.3 8.0

12.9 6.6 157.1 12.7

80.8 30.0 39.1 24.1

18.3 4.4 12.1 57.6

APAC and EMEA to bolster growth going forward
During 2012, IT spend from Asia Pacific (APAC) region grew by 6%, nearly 1.6x faster than mature geographies. IT spend from America remained steady at 5% and Europe, Middle East and Africa (EMEA) recorded a minimal growth of just 1% yoy since 2011. In terms of regional contracts, APAC was the sole market in 2012 to have registered significant growth of ~55% (value terms) and increased its share in total contract value to 15%. EMEA contracts declined by 13% while those of the Americas declined by ~2.5%. Along with APAC, EMEA (2011 IT spend of US$258bn) provides significant opportunity for front on IT players as factors like global companies wanting to expand footprints in these geographies, cost cutting initiatives and demand for robust systems present huge opportunities. The penetration levels in these geographies currently are very low. In addition, as the European market is becoming more amenable to offshoring, growth in this geography is expected to firm up further.

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Sector Update | March 2013

Exhibit 13: Geography-wise revenue growth of tier-I Indian IT players
Growth from US (%) TCS Infosys HCL Tech Wipro Growth from Europe (%) TCS Infosys HCL Tech Wipro 67.0 54.5 73.0 38.5 40.1 43.9 35.7 32.5 7.6 4.9 9.4 13.0 (4.6) (10.2) 20.6 0.8 20.0 17.5 29.2 23.0 25.2 17.9 18.8 18.4 FY2007 38.5 40.3 29.8 33.6 FY2008 35.0 32.4 34.2 37.5 FY2009 7.9 13.8 23.1 19.3 FY2010 7.8 7.3 24.5 (1.8) FY2011 29.1 24.8 23.3 13.6 FY2012 21.9 13.3 19.6 7.3

Source: Company, Angel Research

SAMC – Social, Analytics, Mobility and Cloud – emerging technologies which could reshape the future of IT-BPM industry
As per IDC, Indian IT vendors are expected to generate more than US$225bn from SMAC related revenue by 2020. As per industry sources and commentary from Managements of various IT companies, consumerism and the ubiquity of connected smart devices have led to convergence of four forces: social, mobile, cloud and analytics. Social analytics brings together elements of segmentation, targeting, predictive marketing and effective customer relationships to translate into a revenue mechanism that affects profitability of business. Enterprise mobility helps enterprises meet strategic imperatives, improve operational efficiencies, real-time connectivity across functions and create engaging customer experiences. Cloud envisages virtualization, elastics selling, service automation and immense cost improvement through dynamic abstraction of IT services. Big data offers a unique suite of advanced analytics for better intelligence and derive meaningful insights from customer data to increase sales, better target customers, improve reach and gain competitive advantage. As per IDC, Indian IT vendors are expected to generate more than US$225bn from SMAC related revenue by 2020. SMAC has reoriented the business model of traditional IT firms by shifting focus from cutting costs and managing IT infrastructure to a move towards creative solutions that help clients’ businesses grow. As per Gartner, enterprise mobility market is expected to reach ~US$140bn by 2020, a CAGR of ~15%. Global market of big data is expected to grow by 45% annually to reach ~US$25bn in 2015 while global market of cloud is expected to reach US$650-700bn by 2020. (Source: Nasscom). International Data Corporation (IDC) predicts that 2013 will be a year of big jumps in SME businesses’ cloud use.

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Sector Update | March 2013

Outlook
Global IT-BPM spend is expected to grow in the range of 5-6% over the next two years and global sourcing is set to grow faster at ~7-8% during 2013 and 2014. India has retained its position as a leading global shoring destination with a 50-55% share in global sourcing market and has been able to maintain and inch up its share despite challenges. With customers increasingly engaging with Indian service providers as a strategic partner rather than just a technology service provider, key players of the Indian software industry have capitalized on areas such as continued focus on cost-efficiency, scalable environment, availability of human capital and customer centric approach. We continue to remain positive on the overall Indian IT sector, especially on large- cap companies. The global economy is set to improve going ahead with global GDP predicted to grow by 3.5% in CY2013 and 4.1% in CY2014. Emerging geographies are coming up in a big way as important trade destinations. Nasscom suggests that five major technology changes are expected to open new opportunities for service providers – smart computing, software-as-aservice, social technologies, mobility and analytics. These factors are expected to drive growth in overall technology spend by ~6% in 2013. Global sourcing is set to grow faster at ~7-8% during 2013 and 2014. India continues to be the global sourcing leader, but it accounts for only ~10% of the total global IT-BPM spend of US$124-130bn, which implies that the market is huge and presents immense untapped opportunity India continues to be the global sourcing leader, but the total global IT-BPM sourcing market of US$124-130bn accounts for only ~10% of the global IT-BPM spend, which implies that the market is huge and presents immense untapped opportunities. Indian IT-BPM firms are well set to take advantage from these trends by working towards developing new capabilities, servicing the entire IT services value chain and expanding their focus to new geographies, technologies and industry verticals. Indian IT companies are investing into building platforms to drive further growth opportunities. These domain solutions and technology platforms will offer improved revenue leverage vs talent employed in the industry. Nasscom indicated that FY2014 total revenues from India (domestic + exports, excluding hardware) are expected to grow by ~13-15% to reach US$106-111bn and out of this, exports are likely to be in the range of US$84-87bn, ie a growth of 12-14% yoy. Gartner has recently indicated an optimistic outlook and has increased IT spending growth forecast for CY2013 to 4.2%, up from the prior forecast of 3.8%, mentioning that uncertainty around the globe is coming to end and the same is likely to lead to an increase in IT spending. In addition, IDC also predicts worldwide IT spending to exceed US$2.1tr, up 5.7% yoy in CY2013. We expect tier-I companies to lead growth during FY2014 with volume growth to be 10%+. In terms of mid-cap IT companies, we expect challenges to persist due to factors such as high client concentration, demand pressures, restricted pricing power, limited margin levers, and limited bench sizes.

We expect tier-I companies to lead the growth going ahead.

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Sector Update | March 2013

Valuation
We expect TCS and HCL Tech to lead the growth in tier-I IT pack by growing higher than the industry average in FY2014. We continue to remain positive on TCS and HCL Tech from a longer term perspective, though current valuations preclude us from taking any considerable upsides from current levels for the next couple of quarters. TCS’ stock price has run up significantly and is currently trading at 19.8x FY2014E and 17.6x FY2015E EPS, which leaves little room for upside in the stock price in the near term. HCL Tech is currently trading at 14.7x FY2014E and 13.4x FY2015E EPS. We recommend Accumulate rating on TCS and HCL Tech with target price of `1,625 and `875, respectively. The PE premium between TCS and Infosys has reduced now, given Infosys’ outperformance during 3QFY2013 after six quarters of disappointing results. Infosys is currently trading at 16.9x FY2014E and 15.6x FY2015E EPS which is at a premium to the Sensex. Infosys is expected to perform better than its larger peers during 4QFY2013 aided by recent acquisition of Lodestone, which we believe would lead to re-rating of the stock further. We maintain Accumulate rating on Infosys as well as Wipro with target price of `3,132 and `473, respectively. Tech Mahindra remains one of our preferred picks in the entire IT space as the company has recently acquired two companies which will give it inorganic boost. Also, post its merger with Mahindra Satyam, the risks which the company is facing right now such as client concentration and industry concentration will be curtailed and the company will be able to reap benefits from Mahindra Satyam’s capability in enterprise services. Along with Tech Mahindra, we like KPIT Cummins among mid-caps at the current level with a target price of `130, owing to recent correction in the stock price despite industry leading revenue growth.

Exhibit 14: Recommendation summary
Company HCL Tech Hexaware Infosys Infotech Enterprises KPIT Cummins Mahindra Satyam MindTree Mphasis Persistent TCS Tech Mahindra Wipro Reco Accumulate Buy Accumulate Accumulate Buy Accumulate Neutral Neutral Accumulate Accumulate Buy Accumulate CMP (`) 779 87 2,869 172 103 124 915 399 538 1,556 1,067 430 Tgt Price (`) 876 117 3,132 196 130 143 602 1,625 1,230 473 Upside (%) 12.4 34.8 9.2 14.0 25.8 15.0 11.9 5.0 15.3 10.0 FY2015E EBITDA (%) 19.5 19.2 28.4 18.5 15.2 19.1 19.4 17.4 24.6 28.1 18.1 19.5 FY2015E P/E (x) 13.3 7.4 15.1 7.9 7.1 10.5 9.9 9.6 8.9 17.7 9.3 13.6 FY2012-15E EPS CAGR (%) 17.4 9.5 9.3 14.5 21.8 5.3 19.9 3.3 19.3 17.3 9.3 11.6 FY2015E RoCE (%) 1.5 0.9 2.5 0.4 0.5 1.1 0.9 0.7 0.9 3.5 1.6 1.6 FY2015E RoE (%) 21.1 22.1 20.0 13.1 18.8 20.1 18.8 13.6 16.8 27.4 19.1 17.6

Source: Company, Angel Research

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Sector Update | March 2013
Research Team Tel: 022 - 39357800 E-mail: research@angelbroking.com Website: www.angelbroking.com

DISCLAIMER
This document is solely for the personal information of the recipient, and must not be singularly used as the basis of any investment decision. Nothing in this document should be construed as investment or financial advice. Each recipient of this document should make such investigations as they deem necessary to arrive at an independent evaluation of an investment in the securities of the companies referred to in this document (including the merits and risks involved), and should consult their own advisors to determine the merits and risks of such an investment. Angel Broking Limited, its affiliates, directors, its proprietary trading and investment businesses may, from time to time, make investment decisions that are inconsistent with or contradictory to the recommendations expressed herein. The views contained in this document are those of the analyst, and the company may or may not subscribe to all the views expressed within. Reports based on technical and derivative analysis center on studying charts of a stock's price movement, outstanding positions and trading volume, as opposed to focusing on a company's fundamentals and, as such, may not match with a report on a company's fundamentals. The information in this document has been printed on the basis of publicly available information, internal data and other reliable sources believed to be true, but we do not represent that it is accurate or complete and it should not be relied on as such, as this document is for general guidance only. Angel Broking Limited or any of its affiliates/ group companies shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. Angel Broking Limited has not independently verified all the information contained within this document. Accordingly, we cannot testify, nor make any representation or warranty, express or implied, to the accuracy, contents or data contained within this document. While Angel Broking Limited endeavours to update on a reasonable basis the information discussed in this material, there may be regulatory, compliance, or other reasons that prevent us from doing so. This document is being supplied to you solely for your information, and its contents, information or data may not be reproduced, redistributed or passed on, directly or indirectly. Angel Broking Limited and its affiliates may seek to provide or have engaged in providing corporate finance, investment banking or other advisory services in a merger or specific transaction to the companies referred to in this report, as on the date of this report or in the past. Neither Angel Broking Limited, nor its directors, employees or affiliates shall be liable for any loss or damage that may arise from or in connection with the use of this information. Note: Please refer to the important `Stock Holding Disclosure' report on the Angel website (Research Section). Also, please refer to the latest update on respective stocks for the disclosure status in respect of those stocks. Angel Broking Limited and its affiliates may have investment positions in the stocks recommended in this report. Disclosure of Interest Statement
Analyst ownership of the stock HCL Tech Hexaware Infosys No No No No No No No No No No No No Angel and its Group companies ownership of the stock No No No No No No No No No No No No Angel and its Group companies' Directors ownership of the stock No No No No No No No No No No No No Broking relationship with company covered No No No No No No No No No No No No

Infotech Enterprises
KPIT Cummins Mahindra Satyam MindTree MphasiS Persistent TCS Tech Mahindra Wipro

Note: We have not considered any Exposure below ` 1 lakh for Angel, its Group companies and Directors

Ratings (Returns):

Buy (> 15%) Reduce (-5% to -15%)

Accumulate (5% to 15%) Sell (< -15%)

Neutral (-5 to 5%)

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Sector Update | March 2013
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