Investors in the Happiest Minds offer would be a happy lot, after the stock listed at twice the offer price on the bourses. But the success of the offer and the stellar listing has more to do with a “digital” frenzy among investors, than anything else. For its size and scale, Happiest Minds shouldn’t be commanding a big premium to peers. We’ll get to valuations in a bit. First, let’s address the sudden surge in excitement around IT services.
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COVID’S Digital Push
On Friday, TCS CEO Rajesh Gopinathan told CNBC-TV18 that the industry was on the cusp of a significant growth phase after COVID pushed businesses to move to cloud. He sees large deals in business transformation emerging from this. The first wave of business transformation would be followed by others like automation, much of which could play out in the coming 18 to 24 months, he said. Coming from India’s largest IT services company, that view carries a lot of weight.
Industry research organisations and analysts too have been flagging the positive trend, and many brokerages have raised earnings and price targets for IT services companies. Gartner expects IT spends to grow at 6-8 percent from 2021 to 2024 against an average of 4.5 percent in the past 10 years.
Frost & Sullivan (commissioned by Happiest Minds) estimates an average annual growth of 20.25 percent in emerging technologies till 2025. It expects robotics and automation to grow at 25 percent, AI and machine learning at 55 percent, cloud computing at 21.4 percent and Internet of Things (IoT) at 14 percent.
A McKinsey Global Institute study suggested that automation will displace 400 to 800 million people by 2030, and require them to find new jobs. A recent report by Credit Suisse also suggests a pick-up in automation, spelling good tidings for ABB and Siemens.
There is a growing consensus on growth, but Gopinathan also suggested that the big players have a clear edge in winning large transformation deals in what is a highly fragmented industry. Barings, which already owns Coforge and Hexaware (set to delist), recently inked a deal to acquire Virtusa for $2 billion . The depth and width of knowledge are important aspects weighed in deals and much of this can be addressed through consolidation moves—we’ll see later that Coforge and Hexaware have their own strengths. So, big seems more beautiful now, unless the company in question has a distinct edge or specialization that sets it apart.
THE TRANSFORMATION WAS COMING
To say that COVID is leading to business transformation would be incorrect. Many of the changes in business models driven by technology have been underway for some years now, and COVID has merely accelerated the transition. Limitations imposed by COVID like work-from-home and even shop-floor protocols are propelling a rethink about the way we do business. And decisionson business transformation is now occupying the minds of not just the CIOs but all CXOs, including the person at the helm. This will accelerate the change and lead to greater resources being put behind the shift.
To be sure, work-from-home isn’t a new concept nor is Industry 4.0. I know many in the US who have been mostly working from home for many years now. What’s changed, is the lack of an option and the need to rethink the way we do business.
What's already underway
Technology shifts that have already been impacting lives—like mobile data, e-commerce, OTT, digital transactions and myriad other consumer applications—are now set to broaden in their reach and scope.
BMW, recognized as a leader in Industry 4.0, recently rolled out a new IoT platform at its Regensburg plant that allows it cut time for deployment of new applications by 80 percent and reduces quality issues by 5 percent.
A recent survey of German manufacturers by Pinsent Masons revealed that 89 percent saw improving processes through technology as an organizational priority. The MPI industry 4.0 2020 study also revealed that 83 percent of manufacturing leaders see Industry 4.0 as extremely or very important and expect it to have a significant impact over the next 5 years.
SAP executives have been quoted as saying that enquiries for IoT have increased significantly over the past few months and that IoT was now being deployed not just in factories but across the supply chain—after all the two key pieces of IoT are sensors and clouds, not limiting factors for any application.
What’s also an interesting development in this space is private equity interest and the value seen in moving to smarter factories. Yotta Capital Partners has launched a €120 million Industry 4.0 fund, which will support the transition of French SMEs in the fourth industrial revolution.
In the automobile sector, a chat with the KPIT Technologies team about a year ago revealed that technology now accounts for about 40-50 percent of the cost of a modern vehicle (far lower in India at the moment). And customers are clearly voting for more. Studies suggest that car buyers will opt and pay more for cars rich in technology features. No wonder, automakers are serving more of it. Take Ford’s Co-Pilot 360 suite, which can adjust the speed to maintain a specified distance from the car in front by using cameras and also prevent a collision by applying the brakes. Similarly, telematics can be deployed that will use GPS to track how well you drive and allow your insurer to offer you a lower premium for safe driving. Connectivity too is getting to a new level.
Automakers like Audi and BMW are now embedding SIM cards in cars that will link to the cloud to offer you immediate access to all auto assistance as well as sync all your information—address book, music, emails, and so on—and even, soon, link up with all your internet-connected home appliances like air-conditioning, lighting, coffee-making to offer you a complete connected experience.
But that’s not it. IoT can be deployed even in traffic and infrastructure management and linked to driver safety. For example, sensors in roads can warn of deterioration in road quality and ensure timely maintenance, the same can also link to sensors in vehicles on the road to slow them down before potholes. Similarly, traffic signals can adjust their timings to the traffic in a particular lane and make the system more efficient, saving travel time for users and cutting fuel consumption.
None of this is far-fetched. In fact, many Indian companies have been deploying new technologies to address problems. Tata Power, for instance, we learn, used Big Data and analytics to curb revenue leakage and power theft in its Delhi power distribution business. Some private banks have also been running pilot applications for certain functions using blockchain.
Online broker, kabu.com (an arm of Mitsubishi Financial), on failing to find enough experienced manpower for surveillance of trades, decided to use artificial intelligence to help it with risk management.
To sum up, there is enough evidence to suggest that the technological intensity of organisations is set to expand significantly in the coming years. And businesses will need those in the business of technology implementation to help them make the big shift.
While the likelihood of transformational deals focused on digital and cloud are clearly likely to benefit Indian IT services players, and have been much talked about recently, we need to think of the transformation as much bigger than just that. And here players like L&T Technologies and Tata Elxsi that focus on higher-end industry-focused applications for sectors like automobiles and healthcare could be set for exciting times. Even companies focused on intelligent automation and Industry 4.0 like ABB, Honeywell and Siemens could be set for a new growth trajectory.
To briefly illustrate, health-tech can completely transform customer experience. Med-tech today allows for hundreds of pathological self-screening tests to be done with small devices (like a glucometer). These results get uploaded on the cloud, can be reviewed by doctors who consult online and then issue e-prescriptions, which in turn can be marked to an e-pharmacy that delivers the medicines to your doorstep. And this change is just round the bend, especially with key players like Jio and Apollo Hospitals stepping on the pedal. Many such digital revolutions are likely to and could permanently disrupt sector dynamics.
A future for the dreamers
Over the past years, we have seen many technological disruptions like e-commerce, OTT and cloud computing. There are many more under way like more long-range electric vehicles, self-driven cars, space travel, and what have you. And one look at the top tech stocks in the world underlines a clear similarity: most have been led by people who had the courage to dream. Apple, Amazon, Facebook, Google, and now Tesla are just some. You could also perhaps add homegrown Jio to the list after Jio Platforms' massive fund-raising exercise which saw marquee names signing up for a piece of the pie. All these companies are constantly looking to disrupt the status quo through innovation, and it wouldn’t be far-fetched to expect the next decade to see many, many more business models being upended. And the lever for these companies to disrupt is technology. So, if you want to bet on the future, you have to bet on technology.
Where to put your money
Unlike common perception, not all IT services companies are similar, though they operate in similar spheres.
Most Indian IT services companies are into customizing applications and implementation of IT systems, unlike companies they partner with like SAP or Microsoft. In fact, the big growth area of cloud is dominated by service providers like Amazon, Microsoft and Google, whom Indian players partner. While the IT players have been gradually moving up the value chain from their early body-shopping days, most are still a long way from being technology leaders. Here, top companies like TCS score over most of their smaller peers—even as they look to build new capabilities through acquisitions by institutionalizing new skill sets.
So, if it’s the vanilla IT services, I’d opt for the big boys in the game. This despite their lower growth in the past few years than mid-sized players. And while some like Happiest Minds might have a high digital exposure, it is likely that end-to-end capabilities will count in a complete transformation. What’s more, the client concentration and vertical concentration risk are generally low for the big players, and they generate loads of cash. Besides, a look at the valuations reveals they aren’t pricey in comparison.
A segment I am more excited about given the pace of growth expected in IoT and automation is engineering technology services, which is represented by players like L&T Technology Services, Tata Elxsi, and KPIT Technologies. These companies, though mid-sized, are more closely connected with their clients, and the projects are generally more critical and of longer duration. Besides, these companies operate at a higher level of the value chain, so it isn’t easy for a basic IT services company to graduate to this business, which is a moat.
Some say the youth is our future. Taking a leaf from it, it is interesting to note that an engineering vertical called Instrumentation Engineering changed to Electronics and Instrumentation a few years ago. Also, Mechatronics is a stream on the mechanical side. Expect you get the drift: if the youth are learning to think of technology very differently, the world is bound to change. And if you believe technology will drive change in the next decade, your portfolio allocation needs to reflect this.
Little wonder that investors have been chasing global tech stocks. Interestingly, after the recent slide in big tech stocks, the NASDAQ and BSE-IT indices are now both up about 25 percent since the start of 2020.
For me, I’d bet on the next decade being one for the dreamers. The dreamers who will use technologies to transform the world. I’m excited.