SMALL AND MID-TIER ITES IN BIG TROUBLE

P P Thimmaya, Bangalore
The Economic Times

The gloomy global economic outlook and reduced demand for technology services in the US and Europe is likely to result in an increased ITES in trouble pace of consolidation among small and mid-tier IT services companies in India, analysts say.

Export-oriented small and mid-tier IT companies were able to weather the storm of rapid appreciation in the rupee against the US dollar in 2007 and early 2008, but now they are faced with the stark reality of dwindling orders.

Sudin Apte of Forrester Research says that consolidation in the Indian IT industry was on the way anyway, but the pace may pick up in the next 18 months. He is of the view that a large number of smaller firms are in “denial mode,” thinking they will be able to ride out the bad times, but reality will sink in after they start seeing negative cash flows.

It is estimated that around 60-70% of the country’s IT services exports are contributed by the top 20 players, with the rest coming in from small and mid-tier entities. T R Madan Mohan of Browne & Mohan, a consultancy firm, says that the pace of consolidation will be high because of pressure from private equity investors. PE firms, which invested in software companies expecting an IPO in 2009, are either encouraging the companies to merge or bring in a strategic partner to reduce risk.

Analysts said this kind of consolidation is already happening for firms with a topline of around Rs 50 crore, but the major worry would be for entities, which have annual revenues of less than Rs 5 crore and servicing the BFSI market in the US or the UK.

For example, of the around 1,550 units registered with STPI Bangalore, only 28% of them have gross revenue of more than Rs 100 crore. The expectation is that through consolidation and mergers, a fifth of them will exit the system. Avinash Vashistha, CEO of offshore advisory Tholons, agrees that it would be a tough road ahead for the small and medium-sized firms. However, he also thinks that there is considerable interest among investors in these firms as their valuations are particularly low and there is greater interest in outsourcing and offshoring.

“The worry is that if there is a recession and downward trend till the last quarter of 2008, which is what seems to be imminent, then many of them have to look at drastically different business models,” says Mohan of Browne & Mohan.