>IT SECTOR (MORGAN STANLEY)

● Key debates: 1) Revenue outlook: While consensus still expects revenue growth for the sector in FY2010, we believe the outlook is turning tougher than anticipated, and we now forecast an organic revenue decline of 5-20% yoy across the board. 2) Cost analysis: We use Infosys as a benchmark to estimate the buffer due to lower costs.

● Where we differ: Investors have so far focused on risk to pricing, but a reset of volumes could surprise on the downside, we believe. We have seen cases of banks’ resetting overall portfolio spending on offshore vendors, leading to significant cuts in offshore spending. Resetting business volumes with existing clients is the biggest concern for IT vendors, in our view, due to lower budgets and rationalization of portfolios. Although companies have been able to maintain pricing for contracts so far, we believe rates could come under severe pressure if overall volumes were to contract. Vendor consolidation could benefit select companies.

● Cutting estimates further: We are reducing our earnings estimates for large caps and now forecast 4-5% US$ revenue decline for Infosys and TCS and 13-21% lower revenue for the small/mid-cap vendors in our coverage universe. Rupee denominated EPS are at a slight advantage due to ~10% depreciation so far. While much of the bad news appears to be priced in, we think there could be more downside even from current levels as 2009 unfolds.

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