>IT Services (PINC RESEARCH)

Introduction
We initiate coverage on Indian IT services sector with a Negative view. We believe that the macro-economic factors will continue to impede Indian IT Services industry. The industry is experiencing multiple headwinds along with the slowdown that will play out in terms of reduced growth rates, pricing pressures, project cancellations, delays or no orders and return of economic nationalism resulting in sluggish top-line growth. We initiate coverage on Infosys (Sell), TCS (Sell), Wipro (Hold), and HCL (Hold) rating.

· Global macro-economic headwinds: BFSI, Telecom and Retail the worst affected: The current macro-economic outlook appears bleak in the near term. GDP of the US and Europe, which contributes about 85% of revenue for top 4 Indian IT comapanies, is expected to de-grow. BFSI, Telecom and Retail that contributes 65% of revenue for top 4, are suffering because of declining consumer confidence, write-offs and bankruptcies. M&A has further decreased the size of the pie.

· Globalization of global delivery model: Large global peers like IBM, HP-EDS, and Accenture have managed to grow at a faster pace in India than the top 4 Indian IT companies. Global players have steadily improved their margins over the last 3 years. Tier-1 Indian IT companies are also facing pricing pressure due to competition from the Tier 2 Indian IT companies.

· Pyramid effect not geared for decelerated growth: We believe that with little visibility of volume growth and gloomy macro-economic condition, and in declining attrition scenario, the ability to maintain the pyramid base would be difficult. Any decline in hiring would increase the average age and accelerated hiring would put pressure on utilization ratio and margins.

· STPI benefit to end in FY10, slower volume growth could increase tax rate further in FY11: End of tax holiday will have dampening effect on bottom-line of Indian IT companies. According to us, slower volume growth than expected could increase effective tax rate higher than anticipated in FY11. We are factoring in the number of new business moving to SEZ, but as the volume of new business dries up the companies' effective tax rate could be higher than anticipated.

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