Technology - Stagnant As-a-Service; strong recovery in Managed Services - ICICI Securities

Information Services' (ISG) quarterly index suggested global sourcing industry recovered ~4% QoQ. It is surprising that despite the hype around cloudification over the last ~6 months, As-a-Service ACV remained stagnant QoQ (at US$8bn) and still lower than pre-Covid levels (by 6%, vs Mar-20). This trend is in-line with our observations on "The euphoria around Cloudification/Digitalisation - Truth v/s Hype" highlighted in our recent report (link). Recovery during Sep-20 was entirely driven by managed services (10% QoQ). Within this, as we anticipated, the rebound was led by a strong comeback in BFSI across verticals (50%+). Increased activity in mega deals, contract restructuring and industry-specific BPO also aided the recovery. ISG indicated outlook for managed services is healthier than projected earlier with improving pipelines and currency tailwinds. For CY20, ISG now expects As-a-Service market to grow ~16% YoY, a deceleration of 5% from CY19. This is notwithstanding the consensus expectation of Covid-led robust acceleration in cloud adoption.

- As-a-Service was stagnant despite hype around accelerated cloud adoptions. Despite the recent euphoria around Covid-led accelerated cloud adoption, we are surprised to note As-a-Service ACV remained stagnant QoQ (at ~US$8bn). Interestingly, it is ~6% lower than the ACV reported during Mar-20, largely before the pandemic. The stagnancy in As-a-Service ACV was broad based across geographies (Americas, APAC and EMEA). In 9MCY20, while As-a-Service ACV grew ~15% YoY, it should be noted this still represents a material deceleration (by ~700bps) vs 9MCY19. Within this segment, we understand SaaS has been a relative drag.

- Recovery was entirely driven by managed services. Managed services market in Americas recovered beyond the pre-Covid (Mar-20) level, while it remained almost stagnant in other major market (EMEA) QoQ. Within EMEA, UK market accelerated. In managed services, as we anticipated, the recovery was driven by a strong comeback in BFSI across verticals (50%+). Increased activity in mega deals, contract restructuring and industry-specific BPO also helped.

- Outlook for managed services is healthier than projected earlier. ISG hinted at improving pipelines and currency tailwinds within managed services segment. It projected that ACV will improve slightly and could accelerate further if some larger transactions come to award. As IaaS providers like AWS, Azure are expected to benefit from burgeoning trends in video conferencing, gaming etc., ISG forecasts ~16% YoY growth in CY20. However, it is to be noted that it is a 500bps YoY deceleration notwithstanding the consensus expectation of Covid-led acceleration in cloud adoption.

- We believe the euphoria around cloud and digital needs a reality check. As we highlighted in our recent sector thematic (link), 'Cloudification' and 'Digitalisation' had almost become synonymous with Covid-19. Consensus expectations of a material and permanent increase in growth/profitability of the industry, factor in aggressive assumptions around (1) incremental monetisability of these technologies and (2) irreversible change in human behaviour. Prior hyper-disruptive events (e.g. Spanish Flu, SARS, demonetisation) and current mobility trends present a contrasting evidence. Hype aside, our analysis suggests, Covid-19 can at best drive ~150bps growth acceleration over FY22-23E. We advise bottom up investors to play on growth/profitability improvement led by micro factors. HCLT, Infosys and TCS are our preferred BUYs.

Source : Equity Bulls

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