Mid-cap IT services companies outdo large peers

Growth momentum for mid-cap IT services companies seems to have got a boost with large and mega deals going off the table for now and more mid-to-small deals becoming the norm.

These players have not only outdone the large companies on revenue growth in the December quarter but also have managed the supply-side constraints, which otherwise have impacted the margin performance of tier-1 firms.

For instance, Pune-based Persistent Systems reported sequential revenue growth of 9.2 per cent in US terms and 38.7 per cent year-on-year in revenue growth at Rs 1,491.7 crore. It also managed to take its margins up by 10 basis points (bps). This, despite the fact that the company had stock rewards cost, higher subcontractors, and higher costs due to attrition during the quarter.

“We believe Persistent and other tier-II IT companies would continue to deliver strong revenue momentum over the next 5-6 quarters (translating into high double-digit revenue growth over FY22-FY24E) and, thus, would sustain current valuations of 35x40x, which implies over 1.5x on PEG basis. We currently value PSYS at 36x (earlier 36 times) on FY24E earnings of Rs 122.3 (earlier Rs 119.3) with TP of Rs 4,400 per share (earlier Rs 4,300) and upgrade the stock to accumulate rating,” said Rahul Jain and Divyesh Mehta of Dolat Capital in their research report.

Persistent’s performance was impacted by its inorganic strategy. The company acquired SCI, a payments solution company, and Shree Partner. “We have been reporting three straight quarters of 9 per cent sequential growth and the pipeline we have is healthy and the market environment augurs well for growth going ahead,” said Sandeep Kalra, chief executive officer and executive director of Persistent Systems, during the earnings call.

L&T Infotech, on the other hand, reported 9.2 per cent revenue growth on a constant currency basis and improved margins by 70 bps. It also managed to add 27 logos in this quarter, one of the highest quarterly additions in many quarters.

“LTI’s ability to deliver end-to-end solutions is expected to help in registering industry-leading growth. Its ability to win large deals, presence in niche verticals, effectively mine clients, adding Fortune 500 clients, and digital prowess are other key drivers for future price performance,” said a ICICI Direct report.

“We expect LTI to register 20.0 per cent compound annual growth rate (CAGR) revenue growth in FY21-24E. LTI’s share price has grown by Rs 10.7x over the past five years (from Rs 630 in January 2017 to Rs 6,714 levels now)

For many mid-cap IT firms, deal sizes going down means they get equal opportunity to compete with the larger players. The $30-$25 million deals are an area where most of the mid-cap firms have traditionally been strong.

“With deals getting smaller, mid-cap IT players are getting a seat at the table. When it comes to billion-dollar deals, clients prefer to work with large-cap firms due to risk assessment. But the focus now is agility, digital capabilities, and smaller deal sizes, which is an area where mid-caps have always been aggressive,” said Pareekh Jain, founder of Pareekh Consulting, an IT outsourcing advisory firm.

On the supply side, like their larger peers, mid-cap IT firms are rushing to campus for more freshers. Mphasis has said it is on track to hire 5,500 freshers for FY22.

The company is also retraining its employees in the DXC business with digital skills as the revenue from this unit is declining.

Mindtree, too, has stated that fresher hiring for FY23 will be 40-50 per cent higher than FY22. For the third quarter, it added 1,500 and intends to hire a similar number for the next few quarters. Business Standard