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Technology: Knots to growth in Europe, ICICI Securities

April 14, 2022

We attended the IT Spending Forecast, Q1CY22 Update Webinar held by Gartner. The webinar revolved around how IT spends are impacted on account of geopolitical disruption, inflation, currency fluctuations and supply-chain challenges. Due to the Russia-Ukraine conflict, cyber security, supply-chain resiliency and energy efficiency are also on top of mind for enterprises. As highlighted in our thematic note rising inflation compounded with talent shortage has led to CIOs rethinking their IT budgets which has slowed down the decision-making process, especially in Europe where IT spending has currently paused. Higher inflation will lead to postponement of discretionary spends, and focus on cost optimisation will increase. Higher focus on cost may lead to dampening of tech budgets and reduction in discretionary spending. Though the Russia-Ukraine conflict does not have any direct impact on global IT spending, it has further added to the already prevalent macro uncertainties which will delay the decision-making process.

Industry is witnessing massive price hikes by IT services vendors which can increase further in the medium term, causing delay in signing of large deals (for timeline of 5-7 years) as there is difficulty in fixing the pricing of deals.

The Russia-Ukraine war is causing higher FX volatility which is expected to persist until 2025, according to Gartner. Tier-1 IT services players have received 120-500bps YoY cross currency tailwinds from Q1FY21-Q2FY22 which have helped them report a strong USD revenue growth rate. Post weakening US macro environment, GBP and Euro have depreciated vs the INR. Indian IT services’ US$ revenue growth will face hindrance due to depreciation in GBP and Euro vs US$.

We truly believe tech spending will always be viewed as growth accelerator, but enterprises will also have to mitigate through high-inflationary environment and geopolitical tensions. Given the scale of disruption/uncertainty in Europe, we believe companies having higher exposure to Europe will be impacted. In our coverage, tier-1/tier-2/ER&D companies have an average exposure of 28%/19%/28% to Europe, respectively. With Indian IT sector already trading at 28x 1-year forward P/E, we believe much of growth and earnings expectations (digitisation, cloud migration etc.) over the next three years are already factored in share prices.

Worldwide IT spending growth forecast reduced to 4% (vs 5.1% in Q4CY21): Though projections remained stable in CC terms, extreme volatility in currency fluctuations led to a reduction in US$ forecasts. Gartner expects US$ to face more headwinds, to the tune of 1-3% every quarter in CY22.
Continued increase in cloud spending: Gartner indicated a lot of spending has been happening in the cloud area with enterprises rapidly wanting to shift from on-premise to cloud. While traditional enterprises anticipate 1-2% growth over long term, real growth is coming from tech providers who are building on their cloud and digital capabilities. Cloud infrastructure managed services market is expected to grow at 65% in CY22 with 25% CAGR over CY20-25. IaaS is expected to grow at 32% in CY22 with 20% CAGR over CY20-25.
Talent war may get aggravated: Resource/ talent shortage is the most overwhelming problem for enterprises (clients of IT vendors). People are not only switching for higher salaries but also looking for work-life balance. Wages have increased by 15-20% in US and Europe. Average salary per employee is expected to stabilise by the end of this year or H1CY23, according to Gartner.
Europe will slow down in CY22: Growth in Europe in CY22 will be slower – Western Europe is expected to grow at 6% in constant currency vs 6.7% growth of North America and global growth of 5.8%, led by high inflation. Gartner has not seen cancellation of contracting activity but there are pauses and some contracts have been delayed.
Growth in spending across industries: Every industry is expected to be back at their 2019 levels of spending including transportation. Further, most of these industries are in growth phase and are spending on digital transformations much ahead of revenue recognition. IT spending in E&U, retail, communication & media, banking & investment services and insurance is expected to grow at 8%+ in CY22. Supply-chain issue of semiconductor chips is expected to resolve by the end of this year. The main reason for this problem is China’s zero covid policy leading to shutting down of Chinese cities, impacting semiconductor supply chains.
No direct impact due to Russia-Ukraine conflict: Given that affected eastern Europe accounts for only 1.8% of global IT spending, Gartner does not expect any material impact on markets. However, this conflict is further pushing the issues that were already making noise i.e. inflation, supply-chain disruption, currency fluctuation / volatility, manpower shortage and less stability in providing IT services from remote locations.
Rising inflation to dampen IT spends. Due to rising inflation, prices across the board are going up given the real cost increase. CIOs have reported a massive increase in pricing which is still being budgeted and hence, delaying the decision-making process. Gartner expects inflation to particularly dampen IT spending in Europe due to Russia-Ukraine conflict.
IT spending is being consolidated: As per Gartner, 40% of US$137bn increased tech spending in 2021 was accrued to top 10 vendors. Market is consolidating with more market share going to larger players. Top 10 vendors (Amazon, Accenture, Microsoft, Deloitte, EY, PwC, Capgemini, TCS, McKinsey and Google) accrued 40% of IT services spends. There is shift in preference towards larger providers with headcount also moving in their favour vs earlier. The preference is being shifted to work with larger services providers with small vendors becoming less significant. Due to this consolidation of markets, headcount is also more skewed towards these large providers given the scale of projects.