Shares of India’s prominent IT outsourcing firms are facing a reality check amid the AI boom. Global investors are rushing into the artificial intelligence theme, leaving traditional tech stocks behind. Unlike their counterparts in the developed world and China, Indian software companies, including Tata Consultancy Services Ltd. (TCS), have not made significant strides in generative AI. This, combined with uncertain client spending, could soon render them outdated tech bets.
“Traditional software companies’ earnings and valuations are at risk because their business models are not evolving with the times,” said Deven Choksey, managing director of DRChoksey FinServ Pvt. The Indian software sector has seen a significant fall in stock prices, as shown by a BSE Ltd. gauge of Indian software stocks dropping through key support levels into a technical correction. Despite this, it still trades above its historical average earnings multiple, following a long rally in the nation’s equity market.
Slowing Growth and Increased Competition
India’s IT firms have historically enjoyed robust growth, riding the wave of global outsourcing trends. Major corporations worldwide outsourced substantial amounts of back-office work to Indian companies to cut costs, a phenomenon famously known as “getting Bangalored.” This outsourcing boom provided Indian IT giants like Tata Consultancy Services Ltd. (TCS) and Infosys Ltd. with steady revenue streams and significant market expansion.Â
However, this lucrative period of growth is now facing headwinds. Revenues from outsourcing are slowing as international clients curtail spending due to challenging economic conditions. The global economic landscape has become more volatile, and businesses are tightening budgets to navigate uncertainties. This shift in client spending priorities is impacting the financial performance of Indian IT firms. This heavily relied on the outsourcing model for decades.
Simultaneously, the competitive landscape is evolving rapidly. Software and internet giants such as Microsoft Corp. and Alphabet Inc. (Google) are investing billions of dollars in developing cutting-edge technologies like cloud services and large language models. These advancements are reshaping the tech industry, setting new standards for innovation and service delivery. In contrast, Indian IT companies have been slower to adapt to these technological changes, putting them at a disadvantage in the global market.
Deven Choksey, managing director of DRChoksey FinServ Pvt., highlighted the urgency of this issue. “Coding is getting left behind by computing in the tech investing world,” he noted. Choksey emphasized that Indian firms need to quickly reinvent their business models to embrace artificial intelligence and deliver advanced software-as-a-service (SaaS) solutions and infrastructure. Companies like Amazon Web Services (AWS) are setting benchmarks in this area, and Indian IT firms must strive to match these capabilities to stay competitive. Recent financial reports underscore the challenges faced by Indian IT giants. TCS reported its slowest annual sales growth in three years, while Infosys issued a tepid revenue growth forecast of 1% to 3% for the fiscal year ending March 2025.
Modest AI Contributions and Economic Uncertainty
Despite positive remarks about AI from Indian companies and global peers like Accenture Plc, actual sales contributions from AI remain small. TCS reported its AI pipeline doubled last quarter to $900 million, but this is minor compared to its total annual revenue of around $30 billion. The geopolitical environment and uncertain macroeconomic outlook continue to affect client spending priorities. According to Jefferies Financial Group Inc., the IT sector may face further downgrades after missing sales expectations last quarter.
“Results by IT firms disappointed on the top line, and management commentary points to a weaker-than-expected growth outlook,” wrote analysts Akshat Agarwal and Ankur Pant in a note dated May 7. “Despite up to 7% cuts to consensus estimates last month, we see further risks to earnings, limiting upside” in share prices. The BSE tech gauge’s high valuations, trading at 25 times forward estimated earnings compared to pre-pandemic levels of about 18 times, further indicate caution. Growth metrics for sales and earnings have declined from 2019 levels.
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Future Prospects and the Imperative for Innovation
Indian software makers are currently perceived as laggards in the realm of artificial intelligence (AI). This lag puts them at risk of losing investor interest and facing potential business cannibalization threats. Anurag Rana, an analyst at Bloomberg Intelligence, underscores this concern by stating, “The theme of corporations spending more on AI while cutting back on non-AI spending is global in nature.” The absence of significant advancements in AI within Indian IT firms suggests a pressing need for transformative action.
For Indian IT firms to remain relevant in the ever-evolving tech landscape, rapid innovation and a strategic shift towards AI integration in their business models are imperative. The burgeoning AI boom demands agility and forward-thinking strategies to sustain competitiveness on a global scale. Failure to adapt to this paradigm shift may result in missed opportunities and diminishing market relevance for Indian software makers. As such, embracing AI technologies and fostering a culture of innovation are critical for navigating the challenges and seizing the opportunities presented by the AI-driven future.
