A rather unexpected development in the global outsourcing industry took place earlier this month. Wipro Ltd. (NYSE: WIT), the No.3 Indian IT services company, announced that it had opened an outsourcing facility in the Philippines as part of an attempt to cut costs.
To most investors, this might sound rather odd. After all, isn't India one of the cheapest places in the world to do IT work? Well, the short answer is that this might no longer be the case.
Higher Salaries and Soaring Rupee
Wipro recently released its fiscal third-quarter ending results for the period ending December 31, and while net income rose by 11% to the equivalent of $211 million from the same period a year earlier, it fell short of analysts' expectations because it was the slowest rate of profit growth in four years.
This slow growth rate occurred because the company's margins were squeezed by rising salaries and a strong rupee. In fact, the rupee rose by more than 12% against the dollar last year and approached a 10-year peak in January. Because Wipro generates about 62% of its revenues from clients who pay in U.S. dollars - including the likes of telecom giants Cisco (Nasdaq: CSCO) and Nortel (NYSE: NT) - and has to pay out its costs in rupees, its profit margin has taken a beating on the currency conversion. Escalating wages for Indian IT professionals is also adding to the squeeze. And this situation is not likely to improve in the short run. In a Reuters interview from last week, Wipro CFO Suresh Senapaty admitted that margins were likely to shrink by another full percentage point in the quarter ending March 31. (To learn more, read The Bottom Line On Margins.)
Emerging Economies Overshadow the U.S.
While Wipro has been losing momentum because of its over-reliance on the U.S. market, its larger domestic rivals Tata Consultancy Service and Infosys Technologies (Nasdaq: INFY) both reported expectations-beating results earlier this month and forecast strong growth ahead. It appears that their strategy of diversifying their businesses into Europe, Asia Pacific and Latin America has been paying off. According to a recent study by IT consultants IDC, tech spending in Brazil, Russia, India, China and nine other emerging countries, including Poland and Mexico, is projected to increase 16% in 2008. In contrast, U.S. tech spending is projected to drop to a growth rate of just 4% in 2008, down from 7.7% a year earlier.
Buyout Rumor Denied - and Believable
The bleak forecast for U.S. information technology spending for this year also adds a degree of credibility to recent denials by Wipro management that it was in merger or takeover talks with French technology consultants Cap Gemini. Rumors of a possible deal surfaced last year, but with the prospect of a further slowdown in its U.S. business now likely, it would make sense for a prospective buyer to back off for the time being.
The Bottom Line
Wipro's American depositary receipts recently hit a 52-week low in trading on the NYSE. While some traders may be tempted to bottom-fish the stock at these levels, the prospect that a tech spending slowdown in the U.S. may be much worse than projected should give buyers pause, even at these levels.