MUMBAI (NewsRise) -- As their share prices fall, India's cash-rich software exporters are rushing to buy back their own stock rather than investing in new technologies or buying other companies, a trend that's underlining concerns about the future of these former business pioneers.
With the traditional outsourcing model under assault from advances in automation and cloud computing and a more protectionist stance in some western countries, firms such as Tata Consultancy Services and Infosys need to find new ways to grow.
Acquisitions are an obvious answer. Yet the uneven experience of these companies with western purchases and unwieldy regulations at home may be raising hurdles, say senior executives and observers.
The weakening outlook has pushed software stocks to historic lows. Shares of TCS, India's largest software exporter by sales, hit a two-and-a-half year low in November when Donald Trump's victory in the U.S. presidential election raised the possibility of a tighter work-visa policy, which would limit the number of low-cost Indian engineers who could work on projects there. Shares of Infosys, the second-largest in the industry, hit a two-year low the same month.
The disappointing stock performance, combined with the huge cash reserves of these companies, has escalated demands for better returns.
In February, market-leader TCS, which had 432 billion rupees ($6.6 billion) in cash and investments on its books as of December, announced its first ever buyback worth up to 160 billion rupees. The decision came just days after Cognizant Technology Solutions, a Nasdaq-listed U.S. software exporter that has most of its employees based in India, succumbed to pressure from an activist shareholder and announced a two-year buyback and dividend plan totaling $3.4 billion.
Last week, HCL Technologies, India's fourth-largest software exporter by sales, got shareholder approval for a buyback worth up to 35 billion rupees.
Meanwhile, third-ranked Wipro, which was among the first to announce a buyback in April last year, is considering another round, using up to 30% of its 332-billion-rupee cash reserves, according to a CNBC TV18 report.
"The buyback and dividend payouts may stem the decline in share price...but for valuations to improve, revenues and earnings have to grow," said Ashish Chopra, analyst at brokerage Motilal Oswal. "And for that, companies must invest heavily in new digital technologies, while balancing the payouts," he said.
Speaking at an investor conference last month, Vishal Sikka, chief executive of Infosys, said the company is wary of valuations.
"We are not interested in buying yesterday's technology...we are interested in tomorrow's technology. And tomorrow's technology is usually expensive if it is really good. So, you have to be very, very selective in that," Sikka said.
Infosys, which had cash reserves of 357 billion rupees at year end, is now seeking shareholder approval to change its articles of association to allow buy-backs. The company's last attempt at a major purchase was in 2008 when it bid $720 million for British software firm Axon but lost to HCL.
According to Krishnakumar Natarajan, executive chairman of mid-sized software exporter Mindtree, there is greater need for acquisitions now because the technology landscape is transitioning with speed and companies don't have the luxury of time to adjust.
So far, Indian IT companies have specialized in developing software applications and maintaining infrastructure for client firms, using the large number of Indian IT engineers they can deploy on a project to their advantage. Infosys, which pioneered the software services revolution in 1981, now has more than 199,000 employees worldwide, while TCS has 360,000.
However, advances in cloud computing have shifted the focus to Internet-based software that can be easily customized. Developments in artificial intelligence and automation are also chipping away at jobs.
A recent Economic Times report that Cognizant is planning to lay off 6,000 employees in India cited automation as a reason.
Domestic lobby group National Association of Software and Services Companies has already lowered its revenue growth forecast in dollar terms for the industry to 8%-10% this fiscal year from 10%-12% previously. Outsourcing consulting firm Everest Group expects revenue growth for the top five Indian outsourcing companies to slow to 6.3% this year from 8.7% in 2016.
Analysts say Indian software firms should increase investments not only in cloud computing but also in the Internet of Things, analytics, and big data, while creating development centers in large markets such as the U.S. and Europe to reduce the reliance on stock services.
A few companies such as Wipro, where the founders continue to hold the majority stake, have moved ahead with acquisitions. In January 2016, a month after the New York- and Mumbai-listed company named a former TCS veteran as chief executive, it bought HealthPlan Services, a U.S. health insurance marketplace, for $460 million. In October, Wipro bought U.S. cloud services firm Appirio for $500 million.
According to Mindtree's Natarajan, given the cash available with Indian IT companies, they can both reward shareholders and spend on acquisitions. Yet Indian companies remain hesitant to make major purchases because they tend to find the integration process tedious, he said.
"To merge...you go through so many hoops and loops," he said. "When you are making an acquisition, you can't do a buyback in India."
For instance, the rules make it difficult for the company to offer common incentives such as a new stock ownership plan to employees because the capital structure of the acquiring company can't be changed for 12 months after a buyback, he said. "That seems illogical," he added.
Home-grown companies lack global scale, which further complicates integration and aggravates cultural differences, say observers. Since firms tend to buy businesses in new areas, the lack of familiarity with the business model is another factor that prolongs adjustment.
Some analysts question the need for acquisitions, saying that major ones have destroyed considerable shareholder wealth in the past.
Tech Mahindra's acquisition of U.S. network engineering firm Lightbridge Communications for $240 million in 2014 went awry after the company had to discontinue several low-profit businesses, taking a hit on margins.
Mindtree, which spent roughly $100 million on acquisitions in the past two years to bulk up its digital business, is still struggling to integrate Bluefin, a U.K.-based SAP software consulting firm it bought in 2015. Last year, it unveiled a restructuring at the unit to stem operating losses and on Monday, it announced a 20% interim dividend.
"Acquisitions are not the only way to build capabilities," said Sagar Rastogi, analyst at Mumbai-based Ambit Capital. "Organic initiatives such as training, developing service...or industry-specific solutions in-house and partnerships are cheaper and less risky."
--Dhanya Ann Thoppil