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ISG, Gartner point to increasing IT spends

ISG and Gartner, leading global consultants and advisors to the IT Services industry, released a strong forecast for industry growth in 2021. While Gartner revised up its 2021 IT Services spend for the third straight quarter, ISG hinted at a likely upward change over the next three quarters during its quarterly industry outlook call. We view this as supportive of our positive stance on the IT sector. Here are the key takeaways:

ISG index starts CY21 with all-time high ACV; maintains double-digit guidance

* Overall annual contract value (ACV) increased 11% YoY in 1QCY21, with the Asa-Service (AAS) market up 15% YoY and Managed Services up 6% YoY.

* Growth in AAS was driven by 18% YoY growth in Infrastructure-as-a-Service (IaaS) on account of a robust performance from hyperscalers. Growth in Managed Services was led by 43% YoY growth in the BPO business (on a lower base) and flattish ACV in ITO.

* Americas ACV was up a modest 6% YoY; EMEA grew 20% YoY, led by 25% YoY growth in Managed Services – led by large deals and a favorable base.

Expect significant uptick in Traditional IT for CY21

* ISG guided for a 5% YoY increase in Managed Services (Traditional IT Services) for CY21 after weak growth over the last two years. This was led by four large deals and an array of smaller size deals. Cost optimization remains the key focus of clients.

* AAS is expected to remain strong and grow 18% YoY (last-quarter guidance at +20% YoY) as it continues to benefit from IaaS spend. Software-as-a-Service (SaaS), on the other hand, remains a drag.

* ISG guided for a potential 500–700bp increase in growth in Managed Services if the four to five mega deals under discussion get converted to orders. If it happens, Managed Services would expand 10–12% YoY – this implies the decline of the past five years would be reversed to marginal growth.

Industry to witness growth-led talent crunch

* ISG believes there would be huge competition for talent in CY21; the ability to staff projects with resources would likely pose a key challenge.

* There would be higher demand for the relevant skills – with rising digital transformation, the hire-and-train model would become less relevant.

ER&D rebounding at rapid pace

* ISG indicated engineering R&D (ER&D) outsourcing is picking up rapidly, led by spends on ‘Industry 4.0’. ER&D ACV reported 2x the pre-COVID highs.

* Large M&A deals are underway owing to the potential lucrativeness of the industry – given its strong growth potential.

Gartner 2021 IT spending forecast revised up once again

* Gartner’s 1Q 2021 IT spending forecast indicates ~9.0% YoY growth in 2021, following a 1.8% contraction in 2020. It further estimates 7.3% growth in 2022.

* This is the third straight quarter of upward revision in the 2021 forecast, with 1Q 2021 estimates higher by 8.7% v/s the 2Q 2020 guidance.

* Gartner also highlighted the growing role of business departments in determining the Digital IT spend – Digital IT is increasingly being seen as a revenue driver.

Valuation and view; expect strong double-digit growth to continue

* The strong commentary on both AAS and Managed Services is encouraging for the Indian IT Services industry from a revenue perspective. We build in doubledigit growth across both large- and mid-cap IT Services vendors.

* We continue to see cloud – coupled with transitional cost takeout deals – as major themes for the IT Services industry from the near- to medium-term perspective.

* We continue with our bottom-up stance for the sectoral picks. Among the Tier I players, we like INFO and HCLT on the expectation of industry-leading growth. From the Tier II pack, we prefer LTTS and CYL, given their attractive and industry-relevant portfolios.

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