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ISG hints at decelerating As-A-Service in CY21 (vs pre Covid)

ISG data suggested that, managed services (+6%, vs Mar-20) staged a better recovery from pre-Covid level than As-A-Service (+4%). This was led by the five Europe-based mega deals seemingly comprising higher share of managed services. In CY20 As-a-Service ACV grew 17% YoY (vs initial expectation of ~24%). Optically, this growth looks strong. However, given the counter-cyclical expectations around: 1) Covid-led acceleration in public cloud migrations (post Mar-20), and (2) the much needed optionality of variabalising fixed costs provided by public cloud, which is especially relevant during recessions (like CY20) – this growth is way lower than the current consensus’ expectations. Notwithstanding the favourable base of FY20, ISG expects As-A-Service market to grow only 20% in CY21, hinting at a deceleration vs pre Covid levels (as against street expectations of acceleration). This data further corroborates our argument that once the recovery from trough is in the base (by Jun-21), organic growth rates of the industry (Sep-21++) are unlikely to see a meaningful acceleration (vs pre Covid). In conjunction with the sharp run up in valuations, we maintain our anticonsensus cautious stance.

* As-A-Service performance is way lower than the lofty counter-cyclical expectations: ACV trajectory over the previous four quarters indicates that managed services (+6%) staged a better recovery from pre Covid (Mar-20) level than As-A-Service (+4%). This is interesting on two counts especially given the counter-cyclical expectations around this segment: 1) consensus widely believes that Covid accelerated public cloud migrations, and 2) public cloud offers the muchneeded optionality of variabalising fixed costs to enterprises, which becomes a key deal breaker in recessionary years like CY20. For managed services, higher share in the five European mega deals awarded in Dec-20 seems to have gone in favour. For the full year, As-A-Service ACV increased 17% YoY (vs initial expectations of ~24%). Managed services ACV fell short of initial outlook in Jan-20 by a similar quantum despite the widely held belief that this segment is more vulnerable to cyclical pressures. In summary, performance of As-A-Service segment is way lower than current consensus’ euphoria.

* CY21 outlook hints at decelerating As-A-Service (vs pre Covid): For CY21, ISG now expects ~3% YoY growth in Managed Services with a further upside risk in the scenario of continued strength in mega deal flows. Expectations around this segment are more or less similar vs pre Covid. However, ISG also cautions that margin impact of these large transactions will be a key theme to watch out for. For As-A-Service, ~20% YoY growth is expected (by ISG). While the headline number looks strong, it hints at a growth deceleration vs pre Covid notwithstanding the favourable base of CY20. Notably, this goes against the current consensus expectations of a material acceleration in industry growth rates (overall and in digital / cloud) post Covid.

* Organic growth rates unlikely to accelerate post Covid, in our view: This data further corroborates our argument that once the recovery from trough is in the base (by Jun-21), organic growth rates of the industry (Sep-21++) are unlikely to see a meaningful acceleration (vs pre Covid). In addition, as some of the mega deals entered into by the industry in recent past seemingly have higher share of managed services component, margin headwinds are to be watched out. In conjunction with the sharp and quick run-up in multiples (up to ~75%, vs pre Covid), we maintain our anti-consensus cautious stance on the sector. Prefer Infosys, HCLT, and Mphasis.

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