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ISG outlook indicates continued momentum in 2022

ISG, leading global advisor to the IT Services industry, hosted its 4QCY21 industry call to discuss deal bookings during the quarter. Reported data on annual contract value (ACV; +1% QoQ) for 4Q was much ahead of ISG’s expectation of a meaningful decline. Moreover, despite unprecedented growth of 29% YoY and alltime high ACV in 2021, it expects ACV in 2022 to be up 14% YoY with growth in both legacy and cloud deals. We reiterate our positive stance on the IT Services sector. Here are the key takeaways:

Demand to remain robust, while supply pressure to start easing

* We see the strong double-digit growth outlook for 2022/FY23 from ISG as a positive – as it supports our view that the demand momentum should continue to support growth in IT Services despite the high base. More importantly, growth remains broad-based in both 4QCY21 as well as for 2022E. We expect strong initial commentary from Indian IT services companies for FY23 over the duration of the 3Q results season.

* The commentary on As-a-Service (AAS, including IaaS and SaaS) was not surprising given the strength in cloud migration. On the other hand, continued growth in Managed Services (legacy IT services) should help Tier 1 IT services companies that still have meaningful legacy businesses.

* ISG expects attrition pressure to moderate over the next few quarters as the demand-supply mismatch would start going away on increased fresher hiring over the last 2–3 quarters. Our channel checks further indicate attrition is peaking in the sector and should normalize in early FY23.

* ISG continued to highlight the strong demand and deal momentum in the ER&D Services space, which saw 3x deal ACV in 2021 vis-à-vis previous highs. We maintain our strong preference for the sector, as LTTS remains our top pick in Tier 2 IT. We remain convinced about long-term growth tailwinds for ER&D, led by increased outsourcing and larger deal sizes.

* We continue to prefer Tier 1 IT given the strong competitive positioning and relative attractiveness on valuations. Infosys and HCL Tech are our preferred picks within Tier 1 IT.

ACV bookings scale new high

* Overall ACV increased 32% YoY in 4QCY21, with AAS up 46% YoY and Managed Services 13% YoY.

* In CY21, growth in AAS was dominated by 40% YoY growth in IaaS, while SaaS witnessed 31% YoY growth. Managed Services growth was led by 31% YoY growth in business process outsourcing (BPO) on the lower base and 13% growth in information technology outsourcing (ITO).

* ACV for the Americas was up 27% YoY, and EMEA posted 23% YoY growth. Managed Services in the Americas / EMEA witnessed 19%/11% YoY growth.

Positive initial outlook for 2022

* 2021 growth in both Managed Services and AAS once again beat ISG’s outlook, with full-year growth of 16% YoY and 38% YoY against last quarter’s expectation of 10.1% YoY and 25% YoY, respectively.

* ISG sees continued growth momentum in 2022, with Managed Services growing 5.1% YoY and AAS 20% YoY.

* It continues to see increased demand and large pockets of growth

Pricing turns favorable

* ISG commentary on deal pricing supports the qualitative commentary from the industry on better deal pricing in digital deals. Moreover, the average increase in deals pricing is higher v/s past periods as clients are ready to pay for strategic work.

* While pricing for Managed Services is stable on account of its legacy exposure, high-demand work has seen an upward price revision of 4–7% to support higher wage costs in the industry.

* Coupled with stabilizing attrition, this should start supporting the profitability of IT services companies.

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