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The 4QFY26 earnings for IT services results did little to allay fears of disruption in the sector. 40% of companies missed revenue estimates (40% in line, 20% beat), while 66% met or beat margin estimates. Questions around structural demand drivers remained unanswered. On deflation, AI seems to have found its product-market fit in software engineering and coding. Successive model releases will most likely shift the boundary of what is automatable; we believe that quantifying "deflatable" books is fraught with error, and we need a business model reset. On the other hand, we believe the AI implementation opportunity will surely materialize, but it may not accrue to the traditional vendors as it did in the past, and a new, platformized, AI-native vendor template will emerge. OpenAI’s DeployCo (and Anthropic’s services company as well) is the first credible blueprint for the next-gen system integrator. We will look for vendors who can replicate this (still developing) blueprint; the next 12-18 months could be a period of notable M&A activity in this regard. Until clarity emerges around these questions, we continue to prefer bottom-up plays with deal and earnings visibility in IT: TECHM in large-caps and COFORGE and KPIT in mid-tier. We also like HCLT; despite a short-term miss on growth guidance, we believe it is preparing for the next phase of growth (we are encouraged by news reports of HCLT leading a USD300m round in Sarvam, a sovereign LLM model startup). Our observations regarding the quarter are detailed below.

AI-led productivity gains starting to weigh on growth

* AI is increasingly deflationary, with productivity gains being passed on to clients, compressing growth in the existing book. This quarter, more companies began acknowledging that GenAI-led deflation is translating into commercial pressure.

* HCLT called out a 2–3% deflationary impact from GenAI on its book of business, while Infosys’ FY27 guidance (below estimates) suggests this pressure will continue as productivity gains are passed on. Exhibit 1 showcases organic YoY constant currency growth rate for the quarter.

DeployCo: our thoughts on OpenAI and Anthropic's foray into AI implementation

* On AI implementation, our conversations (see our note dated 4th May, 2026: Thoughts from the disruptors) lead us to believe that AI implementation is a huge opportunity, and enterprises will need the help of managed service providers (MSPs) for this. However, it is also most likely that these implementation gains will not go to the traditional vendors – new-age MSPs will be platform-heavy and will be agentified.

* OpenAI has launched a USD4b consulting and implementation business to help enterprises deploy AI into their day-to-day operations. We believe OpenAI's DeployCo is the first credible blueprint of the MSP of tomorrow.

* While this was taken negatively by the market, we believe tech services are not a winner-take-all market; it generally has multiple winners but little pricing power

* The question then is not whether DeployCo (or any other similar new-age system integrator) displaces IT services, but which company can replicate this model fastest. M&A could be a key difference between winners and losers in the next 24-36 months.

FY27 guidance resets growth expectations for the sector

* Growth expectations for FY27e, which were at 3-5% for large caps before Q4, have now been reset to 1-3%. Infosys’ FY27 guidance of 1.5–3.5% YoY CC (below expectations at the top end) signals increasing pressure on the existing portfolio from AI-led pricing compression and competitive intensity.

* HCL Tech’s soft FY27 guidance (1–4% YoY CC) reflects client-specific headwinds and early-stage AI deflation (2–3% impact), with the interplay between the two a key monitorable. Tech Mahindra continues to execute well on margins with its ~15% EBIT margin target for FY27 largely intact and less dependent on growth.

* Wipro’s 1QFY27 guidance of -2% to 0% QoQ CC (midpoint -1%) suggests another soft quarter despite partial contribution (1.5 months’ impact in 1QFY27) from two large deals.

Currency supported margins this quarter, but pressures remain ahead

* Margins broadly met or beat expectations this quarter, largely aided by favorable currency movement, pyramid rationalization, SG&A efficiencies, and improving productivity. INR depreciation against the USD provided a sharp translation benefit across the board (refer to Exhibit 12). Of the 16 companies reported so far, ten reported a QoQ improvement in EBIT margins.

* However, FY27 may see renewed pressure as wage hikes kick in, and AI investments and large-deal ramp-ups play out. Pricing pressures in a muted demand environment and ongoing deflationary trends could further weigh on profitability. In addition, we believe the GenAI curve remains margin-dilutive in the near term as investments are ramping up, but monetization is yet to follow.

* If USD/INR stabilizes near current levels, incremental margin expansion could prove difficult. We expect margins to remain largely flat over the next 18–24 months across the industry.

* In our view, any company that expands margins meaningfully from here will do so through workforce productivity, not revenue growth.

Outlook: Valuations very cheap, but returns may be capped until clarity emerges

* As seen in Exhibits 14–19, stocks are now inexpensive, with Tier-I valuations ~20%/31% below their 10-year/5-year averages. TCS and Infosys are trading around -1 SD P/E levels and ~40%/26% below their 10-year averages, while HCLT and TECHM are trading closer to their 10-year averages. Until deflationary pressures ease and new AI-led implementation use cases emerge, returns are likely to remain capped.

* We continue to prefer bottom-up plays with deal and earnings visibility in IT: TECHM in large-caps and COFORGE and KPIT in mid-tier. We also like HCLT; despite a short-term miss on growth guidance, we believe it is preparing for the next phase of growth (we are encouraged by news reports of HCLT leading a USD300m round in Sarvam, a sovereign LLM model start-up). Our observations regarding the quarter are detailed below.

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