Rupee hurts

First quarter of FY05 will be challenging for MphasiS

Rupee appreciation has taken its first toll on the Q4 results, with MphasiS BFL posting a lower net profit than in the previous quarter.

While the group's operating profit was up 7.5 per cent sequentially, net profit was lower by 11.4 per cent. The main reason was a steep fall in net foreign exchange gains from Rs 6.11 crore in Q3 to Rs 1.41 crore in Q4. The management points out that the decrease is "primarily due to a significant appreciation of the rupee during the quarter ended March 31, 2004".

Although the "group hedges its risk of loss......the gains recorded on such transactions have been significantly offset by losses attributable to the translation of accounts of foreign subsidiaries and restatement of foreign currency denominated assets."

Revenues were up 6.8 per cent over the December quarter, and operating profit margins were in fact slightly higher. But the rise in revenues was almost solely on account of MsourcE, the group's BPO arm, which accounted for 76 per cent of the incremental revenues during the quarter.

Sequential revenue growth at the software arm has been minuscule, seen from the fact that even on a year-on-year basis growth has been just 13.5 per cent in Q4. It's not only rupee appreciation which has hit the software arm, because even its gross profits declined sequentially, although the decline was much lower than during the previous quarter.

Gross margins continued to decline at the software arm. MphasiS' onsite business rose during the quarter, at the cost of its offsite business, while the number of offshore employees rose significantly. The lower utilisation rates""offshore utilisation rates fell from 67 per cent to 61 per cent during the quarter, while onshore utilisation rates rose a bit""offset a slight increase in onshore billing rates. Many of these problems can be attributed to the loss of business from one Japanese client, who used to be one of MphasiS' top five clients.

That's why, according to the management, in spite of many new client additions, growth at the software arm has been elusive. A reduction in the number of sub-contractors was also a reason for the larger numbers on the bench.

The uninspiring performance of the software arm was compensated by MsourcE, whose revenues rose 16.3 per cent sequentially, while gross profits rose 25 per cent. Operating margins at MsourcE were 10.7 per cent during the quarter, compared to 10.1 per cent in Q3. True, net profit growth was a much lower 4.9 per cent, but that's mainly on account of higher tax provisions compared to a tax credit in Q3.

Although MphasiS' guidance for FY 2005 is upbeat, considering that it assumes continued rupee appreciation, we need to remember that the figures include the recent Kshema acquisition.

Also, while the management believes that gross margins for the whole year will improve for both the BPO and the software services business, the current quarter will be challenging for two reasons""-yet another large client has decided to set up its own captive unit, and recent salary hikes will squeeze margins.

Infosys Tech's US foray

Infosys Technologies is setting up a US subsidiary in Texas, with an investment of $20 million. It is logical for Infosys to expand aggressively in the high margin IT consulting segment, offsetting the pressure on billing rates.

Infosys' onsite billing rates in Q3, FY 04 fell from around $63.1 to approximately $ 62.7. As a result, blended (onshore and offshore) billing rates dropped approximately 0.6 per cent in the quarter ended December '03.

Analysts point out that in comparison, billing rates in the consulting segment are much higher, ranging from $250 per hour at the medium end and can go up to $500 per hour. This should help improve the average billing rates for the company.

But Infosys' subsidiary would have to quickly overcome the problem encountered in this business "" this segment is getting crowded, apart from having the presence of a number of globally recognised players such as Accenture, EDS and Cap Gemini Ernst & Young.

Nevertheless, Infosys' American subsidiary has the potential to create its niche in the consulting space "" the quality of manpower recruited for this venture is one of the best available in the industry, as the subsidiary's four founder-members have held top positions in US consulting firms.

Also, this subsidiary could leverage the existing client network of its parent "" it is well accepted in the industry that clients are increasingly looking for one company that can meet most of their IT needs.

However, a big-ticket purchase still eludes Infosys. This is in sharp contrast to other large players like IBM which has taken over Daksh for approximately Rs 700 crore. Analysts point out that Infosys has stayed away from large acquisitions due to integration issues.

With contributions from Amriteshwar Mathur