IT Services Revenue decline more probable now – Morgan

Investors have so far focused on risk to pricing, but a reset of volumes could surprise on the downside. Morgan Stanley says cases of banks resetting overall portfolio spending on offshore vendors, leading to significant cuts in offshore spending. Resetting business volumes with existing clients is the biggest concern for IT vendors. Lower budgets and rationalization of portfolios is on the cards of major FIs.

Although companies have been able to maintain pricing for contracts so far, rates could come under severe pressure if overall volumes were to contract. Vendor consolidation could benefit select companies.

While consensus still expects revenue growth for the sector in FY2010, the outlook is turning tougher than anticipated, and forecast an organic revenue decline of 5-20% yoy across the board. Cost analysis: Infosys as a benchmark to estimate the buffer due to lower costs.

Morgan is reducing earnings estimates for large caps and now forecast 4-5% US$ revenue decline for Infosys and TCS and 13-21% lower revenue for the small/mid-cap vendors in our coverage universe.

Overall, Morgan Stanley is downgrading TCS, Tech Mahindra, and Hexaware to UnderWeight and maintaining our Cautious industry view.