Mid-tier IT cos need transformational deals

The big players in the IT services space are getting bigger while small players are staying small.Mid-tier software companies are reeling under the pressure of high attrition rates and increase in salary & wages. This was evident from the March 2011 quarter results announced by companies like Infotech Enterprises, Persistent Systems, MindTree, Zensar Technologies and Sonata Software. While the revenue growth remained buoyant, profitability was severely affected.

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Infotech Enterprises reported a 7.3% fall in operating profit margin despite a 33.5% rise in revenue. Similarly, Persistent Systems, a Pune-based company, witnessed profit margin decline 4.4% despite revenue rising 23.9%. The same story holds for companies like MindTree, Zensar Technologies and Sonata Software.

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For several quarters now, mid-tier software companies have witnessed an erosion in profitability. Some are trying to push up revenue by acquiring businesses. Zensar Technologies acquired a company in US and is on the look out to ramp up specific IT services expertise. Persistent Systems is also looking for acquisitions with over Rs 250 crore in cash.

Those tracking the space closely believe that mid-tier companies have to take drastic steps to break the logjam and achieve higher revenue traction. A Mumbai-based investment banker believes that MNC companies could look at buying them. Kale Consultants, a listed mid-tier software company, was acquired by French company Accelya in 2010. There was buzz in the market about Sonata Software too.

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The trouble with mid-tier companies is that they are driven by individuals with strong personalities, according to the banker. Hence, its not easy to convince them about merits of an M&A transaction. Industry experts often point out that large overseas customers hand out contracts to multiple vendors and then major vendors sub-contract niche work to smaller companies. Hence, a wave of consolidation is unlikely in the IT services business. However, companies that consistently face pressure on profits, should look at the option of consolidating costs and grow revenue.

Mid-tier software co March 2011 quarter performance.

• Infotech Enterprises: revenue up 33.5% to Rs 326 crore, operating profit down 7.3%; reported 43% jump in employee cost. Company negotiating price rise for contracts

• Persistent System: revenue up 23.9% to Rs 213 crore, operating profit down 4.4%; company expects wage hike and plans to hire 1,000 fresh employees

• MindTree: revenue up 13.6% to Rs 391 cr, net profit down 41%; loss in telecom vertical, wage hike and plans to hire 4,000 employees.

• Zensar Technologies: revenue up 61% to Rs 375 crore as it focussed on acquisitions. Net profit margin contracted 2%. Company plans more acquisitions and hires.