Diagnosing the health of a software company, once an uncomplicated exercise, is confounding analysts who are struggling to come to terms with the growing irrelevance of time-tested metrics.
The difficulty in understanding the vital statistics of a software company is reflective of the change-technological as well as operational-that is underway in the offshore outsourcing industry.
This means that analysts will have to go back to the drawing board and recreate models to accurately portray the software companies they track and make reliable investment recommendations. Furthermore, questions have arisen about what further disclosures companies must make in order for analysts to understand them precisely.
"Should we continue to look at the metrics the way we have been historically or are the changes that you are trying drive in the business reducing the utility of these metrics?" veteran equity analyst Kawaljeet Saluja of Kotak Institutional Equities asked Wipro chief executive TK Kurien during an earnings call after the Bangalore-based company's December quarter results.
Thus far, the most reliable indicator of a software company's health has been the volume growth which essentially describes the number of hours billed. Taken together with the price at which the billing happened, analysts had a reliable measure of how much money a company was making.
This earnings season, the disconnect was more obvious than ever as IT companies reported robust sales growth but muted volume growth, which appears irrational to anybody going by the earlier way of looking at these numbers.
Such disconnect has its roots in the fundamental shift in the way technology outsourcing contracts are given out - for a fixed price, rather than based on number of hours.
When Kurien said that sales growth and gross profit margins are the only indicators that analysts should rely on, the Kotak analyst suggested Wipro take an initiative in moving away from disclosures that are not useful. "Maybe you can do away with these disclosures. The first 45 minutes of this call has been spent on trying to understand those numbers," Saluja said during the one-hour earnings call.
Suresh Senapaty, chief financial officer at Wipro, told ET that Wipro is open to the idea of moving away from these disclosures, but such a decision will be dependent on a consensus on the Street that the old metrics are no more relevant.
"Some are prepared to change, but some still follow the traditional methods," said Senapaty. "There has to be an education process as to whether these numbers are relevant at all," he added.
While analysts like Saluja doubt the utility of the old metrics, others are more conservative and unwilling to completely let go of those as half the business of a typical IT company is still done in the old time-and-material model, where the number of hours clocked and rate at which those are billed still matter.
"To say those do not mean anything anymore would be taking it too far," said an IT analyst with a domestic brokerage firm on condition of anonymity as he is not authorised to speak to the media.
"Those questioning the old metrics should also come up with new ones that are relevant; otherwise it would be mere showmanship to call for junking the existing ones."
Some, such as foreign brokerage BNP Paribas, have also looked at additional data points such as revenue and profit per employee to supplement the insights provided by volume growth and pricing data.
"From volumes, pricing, sequential growth rates, attrition, utilisation and wages, we believe the discussion needs to shift to order backlog, new bookings, execution timeframe, employee productivity, year-on-year growth rates, and quality of attrition," Saluja wrote in a client note earlier this month. "Companies do not make disclosures on these lines, at this point. However, constructive discussions on them will ensure a new set of 'relevant metrics' are shared with investors."
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