Tuesday, September 16, 2008

Is it the tip of the ice-berg?

The Chapter 11 (Bankruptcy Protection) filed by the 158-year old Lehman Brothers, the $50-billion sale of Mother Merrill to Bank of America, and the ratings downgrade of AIG seems to have sent shiver down the spine of investors in both mature and emerging markets. A reflection of the same was seen in Wall Street, as it posed its worst losses since September 11, 2001. Fears that other big Investment Banks can belly-up also seems to be haunting the investors. It may be pertinent to note that Two weeks ago, U.S. Government bailed out two of its Mortgage agencies – the Fannie Mae and Freddie Mac. A few months ago, it also bailed out Bear Sterns. However, this time it was unwilling to commit tax payers money to bail out Lehman. Understandably, this is a cause for concern for several software and IT companies in India given their dependence on BFSI (Banking, Financial Services and Insurance) segment.

Likely outcome

Albeit a good year into sub-mortgage crisis, several Investment Bankers are still reeling under losses. Case in point is UBS, one of the largest Investment Banks based out of Switzerland, which has posted pre-tax losses to the tune of US$21 billion in the first six months of 2008. Arguably, this just appears as the tip of the iceberg, as the crisis is slowly moving towards the ‘prime mortgage’ segment. To a large extent, this is due to steady increase in job losses, which is forcing even genuine EMI payers to default. Adding to the woes is the steady increase in the mortgage rates, despite the rate cuts initiated by the Federal Reserve. This may further result in a drop in the home prices, as Job losses will deepen. Fed may opt for some more rate cuts, given the liquidity crunch the market is facing currently.

What it means to Software companies

Companies such as Wipro and Satyam claimed (in a Television Channel) that the Lehman’s bankruptcy may not impact them as their exposure to the company is low. Infosys, on the other hand, claimed that the acquisition of Merrill Lynch to add to their revenue, given BOA is their key customer. Taking a broader perspective the scenario does look gloomy, though there seem to some light at the end of the tunnel.

It is pertinent to note that Indian software companies get over 90% of their revenues from US and European Customers, even as $600 billion worth of Investments are made on IT budgets every year globally. But, only a miniscule of it is generally outsourced. However, given the looming crisis several fortune 500 companies may tighten their IT budgets. In other words, several projects on the anvil (on the verge of being outsourced) may get shelved. IT services providers may also be forced to cut their prices (and in turn their margins) while bidding for projects, as the market pie grows smaller. Software companies will be forced to part with their employees to survive this shakeout over the next one year. Companies such as Satyam have started paring its employee count, even as they put several employees under ‘performance improvement’ programs. This crisis, however, will also enable the software companies to source better candidates in the market, at modest price levels.

A closer introspection of results of Investment Banking companies, for the quarter-ended September, may reveal some more interesting insights. Till then, let us keep our fingers crossed.

Madhan Gopalan, the author, is a Consultant with Ness Technologies. The views expressed here are his own and not necessarily that of his Employer. He can be reached at gmadhan72@yahoo.com

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