India's Big Three Tech Firms

Shares of India's three biggest tech and outsourcing companies by sales -- Infosys Technologies, Tata Consultancy Services and Wipro -- have had a tough year. But some analysts say now is a good time to buy their stocks, if investors can handle some near-term volatility.

A sharp appreciation of the rupee against the dollar and fears of a U.S. slowdown, amplified by the credit crisis, have hammered tech companies' shares even as the broader Indian stock market has hit record highs. Infosys's Mumbai-listed shares are down 26% this year, TCS is down 14% and Wipro is off 19%. Meanwhile, the Bombay Stock Exchange's benchmark index, the Sensex 30, is up 45%.

There are grounds for optimism. Fears over a strong rupee's impact on earnings could be overdone, analysts and investors say. Some industry watchers also say the Indian government might extend a tax benefit that has helped tech companies' profits. Many analysts also believe the three big Indian tech companies will continue to post solid earnings as they win bigger jobs from global clients.

"It's good to buy these tech stocks with the expectation that within nine to 12 months select stocks are going to give you returns in excess of 20%," says Viju George, senior technology analyst for Edelweiss Securities, a financial-services firm in Mumbai. He's advising clients to buy Infosys and TCS, which he sees as best-positioned to increase their market shares of the global services industry.

Just over 10% of the $400 billion-to-$450 billion-a-year global technology-services market is now outsourced to foreign service providers, industry watchers estimate. Indian companies have more than 70% of that market segment. Analysts say the outsourcing trend will grow as companies look to cut costs; that should help offset the impact of a possibly weaker U.S. economy.

As dominant players, TCS and Infosys stand to benefit if there is another wave of outsourcing amid U.S. economic trouble. Further, the Indian companies can gain by moving up the value chain and handling more complex jobs. Rather than "mere maintenance work," clients now outsource "newer and newer streams" of tech requirements, Mr. George notes.

To be sure, some analysts have seen India's big tech companies as attractive for a while, yet the stocks have continued to slide. Mr. George cautions that these shares have a potential downside of 10% to 15% from current levels, as valuations yo-yo on news of the U.S. economy. A large chunk of the Indian giants' revenue is still from American customers, though they are trying to boost their non-U.S. sales.

But Mr. George contends that "the risk of a slowdown is very much captured in current valuations," barring a full-fledged U.S. recession.

Even if customers' tech budgets come under pressure, there could be a silver lining for the Indian firms that get outsourced work, says Chennai-based Sukumar Rajah, chief investment officer for equities at the Indian arm of U.S. fund company Franklin Templeton. "Any sharp economic slowdown could result in increased outsourcing by Western firms to protect margins," he argues.

Mr. Rajah expects "well-managed Indian IT companies will do well in the medium to long term." Franklin Templeton holds Infosys, TCS and Wipro shares in a number of its equity funds.

So far, outsourced work is increasing as a proportion of corporate tech budgets, says analyst Pankaj Kapoor at ABN Amro Equities in Mumbai. In recent years, the global technology-services industry has grown at an annual rate of 5% to 6%, industry watchers say. But the Indian tech-services industry on its own is growing at around 35% a year. So, even if there is little or no increase in overall corporate tech budgets, Indian companies are likely to increase their market share.

One factor holding down tech stocks -- the rupee's appreciation against the dollar -- also appears to have abated somewhat, says Sanjay Sinha, chief investment officer at SBI Mutual Fund. The rupee has strengthened nearly 13% against the dollar in 2007, but the steepest gains came earlier in the year.