MaSSSoftech

By DHANYA ANN THOPPIL

BANGALORE -- Sharp cost cuts will likely help Indian software exporters improve their profitability in this financial year despite an economic slowdown that continues to weigh on revenue growth, the principal research analyst at Gartner Inc. said.

"Instead of revenue growth, well-managed (Indian) information technology companies will show an increase in their bottomlines (profits)," Diptarup Chakraborti told Dow Jones Newswires in a recent interview.

He expects these companies to report flat to low single-digit sequential growth in quarterly revenue in the year through March 2010, as demand from their main market - the U.S. - remains subdued.

Last week, the National Association of Software and Services Companies, or Nasscom, forecast a 4%-7% growth in revenue from exports for Indian technology companies, much slower than the 16% growth in the previous year.

In the April-June quarter, India's top two software services exporters by revenue - Tata Consultancy Services Ltd. and Infosys Technologies Ltd. - posted a better-than-expected 22% and 17% rise in net profit helped by cost-cutting measures, while revenue grew 12% and 13%, respectively.

Both companies reduced the number of their employees sequentially during the quarter in an attempt to cut costs in a tough environment.

Mr. Chakraborti said the focus on efficiency will help the software exporters attain higher profitability, with 19%-20% operating margins remaining sustainable over the next two-five years.

For the quarter ended June 30, Infosys posted a 60 basis point sequential improvement in its operating margin to 34.1%, while TCS recorded a 113 basis point expansion to 24.83%.

"There are lots of inefficiencies in the Indian IT services sector," he said. "Just increasing the efficiency will allow you to improve margins."

Last quarter, most Indian technology firms improved their operational efficiency by moving more work to their low-cost Indian centers, having a greater percentage of their employees on billable contracts and lowering travel costs.

Mr. Chakraborti said although the pressure on billing rates has come down, Indian information technology service providers will find it difficult to raise billing rates again after having lowered them.

Infosys said last quarter it expects billing rates for its outsourcing services to decline by about 5% this year.

The weak global economy hurt India's software companies in the past few quarters as customers cut technology spending and sought lower rates for products and services.

"Until the U.S. recovers, there will not be any genuine recovery in the Indian market," he said. "A recovery with steady growth across sectors will not happen before the second quarter of 2010."

The U.S. market accounts for almost 65% of the total revenue of most Indian technology majors.

Within the sector, revenue from information technology services is expected to increase in single digits, while revenue from the business process outsourcing, or BPO, segment will likely grow in double digits, or even high double digits in 2010, Mr. Chakraborti said.

In the year ended March 31, the BPO unit of Infosys posted a 39% jump in revenue to 13.00 billion rupees ($274.8 million).

"The BPO deals are big-ticket, and cost cutting is still a measure taken by most overseas clients through outsourcing to low-cost countries," he said, adding that large BPO companies may recover faster than mid-sized ones.

Business from the banking and financial services companies- a major contributor to software firms' revenue - and telecom firms are showing signs of stability, while orders from the manufacturing and retail sectors are still suffering, he said.

The analyst expects consolidation in the captive BPO segment, as large IT companies are scouting for attractive targets that come with assured business.

Last October, Citigroup Inc. sold its India-based back-office arm to Tata Consultancy Services Ltd. for $505 million, to help reduce its operating expenses and focus on its core financial-services operations.

"There are a lot of captives which are willing to sell out as they do not find any business sense there," he said.

Earlier this month, local media reports said Infosys is in the race to buy the back-office operations of UBS AG (UBS) in India and Poland, along with a multi-year business contract.

Write to Dhanya Ann Thoppil at dhanya.thoppil@dowjones.com