We believe the market may be overlooking Wipro's improving execution. The firm has made several key investments in the last 12-15 months to revive its fortunes, and recent results indicate the company is on the right track. Wipro's continued focus on strengthening its client and employee management programs, coupled with strategic investments in consulting and underpenetrated verticals, should help it win back lost market share, in our opinion.
Offshore model is on target
Wipro continues to be a dominant player in the offshore outsourcing sector. The firm is a pioneer of the offshore-centric model and used its first-mover advantage to carve out a space for itself in the information technology outsourcing market. The company has been consistently ranked among the top four players in the offshore outsourcing space and we see minimal threat to its position in the medium term. Wipro's solid performance can largely be attributed to its well-defined outsourcing strategy and solid execution skills.
The firm's growth was partly aided by increased adoption of global sourcing by large enterprises in developed countries. Global IT outsourcing spending increased at a faster pace in the late 1990s until the beginning of the recession in 2008. As the market grew rapidly, it attracted new players and competition accelerated. Wipro was one of the few companies that not only managed to thrive in this environment, but also dominate it. The company's revenue grew at a compound annual growth rate of 28% during the last 10 years while its operating margin consistently stayed above 20%.
The fundamentals of offshore outsourcing look robust even in the face of recent macroeconomic trends. Offshore outsourcing is getting good traction as global customers increasingly want to use these services because of the cost advantage.
This trend is more pronounced in Europe and the Asia-Pacific region (excluding Japan), where offshore penetration is less when compared with North America. Offshore service providers have had limited success so far in penetrating Europe, which accounts for roughly 30% of global IT services spending. As Europe opens up, we believe it presents sizable opportunities for Tier 1 offshore service providers. Given its excellent track record and brand name, we think Wipro is well positioned to capitalize on these opportunities.
Management reorganization is delivering results
The recent string of solid results indicates that Wipro isn't far from regaining its footing. The company's past performance was subdued largely because of management's short-term focus during and in the immediate aftermath of the Great Recession.
During the recession years, with an eye on offsetting the impact of slow growth on its margins, Wipro overtightened its supply side and was reluctant to invest in front-end capabilities. The company also wasn't proactive in chasing new opportunities. Lack of investment on both the customer and employee fronts led to a sharp decline in growth in subsequent quarters.
The timing couldn't have been worse, when pent-up demand exploded and Wipro couldn't participate in some parts of the rally. In 2011, the company lost to Cognizant its long-held position (for more than a decade) as the third-largest offshore service provider. In an effort to arrest the slide, Wipro reorganized its management team and made significant investments to fill the gap in its client and employee management strategies. Its restructuring started delivering results in the second quarter of fiscal 2012.
Wipro has been fast-closing the gap with Cognizant and TCS in the last few quarters. Infosys' own execution issues led to a sharp decline in its recent performance, and its top-line growth fell behind Wipro's in the March quarter. In our opinion, Wipro has all the pieces in place and it is just a matter of time before it catches up with its Tier 1 peers.
A decline in attrition is Wipro's new mission
Wipro's renewed focus on employee satisfaction and engagement has led to a sharp decline in attrition rates. Compared with its peers, Wipro had a tough time in managing its supply side in recent years, and we believe this was largely self-inflicted. In an effort to maintain its margins, the company tightened its supply chain by restricting hiring to the minimum and offering wage increases that lagged its peers.
While these actions helped Wipro to report solid bottom-line results during the crisis, they came back to bite the company when demand rebounded strongly during the recovery. The firm's attrition rate spiked, and in some cases the company couldn't take up projects because it lacked qualified resources.
After learning the hard way, Wipro fine-tuned its employment management practices and the results have been good so far. The company reported a sharper improvement in broader attrition rates--voluntary attrition declined to 14.4% from 20.9% during the last four quarters. Additionally, we believe attrition at the senior management level is largely in the past. Wipro's improved performance during this period was partly helped by an industrywide decline in attrition, but the magnitude of improvement at Wipro far outpaced its competitors.
Wipro's simplified client engagement model is more agile and customer-centric
Wipro has made considerable strides in fine-tuning its account management model--poor client-mining is the other major reason behind Wipro's recent lackluster performance. While the company historically has been good at hunting new clients, the same can't be said about its client-mining (which, in simple terms, is getting more out key clients).
In our opinion, this was mainly due to a lack of specific account management responsibility. In most cases, each account had multiple touch points, which made it harder to establish accountability. Although this approach worked well in the past, the changing industry landscape has made it less effective.
As the outsourcing industry matured, global organizations have become more inclined to obtain greater value and benefits out of every sourcing relationship. This requires more collaboration between the client and IT service provider. Most of Wipro's competitors changed their go-to-market strategy, and Wipro was one of the last to get on board.
As part of its restructuring, Wipro simplified the account management model and made it more customer-centric. The firm invested in domain experts, enterprise architects, and experienced client managers. The company rolled out a one-point accountability model and gave client managers greater autonomy over their accounts.
Additionally, to align the interests of its client managers with those of the company, Wipro changed the compensation structure. A significant portion of client managers' compensation is variable and tied to the overall performance of the account and client satisfaction.
Early results from these changes look very encouraging. The company reported a notable increase in the number of $100 million and $50 million clients in the last four quarters.
There's more to Wipro than the market can see
With Wipro currently trading about 30% below our fair value estimate of Rs 620 per share, we believe the upside outweighs the downside by a wide margin. The offshore IT services market remains underpenetrated, with penetration levels ranging from the low single digits to the midteens across different service lines and geographies.
For instance, the penetration level is in single digits in Europe and Asia-Pacific, while it trends in the low teens in North America. From an industry perspective, financial services is an early adopter of offshore outsourcing, but lately we are seeing increased traction from industries such as energy, health care, and retail.
We believe these developments offer ample headroom for growth for Wipro in the medium term. In terms of profitability, we think Wipro continues to possess a handful of margin levers to offset any potential headwinds. Some of these levers include increasing employee utilization and productivity, moving work from onsite to offshore, and shifting to fixed-price contracts from time-and-material projects.
The company historically has used a combination of these levers to maintain its profitability. Additionally, unlike Infosys, Wipro's offerings don't come at a premium, so we don't expect any threat to its margins in the future.
According to the research firm Gartner, worldwide IT outsourcing spending is expected to grow by 4%-5% during the next four years. Given companies' increased adoption of offshoring, we think offshore spending will grow at a higher pace. We expect Wipro to beat the market given its track record, delivery efficiency, and breadth of offerings.
