The IT (Information Technology) services sector generally isn't considered a high-growth tech industry. Research company Gartner estimates that worldwide spending on IT services will rise just 2.5% annually this year, down from 2.7% growth in 2014. Nonetheless, it's important for tech investors to understand what IT services are, how they differ from other IT sectors, and which top companies to follow.
What are IT services?
The IT services market includes a wide range of software support companies, communication service suppliers, network integrators, data center specialists, outsourcing partners, desktop management companies, and IT consultancy firms. It does not include data center hardware, enterprise devices (desktops, laptops, mobile devices), enterprise software, or telecom services.
Yet the IT services market is closely tied to those other IT markets. An expected decline in demand for enterprise software this year, for example, reduces revenue from software support services. Meanwhile, higher demand for data servers, fueled by more cloud-based services, boosts demand for data center specialists. To gain a better understanding of this industry, let's discuss three top players in the IT services sector -- Infosys (NYSE:INFY), IBM (NYSE:IBM), and Accenture (NYSE:ACN).
Infosys is one of India's largest IT service firms. Its primary domestic rivals are WiPro (NYSE:WIT), Cognizant (NASDAQ:CTSH), and TCS, the largest IT service firm in the country. Infosys employs over 170,000 people, compared to TCS' massive workforce of over 300,000. But just like TCS, Infosys' largest market is North America.
Infosys discusses its company's future like software upgrades. During the company's first two decades, "Infosys 1.0" focused on improving its staff's ability to write code efficiently for customers across different time zones. During its third decade, "Infosys 2.0" focused on pursuing IT service deals across multiple industries. With "Infosys 3.0", which started in 2010, there are three top priorities -- cost reductions, sales effectiveness, and delivery effectiveness. Looking ahead, Infosys and its Indian competitors all face the challenges of intense price competition and the challenge of keeping costs low with massive employee headcounts.
Nonetheless, Infosys continues to post decent top and bottom line growth. Last year, Infosys' revenue grew 7% annually on a constant currency basis to $8.7 billion as its net profit improved 15%. The stock currently pays a forward annual dividend yield of 2.9%, and paid out 59% of its free cash flow as dividends over the past 12 months. It also expects annual revenue growth, on a constant currency basis, to accelerate to 10% to 12% this year (fiscal 2016). Therefore, Infosys represents a fairly solid way to gain some exposure to the Indian IT market, which grew 7.1% annually last year, according to IDC.
IBM's IT services business is split into two units: Global Business Services (GBS) and Global Technology Services (GTS). Last year, the GBS and GTS units respectively accounted for 19% and 40% of IBM's top line. But between 2011 and 2014, IBM's annual GBS revenue fell 8%, and GTS revenue slipped 9%. IBM blamed those declines on weak client spending, sluggish demand in the software sector, divestments of lower-margin businesses, and a strong dollar eating up overseas profits.
IBM is an American company, but roughly a quarter of its staff is based in India, making it one of Infosys' chief competitors. However, cloud services and analytics platforms (like Watson) are now automating more IT service tasks and reducing demand for human employees. That's why IBM reduced its India-based workforce from 165,000 in 2011 to 113,000 last year.
This doesn't mean IBM is backing out of India -- instead, it means it's trying to grow its business without adding more employees. That's why IBM is placing such emphasis on the growth of its five "strategic imperatives" -- the cloud, data analytics, mobile, social, and security businesses. Revenue from those businesses rose 16% annually in 2014 and accounted for 27% of IBM's top line. As more businesses rely on automated IT services delivered over cloud platforms, IBM believes that percentage could rise to 44% by 2018.
Accenture's IT services business provides similar services as IBM and Infosys. But unlike IBM, Accenture is mostly a "pure play" IT services company that has grown its top line over the past few years. Between 2010 and 2014, Accenture's annual revenues grew 38% as its net income improved 54%.
Research company Everest Group attributes that growth to Accenture's ability to communicate more clearly with CFOs and business leaders than IBM. IBM's customers, on the other hand, often accuse Big Blue of lacking "price competitiveness, operating flexibility, and customer intimacy," according to a recent survey conducted by Value Leadership Group CEO Peter Schumacher. One of Accenture's most notable accomplishments was fixing the disastrously broken Obamacare website earlier this year.
Therefore, investors looking for a more focused play on IT services should take a closer look at Accenture.
The bottom line
The IT services sector is a slow-growth one, but demand isn't expected to dry up anytime soon. Therefore, investors should keep an eye on fierce price competition, the rise of cloud-based and automated IT solutions, and the industry reputations of the leading players to better understand this complex and constantly evolving sector.