Best demand for IT in 25 yrs: Saurabh Mukherjea | Economic Times

We are focusing on TCS as our main play but it could well be that TCS and a couple of other companies will make hay over the next four-five years. I would not be a seller of IT stocks at this juncture, but I would be careful about the cost pressure aspect and the strategic aspect of IT, says Saurabh Mukherjea, Founder, Marcellus Investment Managers. IT business or the IT service sector is in a sweet spot. How does one go about investing in some of the large cap stocks because TCS and Infosys are trading at the upper end of the PE multiple?We have spoken to a lot of CTOs of western companies over the last year or so and the picture they are giving us is that over the next four, five years, each of the top 1,000 western companies will have to digitise their own businesses. They want to take their old economy IT constructs where they had servers and server farms and so on and move to a new economic construct where the data is on the cloud, where they have data lakes and modern analytics and the whole business model gets reinvented around AI, around real time analytics to recreate supply chains which are more responsive to customer demand and to economic patterns. Therefore for the Indian IT services giants like TCS and Infosys, there is potentially four, five years of solid revenue visibility, solid business pipeline visibility across the top 1,000 western clients. The challenges are threefold; firstly, given the sheer scale of the work, the western CTO or the western chief operating officer is saying I do not want to deal with an army of IT services companies; I want one or two lead vendors, say a western company like Accenture and one top Indian company to run the rest of the process. Indian IT services companies will have to have talent which is broad based, a wide offerings suite and they should be able to fill their staffing pipeline and create speed, something which TCS and Infosys are very good at. But I am not so sure how good the midcap IT companies are. In fact, even some of the larger IT companies are saying that they are turning away business because they simply cannot find people. So I think the first criteria here will be can you staff up at great speed to deal with the sheer extent of demand? The second area is can you keep up with the changes in technology? AI itself is moving very fast. In order to keep up with it, one requires billions of dollars of spend on the part of a large IT company. Even Accenture is spending billions of dollars to stay ahead of the curve. I am not so sure the Indian midcap IT companies have that sort of financial firepower to stay ahead of the AI curve. The last is the tech and strategy. IT services and business strategy are basically one and the same. How many of our IT services companies can claim that they can sit with a CEO of a Fortune 500 company and guide corporate strategy? The answer is there are probably two or three such companies in our country. The rest of the companies will have to content with being back room boys. So the good news for Indian IT is massive boom in demand and lots of C-suite work. The bad news is can you get the talent? Do you have the C-suite connectivity and can you spend the requisite amount of money to stay ahead of the curve on technology? This is probably the best demand environment for Indian IT in 20-25 years. This will last for some time. We are focusing on TCS as our main play but it could well be that TCS and a couple of other companies will make hay over the next four-five years. I would not be a seller of IT stocks at this juncture, but I would be careful about the cost pressure aspect and the strategic aspect of IT which is changing the world that we live in. What about metals? That deals directly with the vagaries of the commodity up and down cycles. What would be your positioning in them?Marcellus has never invested in metal stocks because we could never quite understand the global commodity cycle. That being said, it is relatively clear that for the next couple of years, there is very little incremental supply coming and so whether it is steel or aluminium, the new capex cycle is just about beginning across the world. By the time the new capacity addition cycle brings fresh supply on stream, it will be three years at least. Therefore there is a two-three year window for demand to zip up but supply lags and therefore there should be a fairly healthy environment for these stocks. We are not going to invest in the sector for a variety of reasons, particularly our inability to second guess what happens to the demand on the metals piece. 70-80% of the stock price movement in the sector basically reflects the underlying commodity price movements on the London Metals Exchange and therefore if anybody watching this programme is investing in metal stocks, one should be a fairly good judge of where the overall metal cycle is going. If you believe that the overall metal cycle still has legs in it in terms of the overall commodity prices running up for a couple of years, these are perfectly good investments for you to consider. We will stick to top quality franchises with great pricing power because we believe that is a much better risk adjusted way of playing the incipient economic boom across the world. What are you making of Zomato? Did you subscribe to the IPO? While UBS has put a price target of Rs 165 on Zomato, Aswath Damodaran is saying that the fair value should be Rs 40 per share?Such polar opposite views are to be expected in a sector which is still in its infancy. Profitability is some time away for many of the new generation tech plays. We have chosen to invest in Info Edge. We have it in many of our portfolios and we have chosen to benefit from the digitisation of our country through Info Edge rather than looking at stocks like Zomato. Info Edge has at its core, a very powerful cash generation machine called Naukri.com and if you are an HR Officer anywhere in the country watching this programme, I am sure you will agree with me that it is very difficult for HR officers to operate without Naukri.com as a core subscriptions in their lives. That gives Info Edge a massive cash generation engine and what our maths suggest is that the Sanjeev Bikhchandani, Hitesh Oberoi team over the last 20 years have taken the free cash flows from Naukri and reinvested that spectacularly in Policybazaar, Zomato and the matrimony space. The return on the reinvested cash is somewhere around 30-40% for Info Edge and hence we have been long standing fans of Info Edge and we will carry on holding that stock as our way to benefit from digitisation of the country. I honestly do not know Zomato’s fair value. We have not invested in the IPO but this whole digitisation of the country will progress and it will lead to 15 to 20 giant companies dominating our economy. Already 20 giant companies account for 90% of corporate India’s profits and if you and I are investing in India, these 20 companies should be the fulcrum of an Indian portfolio. They are basically running our economy and this pattern of few large companies becoming stronger will continue as digitisation gets stronger in the post Covid world. How does one go about investing in the platform/digital economy?This is a question which has befuddled many. There are two dimensions to the debate. The first is how will the governments across the world deal with the power of these digital platforms? In China, we can see a bit of a showdown between some of the biggest digital names in the Chinese economy and the Chinese government and the showdown seems to be as much about who owns the data. You are a giant Chinese company, you have got data on billions of Chinese consumers; should the Chinese government have access to the data or does that belong to the private sector? Linked to that is the question that if you are a monopoly provider of catering services or online financial services or social media services, should the government be regulating you both from an ethical perspective and from a profitability perspective? A massive debate is taking place in China and in America. Lina Khan’s appointment by Joe Biden will have enormous ramifications on this debate. This big regulatory debate will create volatility in stock prices of these companies across the world and I doubt India will escape that. If the government takes a call on who owns the data and what sort of profitability you are allowed to generate, it obviously will have massive ramifications on share prices. The second aspect of uncertainty is how easy is it to disrupt these network businesses? Facebook is unusual. It is a network business where each Facebook customer benefits from other people joining Facebook. The network effect is actually very pronounced there. But it is not as pronounced in say an Uber or in the Indian context an Ola. The network effects are not as pronounced in a restaurant delivery business because each restaurant does not benefit from another restaurant joining the Zomato network. So the network effects are actually subtly different and the differences in network effects makes some of these businesses easier to disrupt than a social media business like Facebook. There are differences in the strength of the business models and I do not think that those differences in the strength of the business models are as yet reflected in share prices across the world. My reckoning is the next three, four, five years, the market will wake up to the fact that the defensibility, the ability to protect the franchise is fundamentally for some network businesses than it is for others. So two different discourses; massive regulatory debate about these platforms and secondly the ability of these platforms to be disrupted by a new generation of entrants. These two debates will define where the share prices of these stocks go over the coming four, five years.