AI-led tech craze leaves Indian software mega stocks in the dust

(Bloomberg) — Shares of India’s famous IT outsourcing companies are facing a reality check as global investors’ rush into artificial intelligence begins to leave pricey old-economy technology stocks behind.

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Unlike their counterparts in the developed world and China, Indian software makers, including leader Tata Consultancy Services Ltd., have yet to make significant advances in generative AI. That, combined with a still hazy outlook for customer spending, could soon leave it looking like yesterday’s tech bets.

“Profits and valuations of traditional software companies are at risk because their business models do not evolve over time,” said Deven Choksey, managing director at DRChoksey FinServ Pvt.

A BSE Ltd. gauge of Indian software stocks recently fell from key support levels for a technical correction. However, it is still trading well above its historical average earnings multiple, following a years-long recovery in the country’s stock market.

Read more: Why artificial intelligence is so expensive to develop: QuickTake

India’s IT companies enjoyed years of strong growth as the world’s biggest companies outsourced a lot of back-office work to save money, in a phenomenon known as “Bangalored”. Those revenues have been slowing more recently as foreign clients cut spending to cope with challenging economies.

Meanwhile, major software and internet companies such as Microsoft Corp. and Alphabet Inc., have invested billions to develop their own cloud offerings and large language models.

“Coding is being left behind by computing in the world of technology investing,” Choksey said. Indian companies need to reinvent their business models faster to adopt AI and provide better software-as-a-service solutions and infrastructure, as Amazon Web Services, a unit of Amazon.com Inc., does, he added.

TCS last month reported its slowest annual sales growth in three years. Competitor Infosys Ltd. issued a tepid forecast for revenue growth of 1% to 3% in the year to March 2025 in constant currency, eliminating the impact of exchange rate fluctuations.

Although Indian companies and their peers across the world, such as Accenture Plc, are making positive noises about AI, the sales contributions are still small. TCS said its AI pipeline doubled in the last quarter to $900 million — which compares to its total annual revenue of about $30 billion.

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The volatile geopolitical environment and uncertain macroeconomic outlook continue to weigh on clients’ spending priorities. The IT sector could suffer further downgrades after sales fell short of expectations in the last quarter, according to Jefferies Financial Group Inc.

“IT company results disappointed on revenue and management comments point to a weaker than expected growth outlook,” wrote analysts Akshat Agarwal and Ankur Pant in a note dated May 7. last month, we see additional risks to earnings, limiting the upside” in stock prices.

High valuations also point to caution. The BSE technology bellwether is trading at 24 times estimated earnings, compared to pre-pandemic levels of around 18 times. This comes as sales and profit growth metrics have fallen below the levels enjoyed by the industry in 2019.

Read more: Why India risks falling behind in the AI ​​race: Andy Mukherjee

Indian software makers have been seen as laggards in artificial intelligence. In the absence of substantial advances in this area, they may lose the interest of investors, as their business faces threats of cannibalization.

“The issue of companies spending more on AI while cutting non-AI spending is global in nature,” said Anurag Rana, an analyst at Bloomberg Intelligence. “We are not seeing signs of recovery.”

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