After a blockbuster in 2021, Wipro’s (NYSE: WIT) fortunes may finally be on the wane – organic growth has slowed from earlier highs, and Wipro’s ability to maintain its mid-teen organic growth trajectory appears circumspect in the absence of coherent mega-agreements. With the company’s growth also increasingly dependent on mergers and acquisitions, with workforce attrition remaining high and earnings growth expectations muted compared to its peers, expect a new pressure on margins. Overall, Wipro’s riskier future growth trajectory warrants a lower valuation multiple than its leading peer Infosys (INFI).
Puts and Takes of Revenue Growth Numbers
Wipro’s revenue growth remains concentrated in a few verticals, including banking, financial services and insurance (BFSI), retail and manufacturing/high tech. By geography, the Americas continue to be the anchor, offsetting weakness in Europe and Asia/Middle East (APMEA). Bulls will indicate that Wipro’s ACV was up 38% YoY for the quarter (30% YoY for the full year), but YoY growth was mostly driven by a favorable basis, as deal activity at the same time last year was quite low due to COVID. Overall, the order backlog of $450 million was still down about 33% quarter-on-quarter, so the risk of a slower-than-expected recovery in orders remains a major concern.
Source: Wipro Q4 2022 Analyst Data Sheet
That said, Wipro management provided some welcome positives on the conference call – the overall demand environment remains solid, resulting in a higher mix of small to mid-sized deals in the pipeline. This largely explains the discrepancy between the growth trends in total contract value (TCV) and annual contract value (ACV) for the company, in my opinion, the lack of mega deals (no deals over a twelve-month period) significantly affecting the performance of the TCV. With macroeconomic uncertainty (e.g. geopolitical risks and rising inflation) also a priority for the business, expect increased earnings volatility, especially with digital transformation spending likely to suffer. reductions or delays in spending due to lower customer-side profitability.
Slowing growth and margin pressures weigh on earnings outlook
Wipro’s forecast figures indicate that its growth may slow – Q1 2023 growth was set at a moderate 1-3%, and while forecasts of double-digit revenue growth for the entire year are positive, management’s reluctance to set a growth range highlights the uncertainties ahead. Given that the contribution of the Rizing and Convergence acquisitions are already factored into these numbers, the near-term growth forecasts are disappointing, in my opinion. Additionally, demand for consulting-focused IT services does not appear particularly robust, with little sign of materializing a major deal in recent quarters. As such, Wipro’s organic USD revenue growth is expected to fall to the bottom of the Tier 1 IT Services peer group for the coming fiscal year.
Source: Wipro Q4 2022 Quarterly Overview
On the margin side, the EBIT margin guidance range is 17-17.5% over the medium term, with continued high investment for growth over the next two quarters. Additionally, wage increases will continue to weigh on revenue, with recent increases expected to have a disproportionate impact on Q1 and Q2 2023 figures. amortization resulting from the completion of the Rizing acquisition and a continued increase in hiring (more recent hiring target for 2023 of >38,000 compared to >19,000 in 2022 and >9.5,000 in 2021) . Finally, a reversal of the cost savings induced by COVID-19 will also be an issue – in particular, Wipro’s relocation/installation costs remain at the lower end and should normalize upwards over time.
Mergers and acquisitions remain a key growth driver
Along with its focus on organic growth, Wipro will continue to make strategic acquisitions to complement its set of existing offerings (as opposed to acquiring just to add volume). Its acquisitions to date have brought additional consulting capabilities and domain expertise – for example, its most recent acquisitions, Convergence Acceleration Solutions (CAS) and Rizing Intermediate Holdings. CAS is a US-based consulting and program management company operating primarily in communications, while Rizing is a key strategic partner for SAP – a potentially critical extension of Wipro in its SAP Cloud and Full Stride Cloud Services practice at the future. For Rizing, the purchase consideration is ~$540 million in cash to purchase 100% of the company, although the lack of an earn-out clause was a disappointment. Historically, Rizing’s consolidated net revenue has been around $150-200 million, which puts the valuation at 2-3 times trailing revenue – that sounds reasonable on the face of it, but without the info on the EBITDA, it is difficult to assess whether the assessment is fair. That said, a late 2022 close would imply that Rizing will add around 150 basis points to the 2023 revenue forecast, broadening its revenue base slightly.
Meanwhile, the Capco acquisition is also progressing as expected, with BFSI’s vertical growth having picked up strongly in recent quarters. Although the success of the integration is a positive sign for Wipro’s inorganic growth strategy, it is still in its infancy and therefore my base case scenario continues to be a negative for the ratio of distribution of 45-50%, given management’s intention to accelerate M&A activity.
Valuation discount justified in a context of slowing growth
New CEO Thierry Delaporte deserves credit for rejuvenating Wipro’s growth machine, but slowing deal momentum (lagging behind its Tier 1 IT counterparts) points to organic growth challenges ahead. Additionally, margin pressure is an issue given high workforce attrition and the need to integrate mergers and acquisitions in the coming quarters. Net, I suspect the mid-term margin guidance range of 17-17.5% is vulnerable to a downside revision, with high investments likely to impact the 2023 payout as well. pending clarity on the company’s sustainable growth outlook, I consider the multiple discount to Infosys’ current valuation to be warranted given its under-pressure earnings growth outlook and lower ROIC profile .