UBS has upgraded its rating on Tech Mahindra to “neutral” from “sell,” reflecting the recent de-rating and improving margins. On the flip side, it has downgraded its rating on Mphasis to “neutral” from “buy,” as the anticipated turnaround has not manifested, it said.
The brokerage listed two case study examples for the road ahead for IT stocks, in view of the recent AI-led disruption — the Cloud Cycle (2010-19) as a successful pivot and the Blockbuster vs Netflix (1997-2010) case study for a downside precedent.
Cloud Cycle (2010-2019)
UBS said cloud technology was initially seen as a new opportunity. Its adoption triggered fears of legacy revenue deflation. This resulted in Indian IT valuations being de-rated 20% over one-and-a-half to two years.
IT companies pivoted fast, scaling digital transformation, hyperscaler partnerships, new ‘replacement’ revenues.
This resulted in valuations being re-rated by 35% – 40%, UBS said.
Blockbuster Vs Netflix (1997-2010)
UBS said that when Netflix launched in 1997, Blockbuster was the industry leader with thousands of video rental stores.
However, Blockbuster was unable to adapt with legacy stores and high fixed costs. This resulted in 90% of its value destruction over four years, followed by bankruptcy, the brokerage said.
What this means for Indian IT stocks
UBS said that while the Indian IT companies’ valuations are already down between 20% – 25% lower this year, so far, the precedents suggest that de-rating can persist till there is visible business-model evolution.
If evidence does emerge, a Cloud-like re-rating of 35% – 40% is also possible later, according to the brokerage.
However, a downside case scenario of 40%-50% would imply further de-rating (In the case of Blockbuster there was an overall de-rating of 80-90%).
Companies that are showing early indicators of better positioning or higher likelihood of a pivot include Infosys, HCLTech and Persistent Systems, UBS said, adding that it recommends to be selective within the sector as dispersion will rise.
The Nifty IT index was up 0.2% at 2.15 pm on Monday. As many as six out of the 10 stocks are trading with gains, with HCLTech, Tech Mahindra, Coforge emerging as the top gainers, trading 1-2% up.
Also Read: Coforge shares recover from intraday lows as Motilal Oswal sees 73% upside; UBS stays ‘neutral’
