In an interaction with ET Now, Agarwal said the industry’s structural strengths remain intact, but the valuation multiples may not reflect the new growth reality.
AI cuts effort, changes the game
For decades, technological disruptions such as cloud computing, digital transformation and enterprise software upgrades expanded the opportunity set for IT services firms. Each shift led to retraining, new contracts and higher billing.
But AI is different.
“For the first time in four decades, the effort itself is getting reduced,” Agarwal said. AI tools can cut project effort by 20–30%, directly impacting billing volumes under traditional time-and-material or fixed-price contracts.
India’s IT services model — recruiting at scale, training at scale and deploying talent globally — now faces margin pressure from automation-led efficiency gains.
A ‘slow growth’ phase ahead
Agarwal does not foresee revenue declines for large IT firms. However, he expects a mid-single-digit growth phase for the next two to three years.
Here’s his outlook:
- Large-cap IT firms: 5–6% revenue growth; 7–8% EPS growth
- Mid-cap IT firms: 10–12% revenue growth; 13–14% profit growth
Margins, he believes, are unlikely to collapse and may even see slight improvement due to efficiency gains. The bigger concern lies in growth compression rather than profitability erosion.
Contract renewals could pressure pricing
IT contracts typically run four to six years. Every year, roughly 15–20% of contracts come up for renewal. Agarwal expects renegotiations to lead to 20–25% pricing cuts, resulting in a 4–5% drag on annual growth.
“If you grow 10%, your net growth becomes 5%,” he said, describing the impact as gradual but persistent.
No threat to India’s ‘software factory’ status
Despite concerns around AI automation, Agarwal remains confident that India’s IT leadership position is secure.
“We are the software factory of the world. No one can change that,” he said.
He dismissed fears that global AI disruptors could easily replace established IT vendors, citing deep client relationships, legacy system integration and large-scale execution capability as formidable entry barriers.
“There is zero doubt on the business model,” he added.
Valuation reset may be needed
The key risk, according to Agarwal, lies in valuations.
With the sector trading at 18–20x earnings for large-caps and even higher multiples for mid-caps, he questions whether such valuations are justified in a 5–6% growth environment.
“For mid-single-digit growth, why should I pay a 20x multiple?” he asked.
Unless growth re-accelerates or valuations correct meaningfully, he believes the sector could see a “multiple reset.”
Hiring and revenue trends to slow
Agarwal expects slower employee additions and muted revenue growth for the next two to three years. However, he does not anticipate widespread revenue decline or structural damage to the sector.
The takeaway: AI may compress effort and moderate growth, but India’s IT services model remains resilient. Investors, however, may need to recalibrate expectations on returns.
Disclaimer: The views expressed are those of the expert and do not constitute investment advice.