Information technology remains India's best bet, but there are concerns about the changing nature of the business and global competition.

Samir Arora, Head, Asian Emerging Markets, Alliance Capital

"India exports $10 billion-plus of software services to the developed world and this is our only major globally competitive industry. India and Indians have gained significant international respect and visibility courtesy our software companies.

"When analysing the success and future profitability prospects of any software company, we need to analyse its global competitiveness, volume growth, client wins, quality of clients, loyalty of clients, employee additions and, of course, pricing power.

"By focusing solely on the lack of pricing power in the current weak economic scenario, analysts are oversimplifying their own thesis. This reminds me of an incident when a prominent US analyst downgraded Microsoft and the stock fell.

"Shortly, thereafter, when asked about this analyst, Gates cracked, "He's your man, he's great -- if you want to run a spreadsheet." It is now fashionable to be bearish on Indian technology and every analyst and newspaper wants to be ahead of the latest fashion.

In the real world, the Indian software business still has growth and profits and returns on capital and returns on equity that any other business would die for. We moan the fact that the guidance offered by many of these companies is low and that there is no visibility.

We forget that even today, other than in the technology sector no other major company in India even offers a guidance. In any case, cutting stock prices to half in a period of one or two days normally accompanies a major corporate governance disaster or scandal.

In our highly reactive market, weak guidance (in an obviously weak macro environment) solely due to pricing pressure -- when all the other major parameters on which the business should be valued strongly -- has been viewed worse than a major corporate fraud.

This is obviously an over-reaction triggered by day traders and leveraged positions and in no way is a reflection of the inherent strengths and dynamism of these software companies.

Many analysts have been upset by Infosys's low growth guidance and have used that as the primary reason to turn negative on the stock and the sector. At the prices at which these companies were trading prior to this earnings season, this may have been the right recommendation.

However, with the prices of many of these companies having been cut into half, the reaction seems overdone. Infosys now trades at mid-teen multiples for (revised) mid-teen growth rates and many smaller companies trade in low double figure multiples -- cheaper than their old economy counterparts.

One argument used often to justify bearishness for Indian software companies is the current strength of the Indian rupee. Ask the software analyst as to why he is so bullish on the Indian rupee in the medium to long term.

That is because he believes that our reserves will continue to build up because of our strong export growth. Probe further as to which exports he is thinking about and the answer is the same -- Indian software and business process outsourcing services exports.

So how come we became bearish on the technology sector due to our view on the rupee that can continue to be strong only if technology exports are vibrant? This is a clear case of flawed reasoning.

The bottom line is that in India there will always be attraction for a pure foreign exchange earner and any analyst bearish on the sector because of his views on the Indian rupee is actually more bullish on the technology sector than he realises.

Analysts and public know about the massacre of Internet stocks in recent years with their flawed business models, over-hyped prospects and so on. Well, you would be surprised to learn then that in the past 12 months shares of Amazon, E-bay and Yahoo! have each gone up more than 60 per cent. The lesson in all this -- do not take any view too far."

Pramod Gupta, Analyst, Enam Securities

"The stalwarts of the software sector have disappointed on both results and future guidance. Most managements have cited rupee appreciation, a weak US economic environment and events like geopolitical tensions, the Iraq war and now SARS for the weak performance and the outlook.

"However, we believe the concerns are not temporary and cyclical but structural in nature. We remain concerned on the changing sector dynamics and eroding competitive edge of Indian vendors.

"The Indian IT services industry is precariously poised. It faces a low demand environment and its main strategic advantage of low-cost offshore labour is being eroded. Competition is getting stiffer and multinationals like IBM, EDS, CSC and Accenture are ramping up their offshore capacities.

"The key offerings -- offshore application maintenance and re-engineering -- are getting commoditised as clients bring pressure on pricing.

"Domain expertise and service breadth hold the key to deepening relationships with clients and, hence, growth. Most Indian companies hope to achieve long-term growth by expanding their market size through the following three strategies:

• Focusing on geographical and vertical diversification;
• Developing new service offerings; and
• Entering new service areas and segments.

"Some are trying to change their positioning from being low-cost service providers to offering a differentiation. These vendors' value propositions would be put to test as they compete head-on with global majors.

"Gaining market share in a shrinking market and deflationary environment would entail pricing pressure. Also, with little experience and track record in new service lines, entry would be at the very low end, and Indian vendors would need to compromise on pricing and profitability to capture market share.

"Entry into new service segments would also require a change in internal structures and management thinking. Managements would need to effect major organisational transformation in each part of the company -- from sales and marketing to administration and delivery.

"To enter new service segments, companies would have to acquire new skill sets. Also, existing employees would need to be protected from the lure of multinationals setting up capacities in India. Moreover, the employee profile, and hence the organisational hierarchy would also need to change due to the widening base of offerings.

"The business model is likely to change; and the industry would face tougher service level agreements. Some of the new service segments are going to be cyclical and project-based (which means lower utilisations).

"Also, exclusive skill sets would be required for some service segments like consulting, SI, BPO and IS outsourcing. This would increase the complexities of managing capacity utilisations, manpower planning and so on. This is likely to pose major challenges, especially as the cyclical nature of the business manifests itself.

"Moreover, BPO and ITES have high capital intensity, and SI and IS outsourcing require balance sheet strength -- this implies the increasing financial risk of the business model.

"We believe industry valuations would be under pressure in the long term, as the return ratios would be heading south and risks in the business model would increase. Even after the recent correction in stock prices, valuations of the sector discount 15 to 20 per cent growth in cash flows for the next five years.

"The cash flows are going to be subdued due to lower revenue growth and margin pressure. We expect annual growth rates of most companies to come under pressure in the next one or two years and profit margins to remain under pressure -- PEs would de-rate from here also.

"Therefore, astute investors would do well to realign their portfolios to reflect these realities now."