Indian Information Technology (IT) companies are challenged by multiple factors simultaneously: cloud and digitisation, changes in leadership, potential tax rate reduction, changes in the business model and, of course, unpredictability in immigration policies in the United States (US). While each of these aspects deserves a separate write-up, the focus of this article is the potentially ‘tighter’ visa regime and the possible impact of such a move by the US administration.
There has been no dearth of media coverage in the recent past on the impact of a ‘tighter’ US visa regime (specifically, the H-1B visas) on the business of outsourcing companies. Media reports attribute erosion in the valuation of several large listed IT companies due to the adverse impact of the anticipated changes.
Andy Mukherjee of Bloomberg puts a figure of $1.2 billion on the annual impact on Infosys, halving Infosys’ profits and, therefore, possibly its valuation. Mukherjee arrives at the figure based on essentially two numbers: the number of applications (25,375) and a likely impact on the $49,000 salary on average. This is a good starting point for investors who want to test the sensitivity of the valuation models in the face of uncertainty.
How many people?
Without stating as much, Mukherjee assumes that the number of applications is equal to the number of salaried H-1B employees in the US. This is quite erroneous. He references MyVisaJobs for the numbers. The reference provides the number of Labor Condition Applications (LCA) and not H-1B approvals or the number of H-1B employees in the US, and explicitly states that the number of approvals may be less than a third of the number of LCAs. Tata Consultancy Services applied for about 4,000 H-1B visas last year and received approvals for about one-third of them.
Obviously, the number of employees on an H-1B visa in any of these companies is higher than the approvals in that specific year. Let us consider Infosys’ report for the quarter ending December 2016, when it reported onsite billing person months of about 108,562, which translates to an average of over 36,000 onsite staff. Assuming that onsite staff distribution is proportionate to the revenue distribution (though, European clients tend to prefer more onsite staff than the US ones), Infosys is likely to have about 21,600 onsite employees. Ambit Capital estimates about 70 per cent of the onsite staff at Infosys may be on H-1B visas. This gives us a figure of about 15,000 H-1B employees. The impact would be substantive, but it’s materially smaller than Mukherjee’s number.
How does one deal with average salaries?
Elstrom and Rai, in a Bloomberg article, quote Ron Hira, an associate professor at Howard University, comparing average LCA salaries of Apple and Google with those of Infosys and TCS. LCAs, and salary ranges thereof, are specific to the metropolitan area. In effect, Elstrom and Rai compare average salary paid in the Bay Area by Apple or Google (Zip codes where H-1B salaries of most firms are in six digits) with pan-US averages of TCS/Infosys/Accenture, whose client base spreads across the US.
Ironically, Mukherjee’s Bloomberg article points out that salaries in Dallas are 20 per cent less than in San Francisco. Rather than comparing apples and oranges, the right comparison set would be Accenture/IBM/TCS/Infosys, where the differences are quite small.
Will margins gap with competition erode?
‘Tighter’ visa rules, Mukherjee claims, will trigger erosion of the 10+ per cent margin advantage TCS/Infosys have over Accenture/IBM. While it is understandable that margins for all the companies will come down, it is not clear why the relative difference should change much. Almost all businesses make little margin on onsite Application Development & Maintenance (ADM) work anyway. Mukherjee’s data shows that all these companies have very similar average H-1B salaries, and will all be subject to similar policies; so, this is not a determinant in the difference in operating margins.
The two fundamental reasons for the differences in margins - the proportion of work done offshore and the proportion of overheads offshore - are likely to get accentuated in favour of Indian IT companies. TCS has explicitly stated that at a threshold H-1B salary of $100,000, they expect no margin impact.
Finally, consider the likely playbook of response by the US and Indian companies to the changes:
1. IT service companies will pass on a large part of the cost to their clients. The likes of Accenture and IBM have little operating margin room to put competitive pricing pressure on onsite ADM work on the likes of Infosys or TCS.
2. As Mukherjee points out, some of the Indian IT companies are already increasing their hiring in the US to compensate for lesser visas.
3. Clients of IT service companies will demand higher offshore ratios to balance their overall budgets. This will end up increasing margins of the vendors. External shocks have twice resulted in higher offshore proportion: once after the dot-com bust and once more after the financial crisis.
4. Last but not the least, American technology companies have already started lobbying against a tighter regime.
One is certainly not writing off the likely impact of a rise in H-1B threshold salaries to $130,000 per annum. The purpose here is to provide a more realistic picture of impact rather than a hyped-up number. Financial analysts provide a sober assessment.
One shouldn’t be surprised that the Indian media seems to parrot outlandish analyses to get eyeballs. An opportune time to recall Warren Buffett’s adage about turning greedy when others are fearful?!
Note: The author has worked for some of the IT companies mentioned in the article and holds stock in a few of them (albeit those holdings amount to the fourth or fifth decimal place of a per cent).
Puranika Narayana Bhatta is CEO of Latlong, a software products company.
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