Institutional Equities

Information Technology Sector 6 March 2017

H1-B Visa ‘Premium Processing’ Temporarily Suspended; Modest Negative Girish Pai Impact On Execution Likely; Sub-contracting Costs Could Potentially Rise Head of Research United States Citizenship and Immigration Services (USCIS), on 4 March 2017, stated that it was [email protected] temporarily suspending ‘Premium Processing’ of H-1B visa petitions (see its complete statement on Page +91-22-3926 8017 2). The change is slated to take effect from 3 April 2017 for all H-1B petitions (for both 85,000 capped visas

and cap exempt visas–renewals and inter-company transfers, in our view) and may last up to six months.

The premium processing option allowed companies to pay an extra US$1,225 per visa to have their

petitions reviewed in two weeks, rather than the usual two to six months. In response to this development,

industry body NASSCOM put out a statement on 5 March 2017 that ‘temporary suspension of premium H-

1B processing will create some process delays for companies - Indian and American - but is not a

significant impediment’. A large Indian Tier-1 company that responded to our query on this matter

indicated that very few of its H1-B visas go through this route and the few that are taken up are in case of renewals when they are close to expiry. We are not sure whether to extrapolate this statement to the entire industry as USCIS had indicated in its statement that there was a ‘significant surge in premium processing requests over the past few years’ indicating a large number of such applications. We understand that US

technology companies like Microsoft (MS) and Facebook (FB), who rely on H1-B visas, are also probably

large users of this premium processing programme. While it makes less sense for a fresh applicant to use this service (as anyway an applicant cannot be deployed before 1 October of any particular year), it makes a lot of sense in the case of renewal or inter-company employee transfer (which may be the case for MS or FB). The fact that both cap-exempt and non-exempt visa petitions will not witness premium processing for a while could mean visibility problems on project staffing, especially on new projects won in FY18. With about a third of the H1-B visa holder base renewing every year, it is quite likely that companies may rush through with premium processing requests by the end of March 2017 (USCIS says it will process them) to ensure that existing projects are not affected. We believe this could potentially be margin-dilutive in the March 2017 quarter. We see an increased use of sub-contractors and possibly building of onsite bench to handle any eventuality as the length of suspension can extend to six months. Any increase in onsite bench and hiring of sub-contractors will add to the cost base. Anecdotal evidence from Indian companies indicate

that visa rejection rates have gone up in recent years and such premium processing service helps give Sector Update Sector

visibility to project staffing. We are not very sure whether this marks the first step in the Trump administration’s tightening of visas. In anticipation of likely tightening of the H1-B visa regime, we had cut our margin estimates for companies under coverage in our report H1-B Related Minimum Wage Increase – Material Damage Likely To Margins Curbs on H1-B visas is popular on both sides of the aisle in US Congress: With about half-a-dozen pieces of legislation introduced (and re-introduced) since January 2017 to curb alleged misuse of the H1-B visa regime from both Democrats and Republicans, it is likely that this will be taken up at some point in time in 2017. While some of these legislations have argued for raising the minimum wage to US$100,000mn or to US$130,000mn, some have argued for a change from the current lottery-based system to the one based on merit (the employee with the highest compensation getting the visa first). But all of them seem to suggest that any large employer in the US (greater than 50 employees) with more than 50% of its staff on H1-B visas will not be eligible to bring in more H1-B visa holders. The last element has been forcing Indian companies to proactively recruit locally over the past few years to shift the employee mix. We believe that most large Indian IT services companies currently have 60%-70% of their US employee base as H1-B visa holders. Financial impact goes beyond increase in minimum wages: As stated by us in multiple updates written by us (see links to them on Page 2), the financial impact goes beyond just increase in minimum wage. Lower mobility of local staff could lead to lower utilisation onsite (H1-B holders are very mobile within the US, according to companies), higher fresher cost, the higher-than-usual wage inflation as there is a scramble for onsite talent, likely rebadging of employees who are transferred to the vendors’ rolls, etc in our view are areas which could lead to margin dilution going forward. We believe mitigation in the form of a shift in work offshore is there, but statements by players like Cognizant Technology Solutions indicate that the room here is not substantial. Automation is probably the only key lever that could play a role in mitigating the pressure. However, we believe replacement of onsite based labour in a material way by automation is sometime away. Digital business is onsite-centric and project-oriented with low visibility of demand and prone to lower utilisation: With incremental business coming from digital projects over the past several quarters, the delivery mix has been increasingly shifting onsite. Also, while digital project sizes have been going up over time, unlike traditional services, these are still small with low demand visibility. Our discussions with industry indicate that there are times when teams are idle between projects. This phase, when the manpower is not billed, could hurt margins. Pressure on US President Mr. Donald Trump to deliver on his campaign promises: Having made H1-B visas one of the issues in his campaign (see Mr.Trump’s statement in this regard on Page 4), there has been a call from US Senator Mr. Richard Durbin, someone who has been focused on this matter for more than a decade, to write a letter to Mr. Trump to take action before 1 April 2017 (see Page 5). It remains to be seen if an executive order will be issued before that. NASSCOM and Indian government have been in dialogue with the Trump administration to prevent such a thing.

Institutional Equities

We have a negative view on Indian IT services sector: In the near term, we believe the changes to H1- B visa rules are likely to be realised and they will have a material negative impact on the margins of the companies under our coverage over FY17-FY19 (H1-B Related Minimum Wage Increase – Material Damage Likely To Margins). We expect RoIC to also move down in tandem. We expect the sector to post 3%-6% US dollar or USD revenue growth in FY18 (likely lowest on the street, organic). In our sector reports Structural And Cyclical Speed-breakers Ahead and Downside Risks Open Up - It Is That Time Of The Cycle!, we had indicated the reasons for being bearish on the sector: These include: (1) The probability of below-trend growth in the US over the next 12-24 months is high as the economic cycle is maturing. This, in our view, will have a deleterious impact on Global 2000 corporations’ sales growth - key driver of Indian IT sector’s revenue growth. (2) We believe volume growth, pricing and margins are all likely to disappoint current consensus expectations amid intense competition because of convergence of capabilities and strategies among Tier-1 Indian players. (3) We see revenue cannibalisation from automation to accelerate as the entire industry is in a challenger-defender paradigm and some players have already factored in aggressive assumptions on gains from it and therefore have to deliver unless they want to witness material margin downside. (4) We do not believe digital business is material enough to offset the pressure one expects in traditional business. Besides we believe Indian industry is not getting a fair share of this business because of lower capabilities in consulting and design. (5) We see P/E multiple remaining compressed for the sector as revenue and earnings growth will be anaemic. We also expect return ratios to move down materially over FY17-FY19. Links to reports published by us on the H1-B and related issues Indian IT Services Sector - The Trifecta Creates Risks Information Technology Sector- H1-B Related Minimum Wage Increase – Material Damage Likely To Margins Information Technology Sector- An Executive Order On H1 B Visas Could Bring Forward The Pain To FY18 Tata Consultancy Services- Exhibits Divergence From Peers On H1-B Visa Issue

United States Citizenship and Immigration Services (USCIS) statement on premium processing USCIS Will Temporarily Suspend Premium Processing for All H-1B Petitions

Starting April 3, 2017, USCIS will temporarily suspend premium processing for all H-1B petitions. This suspension may last up to 6 months. While H-1B premium processing is suspended, petitioners will not be able to file Form I-907, Request for Premium Processing Service for a Form I-129, Petition for a Nonimmigrant Worker which requests the H-1B nonimmigrant classification. We will notify the public before resuming premium processing for H-1B petitions.

Who Is Affected

The temporary suspension applies to all H-1B petitions filed on or after April 3, 2017. Since FY18 cap- subject H-1B petitions cannot be filed before April 3, 2017, this suspension will apply to all petitions filed for the FY18 H-1B regular cap and master’s advanced degree cap exemption (the “master’s cap”). The suspension also applies to petitions that may be cap-exempt.

While premium processing is suspended, we will reject any Form I-907 filed with an H-1B petition. If the petitioner submits one combined check for both the Form I-907 and Form I-129 H-1B fees, we will have to reject both forms.

We will continue to premium process Form I-129 H-1B petitions if the petitioner properly filed an associated Form I-907 before April 3, 2017. Therefore, we will refund the premium processing fee if:

 The petitioner filed the Form I-907 for an H-1B petition before April 3, 2017, and  We did not take adjudicative action on the case within the 15-calendar-day processing period.

This temporary suspension of premium processing does not apply to other eligible nonimmigrant classifications filed on Form I-129.

2 Information Technology Sector

Institutional Equities

Requesting Expedited Processing

While premium processing is suspended, petitioners may submit a request to expedite an H-1B petition if they meet the criteria on the Expedite Criteria webpage. It is the petitioner’s responsibility to demonstrate that they meet at least one of the expedite criteria, and we encourage petitioners to submit documentary evidence to support their expedite request.

We review all expedite requests on a case-by-case basis and requests are granted at the discretion of the office leadership.

Why We Are Temporarily Suspending Premium Processing for H-1B Petitions

This temporary suspension will help us to reduce overall H-1B processing times. By temporarily suspending premium processing, we will be able to:

 Process long-pending petitions, which we have currently been unable to process due to the high volume of incoming petitions and the significant surge in premium processing requests over the past few years; and  Prioritize adjudication of H-1B extension of status cases that are nearing the 240 day mark.

Expedite Criteria

USCIS reviews all expedite requests on a case-by-case basis and requests are granted at the discretion of the office leadership. The burden is on the applicant or petitioner to demonstrate that one or more of the e xpedite criteria have been met.

USCIS may expedite a petition or application if it meets one or more of the following criteria:

 Severe financial loss to company or person;

 Emergency situation;

 Humanitarian reasons;

 Nonprofit organization whose request is in furtherance of the cultural and social interests of the United States;

 Department of Defense or national interest situation (These particular expedite requests must come from an official U.S. government entity and state that delay will be detrimental to the government.);

 USCIS error; or

 Compelling interest of USCIS

3 Information Technology Sector

Institutional Equities

What is Form I-907 (Request for Premium Processing Service)? (Source: American Immigration Center Website: www.us-immigration.com) March 28, 2011

In many cases, when employers request employment authorization or employment-based applications, they need workers and assistance right away. Not having qualified workers for their company can cost them a substantial amount in lost revenues and profits. However, the USCIS process for employment-related petitions can take some time. Employers who are unable to wait can file Form I-907 (Request for Premium Processing Service) to expedite the process.

The Request for Premium Processing Service is not available for all employment-related petitions. However, employers applying with Form I-129 (Petition for a Nonimmigrant Worker — including R-1 visa, E-1 visa, E-2 visa, H-1B visa ,H-2B visa, H-3 visa, L-1 visa, O-1 visa, O-2 visa, P-1 visa, P-3 visa, Q-1 visa, and TN visa holders) or USCIS Form I-140 (Immigrant Petition for Alien Worker)usually qualify to apply for Form I907. Applicants for visas are not allowed to file immigration form I 907. This form is filed by visa petitioners such as employers or by authorized attorneys or representatives recognized by the USCIS.

Form I 907 is complex and expensive to file. Filing fees are $1225 as of March 2011, not including any related costs. There are more than 5 pages of instructions for the 2-page form, which is why employers must be certain that the costs of not having the right workers exceed the costs of the form. Employers often hire US immigration attorneys or other help to fill out USCIS Form I-907, since any errors can delay the processing of the form or result in a rejection. As well, employers must be certain that their petitions are eligible for Premium Processing Service before applying. The USCIS has a handy website to help employers understand which petitions are eligible.

There are four possible responses from the USCIS for form I 907: the USCIS will mail an approval, send a denial, will mail information about a misrepresentation or fraud notice, or will request evidence. Since this type of application is so time-sensitive, USCIS makes it easy for applicants to check the status of their application online. In fact, applicants use a dedicated email address and telephone number to check the status of their application, a feature not available for most USCIS immigration forms.

If approved, the Premium Processing Service ensures quick processing – a guaranteed 15-day processing – to qualified applicants. The 15 days begins when the USCIS receives Form I907. If the USCIS does not process the application in 15 calendar days, the agency will refund the filing fee for immigration form I 907 and continue to process the application for Premium Processing Service.

Mr. Donald Trump’s position on H1-B visas as put out on his campaign site a year back

"Megyn Kelly asked about highly-skilled immigration. The H-1B program is neither high-skilled nor immigration: these are temporary foreign workers, imported from abroad, for the explicit purpose of substituting for American workers at lower pay. I remain totally committed to eliminating rampant, widespread H-1B abuse and ending outrageous practices such as those that occurred at Disney in Florida when Americans were forced to train their foreign replacements. I will end forever the use of the H-1B as a cheap labor program, and institute an absolute requirement to hire American workers first for every visa and immigration program. No exceptions."

4 Information Technology Sector

Institutional Equities

Letter of Senator Durbin to the US President Mr. Trump recently

5 Information Technology Sector

Institutional Equities

6 Information Technology Sector

Institutional Equities

Exhibit 1: Comparative valuation

Indian IT services sector: Valuations TCS Infosys Wipro HCL Tech TechMahindra Persistent Year-nding March March March March March March Prices as on 03-Mar-17 2,494 1,031 494 853 504 641 Currency INR INR INR INR INR INR Market value (Rsbn) 4,913 2,357 1,195 1,203 441 51 (US$mn) 73,547 35,280 17,894 18,015 6,599 767

March 2019 Target Price 1,983 926 427 741 387 575 Upside/(downside) -20.5% -10.2% -13.5% -13.1% -23.2% -10.3%

Recommendation Sell Sell Sell Sell Sell Sell

EPS (Rs)

FY16 122.9 59.0 36.7 40.1 35.0 37.2 FY17E 134.8 62.3 34.3 58.0 34.3 38.9 FY18E 134.0 62.0 34.6 60.3 37.7 45.2 FY19E 137.7 64.3 37.1 64.4 38.4 49.9 P/E (x)

FY16 20.3 17.5 13.5 21.3 14.4 17.2 FY17E 18.5 16.6 14.4 14.7 14.7 16.5 FY18E 18.6 16.6 14.3 14.1 13.4 14.2 FY19E 18.1 16.0 13.3 13.3 13.1 12.8 EV/EBITDA (x)

FY16 15.8 11.9 9.2 15.8 9.5 12.0 FY17E 14.9 11.3 9.0 10.5 9.3 11.0 FY18E 14.9 10.9 8.3 9.6 8.1 9.1 FY19E 14.6 10.7 7.8 9.0 7.8 7.9 EV/Sales (x)

FY16 4.5 3.3 2.0 3.5 1.6 2.2 FY17E 4.1 3.1 1.8 2.3 1.4 1.7 FY18E 3.8 2.7 1.6 2.0 1.2 1.5 FY19E 3.5 2.5 1.5 1.8 1.2 1.4 RoIC (%)

FY15 60.9 64.9 34.3 61.2 41.6 48.1 FY16 63.1 58.8 31.8 38.5 33.8 43.5 FY17E 60.0 52.6 28.9 46.6 27.2 30.9 FY18E 56.5 47.2 25.5 42.1 25.1 31.4 FY19E 55.2 44.4 25.6 40.4 23.6 30.8 Source: Company, Nirmal Bang Institutional Equities Research

7 Information Technology Sector

Institutional Equities

Disclaimer Stock Ratings Absolute Returns

BUY > 15% ACCUMULATE -5% to15% SELL < -5% This report is published by Nirmal Bang’s Institutional Equities Research desk. Nirmal Bang group has other business units with independent research teams separated by Chinese walls, and therefore may, at times, have different or contrary views on stocks and markets. Reports based on technical and derivative analysis may not match with reports based on a company's fundamental analysis. This report is for the personal information of the authorised recipient and is not for public distribution. This should not be reproduced or redistributed to any other person or in any form. This report is for the general information for the clients of Nirmal Bang Equities Pvt. Ltd., a division of Nirmal Bang, and should not be construed as an offer or solicitation of an offer to buy/sell any securities. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, so far as it relates to current and historical information, but do not guarantee its accuracy or completeness. The opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. Nirmal Bang or any persons connected with it do not accept any liability arising from the use of this document or the information contained therein. The recipients of this material should rely on their own judgment and take their own professional advice before acting on this information. Nirmal Bang or any of its connected persons including its directors or subsidiaries or associates or employees or agents shall not be in any way responsible for any loss or damage that may arise to any person/s from any inadvertent error in the information contained, views and opinions expressed in this publication. Nirmal Bang Equities Private Limited (hereinafter referred to as “NBEPL”) is a registered Member of National Stock Exchange of India Limited, Bombay Stock Exchange Limited. NBEPL has registered with SEBI as a Research Entity in terms of SEBI (Research Analyst) Regulations, 2014. (Registration No: INH000001436 - 19.08.2015 to 18.08.2020). NBEPL or its associates including its relatives/analyst do not hold any financial interest/beneficial ownership of more than 1% in the company covered by Analyst. NBEPL or its associates/analyst has not received any compensation from the company covered by Analyst during the past twelve months. NBEPL /analyst has not served as an officer, director or employee of company covered by Analyst and has not been engaged in market-making activity of the company covered by Analyst. The views expressed are based solely on information available publicly and believed to be true. Investors are advised to independently evaluate the market conditions/risks involved before making any investment decision. Access all our reports on Bloomberg, Thomson Reuters and Factset.

Team Details:

Name Email Id Direct Line

Rahul Arora CEO [email protected] -

Girish Pai Head of Research [email protected] +91 22 3926 8017 / 18

Dealing

Ravi Jagtiani Dealing Desk [email protected] +91 22 3926 8230, +91 22 6636 8833

Pradeep Kasat Dealing Desk [email protected] +91 22 3926 8100/8101, +91 22 6636 8831

Michael Pillai Dealing Desk [email protected] +91 22 3926 8102/8103, +91 22 6636 8830

Nirmal Bang Equities Pvt. Ltd. Correspondence Address B-2, 301/302, Marathon Innova, Nr. Peninsula Corporate Park, Lower Parel (W), Mumbai-400013. Board No. : 91 22 3926 8000/1; Fax. : 022 3926 8010

8 Information Technology Sector