Indian IT companies may earn more from third party items sale

IT firms in India are increasingly partnering with third-party sellers to boost their revenue. While most of them have a pass-through revenue component, analysts expect top companies like TCS, Infosys and Birlasoft to announce higher pass-through revenue in the quarterly earnings season that begins next week.

Pass-through revenue is the revenue generated from third-party services and products, which are directly passed on to clients without any markup.

For Infosys, Kotak institutional equities’ analysts said they expect marginally higher revenue in the second quarter from sale of third-party software. Their note said investors may focus on five items, of which one will be revenue from sale of third-party items.

Similarly, analysts at Nomura wrote in a note that they expect TCS to derive higher revenue contribution from BSNL (which has a pass-through component) that is likely to limit the margin expansion to 20 bps quarter-on-quarter.

On Birlasoft, they wrote, “We expect BSOFT’s EBITDA (earnings before interest taxes depreciation and amortisation) margin to drop from 15.8% in FY24 to 12.4% in FY25F, driven by stiff competition in a low-growth environment; continued investment in team and capability building with slower revenue growth; and higher pass-through revenue.”

Apart from limiting an IT firm’s margin expansion plan, pass-through revenue significantly boosts revenue per employee without actually seeing a positive improvement in employee productivity, said analysts.

They said growth in revenue per head without a simultaneous growth in margin shows that IT firms have mostly relied on large deals, which are loaded with bundled services that include selling third-party products at lower margins.

Peter Bendor-Samuel, chief executive at Everest Group, a consulting and research firm, said an increase in revenue generated by selling software and cloud (of third parties) helped “revenue per employee” but didn’t help margins (this is affected by accounting treatment).

HSBC, in a recent note, said that most large companies saw their RPH (revenue per head) increase, but that was mostly due to increase in utilisation, pass-through revenue and sub-contracting ratio.

On the irony of increased revenue per employee without a change in margin, Peter said that significant wage inflation during and after Covid increased the price (rate card) of services, which boosted revenue per employee but did not increase margin.