Visa Reform Raises Uncertainty for Offshore IT Services
Our long-term opinion of the industry is unchanged, and we see options for the firms to lessen the burden.
In the wake of a sweeping U.S. immigration ban, the executive order for which was signed by President Donald Trump on Jan. 27, we are seeing repercussions and volatility for the information technology services industry, which relies on the movement of both temporary and permanent immigrants. According to early reports, programs like the H-1B visa program--which is used by offshore IT service providers to import skilled labor--are expected to face reform. Jeff Session, the nominee for U.S. attorney general, has been vocal about reforming visa regulation, while a bill introduced to the House of Representatives by Democratic Rep. Zoe Lofgren of California aims to raise the minimum H-1B salary from $60,000 to $130,000. While there has been much discussion by both sides, the extent of the finalized legislation and its passing remains unclear.
At this stage, we recognize the risks associated with higher costs that could pressure both revenue and operating margins for several IT services leaders. However, we believe there are some important factors to consider, such as outsourcing, automation, local mergers and acquisitions, rolling H-1B visas, and political pressure, that may help to alleviate long-term pain for providers whose business models rely on help from legal immigration. Despite the near-term uncertainty, our long-term opinion of the industry is unchanged, and Cognizant Technology Solutions (CTSH) remains our favored undervalued name. We are maintaining our fair value estimates and narrow moat ratings for Cognizant, Infosys (INFY), Tata Consultancy Services (TCS), and Wipro (WIT).
The U.S. government appears to be concerned about employing overseas IT workers to the detriment of U.S. IT workers. The biggest issues for this argument are that overseas workers get paid less than (and thus undercut) the local workforce, while there are many unemployed U.S. workers in the IT field who can do the same job. Yet based on our analysis, we're not convinced that this notion holds true in a majority of cases.
According to a 2015 NASSCOM report and Zinnov analysis, Indian technology wages were comparable with those of U.S. nationals. The report found that U.S. nationals were paid $81,447 on average, while U.S. visa holders were paid $81,022 plus the additional fixed cost of $15,000 per visa holder for visa costs, ticket costs, and so on. As further evidence, according to myvisajobs.com, the average salary Cognizant paid for an H-1B visa holder in 2016 was $74,628, which is below the $81,022 quoted above, but also only refers to guaranteed income and excludes any bonus or benefits.
Additionally, U.S. regulations require that H-1B visa holders face a prevailing wage test to ensure they are paid at an equivalent wage to locally employed staff; if they weren’t, this would violate the current regulations and lead to legal trouble. We have seen some past instances of legal proceedings, but in the past few years, we suspect the microscope is steadily focused on these firms’ operations, given the past legal proceedings and heightened national interest. We think this attention has helped mitigate gross wage abuse.
The Bureau of Labor Statistics says the computer and mathematical occupation unemployment rate was 2.6% in December 2016. As we have seen over the past five to six years, this unemployment rate has been roughly half the rate of overall U.S. unemployment. At such low levels, the computer and mathematical occupation unemployment rate is actually below a natural rate of unemployment, which according to the Federal Reserve Bank of St. Louis was 4.7% at the end of calendar 2016. This measure indicates a tight hiring market and supports Silicon Valley’s contention that it continually faces a shortage of skilled workers. A report from Gartner also says, “By 2020, there will be 1.4 million computer specialist job openings, according to the U.S. Department of Labor. But projections show universities are not likely to produce enough qualified graduates to fill even about 30% of these jobs.” Such statements echo the need for more skilled workers in the United States, and detrimental regulation could exacerbate such need.
As digital and cloud transformation workloads perpetuate throughout the industry, we believe a skills mismatch has become ever present. Local skills may not meet the required skills necessary for these newer types of rapidly evolving services. Lately, the Indian providers have had to completely reconfigure their training and development programs, with Infosys, Tata, and Wipro retraining hundreds of thousands of their employees on design thinking and digital technologies such as automation and artificial intelligence. As a result, we do question the local skills mix, given the pace of change and possible lack of exposure to such work.
The above points run counter to the argument for tougher immigration regulation. However, if the new administration does decide to impose detrimental legislation, we believe there would be greater local skill shortages, which could lead to high inflationary conditions for local IT workers, raise the cost per employee, and pressure operating margins. This may also hamper revenue growth as firms lack the ability to staff contracts out for bid. The uncertain environment and magnitude of possible outcomes do give us cause for concern, but over the long term, we think the offshore IT service providers have some tools that may help alleviate revenue and margin concerns.
More outsourcing, automation, local mergers and acquisitions, rolling H-1B visas, and political pressure are just some of the options that may lessen the burden of revised immigration regulation. In terms of outsourcing, we think more work will simply leave the U.S., particularly for work associated with business process outsourcing and IT outsourcing. Also, a recent big push by the offshore IT service industry has been in automation. Why use humans at all? We believe new legislation could accelerate these firms’ emphasis and investment in automation to limit the human capital component of work.
In the past couple of years, we have seen offshore IT service providers increasingly conduct M&A of local consultants and systems integrators. We’d expect to see more M&A to build local competencies, while the offshore providers still leverage their ability to deliver remote services from overseas locations. As it comes to timing and impact, for visas such as the H-1B, they last three years and the company and employee have the option to extend it another three years for a total of six. If the H-1B program is altered significantly or scrapped, we don’t think all employees will instantly become redundant, given the (hopefully) rolling nature of the visa. While disruptive, we believe the affected firms will at least have some time to take countermeasures as employees expire on a rolling basis, rather than all at one time.
Lastly, early reports point to a cordial relationship between Trump and Indian Prime Minister Narendra Modi. For geopolitical reasons, Trump would be wise to keep this relationship intact. For Modi, the issue of U.S. visa reform has been a sticking point in the past, given the importance of the IT industry to India’s economy. With Modi set to meet with Trump in June, more-tempered immigration measures are possible.
Andrew Lange does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.