AI structurally changing IT biz mix, Jefferies warns of managed services shrinkage ahead

New Delhi, Feb 24 (PTI) The IT services sector is set for a structural shift as AI reshapes the core business mix, which will not only increase 'cyclicality' but also require an overhaul of talent and operating models, "thus adding risks", a report by Jefferies has said.

The brokerage in its note 'P(AI)n Not Over Yet; Stay Selective' warns that AI-led shifts will likely shrink the traditional 'managed services' segment while increasing the consulting and implementation.

Despite a 16 per cent year-to-date fall, stocks still offer higher downside than upside, according to the report.

Jefferies suggests the 'P(AI)n' is not over, leading the firm to cut price targets by up to 33 per cent in some cases. It has also downgraded some industry leaders, including TCS and Infosys.

It is pertinent to mention that in the past few weeks, investor sentiment in the global tech sector, and traditional IT services and software space, has become notably jittery as sophisticated models like AI-disruptor Anthropic’s Claude evolve from assistants into tools capable of executing complex tasks.

"Nifty IT has fallen by 14 per cent and underperformed Nifty50 by 12 percentage points year to date. While 3Q results led to earnings upgrades for nearly all IT firms, recent developments in AI have raised concerns on the medium-to long-term growth outlook for IT firms and driven up to 27 per cent derating," Jefferies said.

This suggests that stock performance will more likely be tied to the longer-term business outlook rather than earnings delivery in the near term.

Jefferies has predicted a structural change in the business mix ahead.

"While IT firms should remain relevant, the nature of their client engagements is likely to structurally shift towards advisory and implementation, with application managed services (22-45 per cent of revenues) seeing sharp revenue deflation," it warned.

The extent and timing of this deflation are likely to exacerbate as AI tools become better, it further said.

"Moreover, the rising share of advisory and implementation engagements would not only increase the 'cyclicality' in revenue growth, but would also demand an overhaul of talent strategy and operating models. Such changes in operating models are not easy to execute, and investors must factor in this risk in PE multiples," according to Jefferies.

Its calculations suggest that at the current market price, stocks are pricing in revenue CAGR of 6-14 per cent for large IT firms and 9-17 per cent CAGR for mid-sized IT firms over FY26-36.

"In our view, maintaining the long-term revenue growth trajectory in line with the previous decade is the best case outcome for IT firms (case 1)...The worst case outcome could be 3 per cent lower revenue CAGR over FY26-31 (15 per cent cumulative deflation), followed by no growth beyond FY31 (case 3)," it said, playing out three different scenarios.

Recent launches from Anthropic’s Claude - including Claude Code, aimed at automating legacy code modernisation, and Claude Code Security, an AI-powered vulnerability detection tool - have intensified debate that swathes of labour-intensive, legacy IT services and software layers could soon become automated, even commoditised.

As a result, the conversation on AI has shifted from a narrative of a productivity booster to an imminent disruptor of long-standing IT business models.

It is in this turbulent juncture that investors and analysts are actively debating whether such tools could displace human-led teams across programming, application modernisation, legal processes, cybersecurity audits and other conventional service areas.

The market reaction has been sharp - in India and outside.

Technology heavyweights, such as IBM, suffered significant declines, with shares plunging more than 13 per cent in a single session on Monday, marking the steepest fall in over 25 years following claims about Claude Code's ability to streamline modernisation of a legacy programming language.

The plunge raised fresh fears about the durability of traditional consulting and infrastructure revenues.

Globally, cybersecurity and software firms, including CrowdStrike, Datadog and Zscaler, too faced pressure as investors tempered growth expectations in segments previously considered relatively insulated from disruptions.

In India, major IT services companies such as TCS, Infosys, HCL Technologies, Wipro and Tech Mahindra witnessed notable selloffs, dragging the Nifty IT index lower amid fears that AI adoption could structurally reduce demand for conventional outsourcing and managed services.

Analyst opinion remains divided, though guarded - firms like Jefferies have downgraded several IT stocks and cut target prices, citing evolving revenue models and pricing pressures, while others contend that the correction may be excessive.

They contend that enterprises continue to view AI primarily as a productivity enhancer rather than a complete substitute for human capabilities.

A latest note by HSBC Global Investment Research argues that software will be the primary mechanism for the diffusion of AI across the world's largest enterprises.

"Foundation models and vibe-coding are not replacements for software within an enterprise for their main IT platforms," it said, adding that "we see 2026 as the kick off for monetisation within software".

HSBC report further claims that foundation AI models are inherently flawed technically and not suited for 'a lift-and-replacement' of major software platforms.

"While there are limited cases where this is appropriate, like an image creation programme or small software app, this is not realistic for the majority of high fidelity enterprise class platforms, in our view," HSBC said in its note. PTI MBI MBI BAL BAL