Barrons, July 2016

A technological generation ago—the early 2000s—upstart software outsourcers from India like Tata Consultancy Services , Infosys , and Wipro wrought an industry revolution and put their country on the map as a global brain center. Now they are in danger of falling behind the times. Shares of all three have slumped over the past month or so after quarterly results disappointed on growth, margins, or both.

Their main problem is the cloud-based, or digital, products that are replacing their back-office services. “The past 24 to 36 months have seen a substantial shift toward a whole new wave of digital players,” says Joseph Foresi, who covers software globally for Cantor Fitzgerald in Boston. Old in-house software solutions rely on armies of Java programmers who work more cheaply in India than elsewhere. New digital ones automate some of the rote programing and require seamless integration of code-writing with data analytics or customer service in a single app. Creating the apps isn’t a particular strength for Indian firms.

A few U.S.-based incumbents likeAccenture (ticker: ACN) and Cognizant Technology Solutions (CTSH) are outpacing the Indians in this critical shift, analysts say. So are fast-growing digital-only entrants like Luxoft Holding (LXFT),EPAM Systems (EPAM), and Globant(GLOB). The biggest of the Indian companies, Tata (TCS.India), reports 16% of its earnings from digital products, compared with 26% at Accenture, Foresi says.

A rising tide of economic nationalism in the main customer countries is a secondary threat, notes Sangeeta Gupta, senior vice-president at software industry group Nasscom. Indian firms have responded by moving more operations to the U.S. and Europe, at the risk of sacrificing their raison d’être, cost-cutting.

BUT THE BRAIN TRUSTS of Bangalore and Mumbai are hardly finished, says Sagar Rastogi, technology analyst at Ambit Capital in Mumbai. Tata earned net profit of $940 million last quarter, up 4.7% year on year—hardly dire straits. The Indians are off to a slow start in digital partly because they lack the acquisition culture of U.S. firms. But Tata and its peers can build capacity from within and grab share as the market matures, Rastogi argues. “Right now, clients want an app that looks pretty, and are less attentive to price,” he says. “As they add more capacity, they will need more labor again.” India will gain.

Tata is the relatively steady mother ship of Indian software. But Rastogi’s stock pick is No. 2 Infosys (INFY), which Stanford University–educated CEO Vishal Sikka has been reinvigorating. Infosys’ shares are off by 10% since July 15, when it revealed that first-quarter (June) profit slumped 4.5% from the previous three months. Rastogi urges clients to buy on the dip, though. “I like Infosys for the charismatic CEO,” he says.

Charisma or no, the onetime disrupters of Indian software now look more like disruptees in a world that increasingly demands business solutions that fit sleekly onto an iPhone. That’s a tough prognosis for companies still valued more or less as growth stocks. Tata trades at a price/earnings ratio above 20, compared with 15 for a mature tech titan likeCisco Systems (CSCO).

Tata, Infosys and Wipro (WIT) amazed the world once, creating a knowledge industry in a country that was a byword for backwardness and poverty. Unless they can amaze again, investors can expect more rough patches.