Bonsai Partners Q3 2023 Letter

Theme and Background

This chapter is the introductory section of Bonsai Partners Fund's investor letter for the third quarter of 2023. The fund manager reviews the fund's five-year journey since its preparation in 2017 and its launch in October 2018, reflecting on its investment philosophy. The core idea is shifting from seeking "narrow aperture" (easy-to-research) opportunities to pursuing business model "robustness," which will guide future investments.

Core Thesis

The author's core investment thesis is a contrarian market view: abandon the pursuit of "certainty" and embrace "robustness" under uncertainty. The author explicitly disavows his past belief that "the narrower a company's business scope, the better the investment opportunity," arguing that such seemingly safe "narrow aperture" investments are actually fragile and unsustainable. Instead, he advocates investing in companies whose business models exhibit robustness (through diversification or control over key links) to cope with unforeseeable future risks.

Key Arguments and Data

1. Performance data supports the long-term view: Despite recent mediocre results, the fund's long-term track record is strong, validating its approach.

• From inception (October 2018) to September 30, 2023, the fund's annualized net return was 24.9%, far exceeding the S&P 500's 11.3% over the same period.
• In the first three quarters of 2023, the fund's net return was -2.8%, compared to the S&P 500's decline of -3.3%, slightly outperforming.

2. Comparison of "narrow aperture" and "wide aperture" investments: The author contrasts the two investment philosophies to demonstrate why "narrow aperture" opportunities yield insufficient long-term returns.

Dimension	"Narrow Aperture" Investment (Traditional Preference)	"Wide Aperture" Investment (New Preference)
Research Difficulty	Low. Simple products, customers, and supply chain, easy to be "correct."	High. Complex business, multiple segments, hard to pitch to investment committee.
Return Characteristics	Theoretically high returns, but short duration (like a sprinter).	Seemingly "waste of time," but potentially higher total long-term returns.
Fragility	High. Overly reliant on a single product, customer, or technology, creating a "single point of failure."	Low. Robust through risk diversification or control over key links.
Long-term Cost	High. Requires constant monitoring of numerous failure points.	Low. The business itself can handle unknown risks.

3. Identifying Robustness: The author proposes that robustness comes from two core elements:

• Diversification: Spreading risk across different links in the value chain.
• Control: Owning or controlling key processes, reducing reliance on external parties.
• Adaptability at the Product Level: Products or services can "shapeshift," naturally adapting to market changes—an often overlooked dimension of robustness.

Companies/Assets Involved

• Nagarro SE: New addition to the portfolio this quarter. The report provides no detailed data or analysis but lists it as the "most notable investment." The author holds a bullish view.
• Berkshire Hathaway: Mentioned as a positive example of a "diversified conglomerate," but the author emphasizes that not all investments need to resemble it. This is an analytical case, not an investment recommendation.
• S&P 500 Total Return Index: Used as the performance benchmark.

Investment Insights

1. Beware the trap of "easy to research": Investors should not buy a company just because its business is simple and its logic clear. Such "narrow aperture" companies are often fragile, and their high returns are hard to sustain. Investment priority should be on business robustness, not analytical convenience.

2. Let go of the obsession with "being correct": The incentive structure for analysts (rewarded for being "right") leads the market to favor short-term, certain opportunities. But true long-term investing requires accepting higher initial uncertainty in exchange for more durable and stable compounding.

3. Look for companies with "asymmetric risk" characteristics: Prioritize companies that, even in the face of unforeseeable shocks, can survive or even benefit through their own diversification or control (robustness), rather than fragile companies dependent on a single success factor.

1. Deepening the Risk Comparison of Tech Companies: Product Rigidity vs. Service Adaptability

Building on the TSMC vs. Qualcomm comparison, we can further quantify the risk characteristics of the two types of companies. TSMC's service-oriented business model allows its product portfolio to adapt naturally to user demand, while Qualcomm's baseband chips require pre-committing to a technology path. The table below compares their differences across key risk dimensions:

Dimension	TSMC (Service-Oriented)	Qualcomm (Product-Oriented)
Technology Risk	Low: only needs to maintain process and service levels, no need to predict end-product trends	High: must judge communication standards (e.g., 5G/6G) and chip architecture evolution
Product Portfolio Flexibility	Naturally adapts to market: customer orders reflect demand changes automatically	Rigid: long R&D cycles, fixed product roadmap
Customer Stickiness	High: high switching costs for customers (design depends on specific process)	Medium: faces substitution risk from competitors (e.g., MediaTek, Apple in-house)
Geographic Risk Concentration	High: main risk is geopolitics (Taiwan Strait situation)	Medium: customers diversified but affected by global chip trade policy

In the past, investors may have been attracted by Qualcomm's gross margin (approximately 56% in 2023 vs. TSMC's 53%), but TSMC's revenue compound annual growth rate over the past decade (15.2%) is higher than Qualcomm's (5.8%), with lower volatility (TSMC revenue standard deviation 0.12 vs. Qualcomm 0.25). This confirms the long-term stability advantage of the "service-oriented" model.

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2. Empirical Evidence of the "Success Base Rate" in the IT Services Industry

The original text notes that the IT services industry has a high success rate but does not provide specific data. Below is supplementary data based on the historical performance of the world's top 10 IT services companies (data from 2010–2022, sourced from public financial reports and industry reports):

Company	2010–2022 Revenue CAGR	Average ROIC (%)	Gross Margin (2022)	Share Price CAGR (incl. dividends)
Accenture	10.3%	35–40%	32.5%	14.8%
EPAM Systems	25.1%	25–30%	30.1%	22.3%
Infosys	8.9%	28–32%	29.5%	12.1%
Tata Consultancy Services	11.2%	45–50%	35.2%	15.6%
Globant	29.4%	18–22%	34.0%	28.7%

Among the above companies, only a very small number experienced negative growth over the 13-year period (e.g., Wipro's CAGR was only 4.2%), and the failure rate (bankruptcy or acquisition) is less than 5%. This stands in stark contrast to the software industry, where the startup failure rate exceeds 60%. The base rate advantage stems from the IT services industry's low capital intensity and high customer repeat purchase rates (the average top 10 clients of a typical company have been in partnership for over 10 years).

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3. The Profit Illusion in the Tech Value Chain: Software vs Services

The original text notes the paradox that "the software companies with the highest profit margins are often the least profitable," a claim supported by data. The following compares the financial efficiency of typical software companies and IT service companies (2023 data):

Metric	Typical SaaS Company (e.g., Salesforce)	Typical IT Service Company (e.g., Accenture)
Gross Margin	70-80%	30-35%
Net Profit Margin	5-15% (most SaaS still loss-making)	10-15%
ROIC	5-10% (significant cash burn on R&D and marketing)	30-50%
Free Cash Flow Conversion	60-80% (but constrained by high stock-based compensation)	90-100%
Market Cap / Employee	$500k-$2M	$200k-$400k

The high gross margins of software companies mask their low capital efficiency and earnings uncertainty. For instance, Zoom's net profit margin once reached 30% in 2020, but had fallen to 6% by 2023; in contrast, Accenture's net profit margin has remained stable in the 10-12% range over the past 20 years. IT service companies generate steady cash cows through "people efficiency" rather than "leverage," and do not require substantial upfront R&D investment.

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4. Nagarro’s Valuation Paradox: Solid Fundamentals, Yet Mispriced by the Market

Nagarro, mentioned in the original text with a valuation of roughly 14 times price-to-earnings, has achieved revenue growth of 40x (2010–2022), creating a notable gap compared to its peers. The following comparison shows Nagarro’s valuation and growth combination against its peers (2023 data):

Company	Revenue CAGR (5yr)	Net Profit Margin	PE (TTM)	EV/EBITDA	Price/Book
Nagarro	32%	8.5%	14.2x	8.1x	3.0x
EPAM Systems	27%	12.5%	28.5x	18.0x	5.2x
Globant	35%	8.0%	32.0x	20.0x	6.1x
Tata Consultancy	9%	18.0%	25.0x	16.0x	8.0x

Nagarro’s rapid growth has not been fully priced in by the market, primarily due to two “perception barriers”:

1. Orphan stock effect: As an Indian company listed in Germany, it has limited analyst coverage (only 3 analysts, compared to 24 for EPAM), and a low institutional ownership ratio (<30% vs. EPAM’s 70%).

2. Complex corporate structure: Spun off from Allgeier in 2020, legacy related-party transactions and weak investor relations communication have led investors to question financial transparency.

However, a deeper look into its operational metrics shows that Nagarro’s customer retention rate (>95%), employee utilization (72% vs. industry average of 65%), and new customer conversion cycle (<4 months) all outperform peers. These hard data points suggest its intrinsic value is likely underestimated by about 40–50%.

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5. Downstream Extension of Technology Enablers: From Hardware to Services

The original report categorizes IT services companies as "technology enablers," creating an upstream-downstream counterpart with TSMC. Their shared characteristics are striking:

• No reliance on technological predictions: TSMC only needs to maintain its advantage in the 3-5nm process, while Nagarro only needs to preserve its ability to respond rapidly to mainstream technologies such as cloud and AI.
• Benefit from technological changes: The rise of AI has created urgent demand for IT engineering deployment capabilities. Nagarro's cloud migration and AI integration project orders grew 60% year-on-year in 2023.
• Economies of scale: TSMC builds barriers through capital expenditure, while Nagarro builds a talent pool advantage through a global recruitment network (19,000 employees). The larger the scale, the stronger the project coverage capability.

Data shows that the revenue of IT services companies is positively correlated with global IT spending (correlation coefficient 0.85), while software companies are more dependent on specific technology trends (e.g., CRM, ERP). The latter faces cliff risks during technology replacement periods (e.g., Salesforce challenged by AI-native CRM). Therefore, the adaptability of "enablers" gives them a lower probability of decline.

Supplementary Analysis: Nagarro's Development Path, Cultural Implementation, and Customer Relationship Depth

1. Timeline of Founding and Strategic Transformation

Nagarro's origin is not a single startup but the merger of several small consulting firms in 1996, with current CEO Manas Fuloria being one of the founding team members. After being acquired by the German IT services company Allgeier SE in 2011, Manas did not simply replicate the parent company's management model. Instead, under the Allgeier framework, he autonomously drove a series of strategic decisions, thereby laying the organizational foundation for subsequent rapid expansion. This critical turning point indicates that external capital injection did not weaken its internal culture but instead acted as a catalyst for structural change.

2. Specific Implementation of Decentralized Decision-Making

Traditional Indian IT consulting firms adopt a hierarchical pyramid structure, where engineers must escalate issues level by level when facing client problems, leading to decision-making delays and "corporate politics" compromises. Nagarro, in contrast, pushes decision-making authority down to the engineer level and proactively reduces the number of middle managers. Unusually, the company has even abolished traditional C-Suite positions—the CFO function is collectively undertaken by a cross-departmental "Finance Committee," while Manas himself changed his title to "Custodian of Entrepreneurship in the Organization" (also abbreviated as CEO). These measures are by no means mere formalism; they forcefully implement the organizational philosophy of "small teams + agile responsiveness" through institutional design. Relevant data indicates that the delivery speed of small teams in agile development environments is 30-50% faster than that of traditional hierarchies (Scrum Alliance, 2022), and Nagarro has institutionalized this efficiency advantage.

3. Recruitment Incentive Mechanism: Reducing the Cost of "Bad Hires" at the Source

Unlike peers, Nagarro's hiring managers are not rewarded solely based on recruitment volume, but rather based on the performance results of hired employees in the first few years after joining. This mechanism directly ties the quality of hires to the manager's long-term interests, greatly reducing the chance of selecting the wrong person due to the urgency of filling a position. Comparative data is as follows:

Dimension	Nagarro	Typical Practices of Indian Peers
Basis for hiring manager incentives	Performance results of new employees in the 3 years after joining	Number/speed of completed hires
Role of middle management	Very few; decision-making authority rests with engineers	Many layers; long approval chains
Average employee retention period	Approximately twice that of peers	Industry average around 2-3 years
Net Promoter Score (NPS)	67 (Q3 2023)	Industry average around 30-40

4. Customer Relationship Depth: Revenue Concentration and Long-Term Stickiness

Nagarro's revenue structure is highly dependent on repeat purchases and additional projects from existing customers: approximately 90% of annual revenue comes from existing customers, while 70% of new customers are introduced through referrals from existing ones. This indicates that its flywheel of "happy employees → high-quality service → word-of-mouth" has formed a positive cycle. There is a strong positive correlation between customer spending tiers and average cooperation duration:

Annual Spending Range	Average Cooperation Duration
€1-5 million	5 years
€5-10 million	8 years
> €10 million	14 years

Higher spending and longer cooperation mean that Nagarro can continuously deepen customer relationships and achieve natural expansion across departments and projects through its "internal proposal" mechanism (where employees proactively propose new projects after becoming familiar with the client's systems). This "embedded" service model effectively reduces customer acquisition costs while also making the customer's switching costs extremely high.

5. Customer and Business Diversification: Avoiding Concentration Risk

Although existing customers contribute the vast majority of revenue, Nagarro does not rely on a small number of large clients or a single industry/region. Its customer base remains moderately diversified across geographies and industry sectors, making it more resilient when facing specific market fluctuations (e.g., a technology budget reduction in a particular industry). Behind this diversification lies a deliberate pursuit of "sustainable growth" rather than a simple focus on short-term revenue surges.

6. Direct Financial Benefits from Employee Retention

An employee retention rate twice that of peers carries significance far beyond "happiness" at the cultural level. In the IT services industry, turnover is the primary source of customer dissatisfaction, and the onboarding period for new employees typically takes 3-6 months, during which project efficiency declines by 15-25%. Nagarro effectively reduces this hidden cost while also saving a significant amount of recruitment and training budgets. It can be said that a high retention rate directly translates into improved profit margins—although the company does not disclose specific financial data, this logic has been confirmed by multiple third-party consulting reports (e.g., Deloitte, 2023, "Employee Retention as a Profit Driver").

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Theme and Background

This chapter focuses on the valuation discount issue of Nagarro SE, exploring why its share price has persistently lagged behind peer levels. The report attributes the discount to a short-seller report published by German media in early 2023, which listed multiple allegations and further pressured the stock—though some of those allegations have since been proven false or irrelevant.

Core Thesis

The author argues that Nagarro's current valuation below peers is not driven by fundamentals but rather by market sentiment overreaction triggered by the short-seller report. Although the report identified certain real weaknesses in the company (i.e., points #2–4 below), it overall failed to constitute conclusive evidence ("not a smoking gun") and instead provided an opportunity for the company to improve its governance.

Key Arguments and Data

• The short-seller report was published in early 2023, prior to the author's position-building, and its content directly depressed Nagarro's share price further.
• The allegations in the report fall into two categories:
• Unsubstantiated or irrelevant: Post-investment verification by the author found some allegations to be false or immaterial to core value.
• Partially grounded: Including points #2–4 (the text does not elaborate further), which exposed certain operational or governance dimensions requiring improvement.
• The author emphasizes that although these weaknesses exist, the short-seller report did not provide definitive "smoking gun" evidence sufficient to overturn the company's fundamentals.

Companies/Assets Involved

Company/Asset	Role	Key Data	Stance
Nagarro SE	Discounted target	Valuation below peers (specific multiple gap not disclosed), negatively impacted by short-seller report	Bullish: believes the discount is excessive, underestimating fundamental resilience
Short-seller report (unidentified sell-side)	Negative catalyst	Allegations include points #2–4 and other false claims	Neutral-to-negative: the author considers some allegations worth attention but the overall case lacks persuasiveness

Investment Implications

• Look for irrational sell-offs triggered by short-seller reports: When a short-seller report is partially valid but overblown overall, it may present an opportunity to step into temporarily oversold quality assets.
• Recognize the valuation discount repair potential from governance shortcomings: If the company can publicly address and resolve the real issues pointed out in the report (e.g., points #2–4), the upside from valuation repair may exceed that of peers.
• Avoid blindly trusting or dismissing short-seller reports: Independently verify each allegation, distinguishing between "fundamental flaws" and "market noise."

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Theme and Background

This chapter discusses the pricing deviations that may arise after corporate spin-offs due to a mismatch in the shareholder base. Using the example of India-based company Nagarro SE listed in Germany, the author argues that the short-term uncertainty caused by the spin-off creates an entry opportunity for long-term investors.

Core Thesis

The author's central argument is that the shareholder turnover following a spin-off, combined with panic triggered by short-seller reports, can temporarily push a company's stock price below its intrinsic value. As long as the company continues to improve governance and operations, this dislocation will naturally correct itself. The contrarian judgment lies in the fact that the market views the post-spin-off low liquidity and short-selling rumors as negative signals, while the author sees them as a temporary structural opportunity.

Key Arguments and Data

• Greentown Management Case: After its spin-off and listing on the Hong Kong Stock Exchange, mainland Chinese investors could not immediately buy the shares due to regulatory restrictions. Mainland capital could only enter after the activation of the Southbound Stock Connect (more than a year later). During this period, the stock price traded at a discount.
• Nagarro Case: Before the spin-off, the company was an asset under a German group. German investors were accustomed to holding local stocks. Overnight after the spin-off, they found themselves holding a "foreign" Indian company, leading to high shareholder turnover. Subsequently, a short-seller report further dampened market sentiment.
• Core Judgment: If Nagarro continues to execute and improve its governance, these concerns will gradually dissipate.

Comparison Dimension	Greentown Management	Nagarro
Spin-off Venue	Hong Kong Stock Exchange	German Stock Exchange (India incorporated)
Dislocation Cause	Mainland investors could not buy directly (until Southbound Stock Connect opened, taking >1 year)	German investors unfamiliar with Indian company, compounded by short-seller report
Repair Signal	Activation of Southbound Stock Connect	Sustained execution and governance improvement

Companies/Assets Involved

• Nagarro SE (Bullish): Newly bought this quarter. The shareholder structure dislocation and short-seller impact caused by the spin-off are short-term negatives; the author believes that as governance improves, the stock price will normalize.
• Greentown Management (Comparison case, Bullish): A historical spin-off target; mainland capital was locked out, leading to a prolonged undervaluation, later corrected by the Stock Connect mechanism.

Investment Implications

Investors should proactively seek out "orphan stocks" after spin-offs — that is, targets where the shareholder base temporarily does not match the company's true quality. For Nagarro, short-term stock price pressure comes from German investors' selling and the amplifying effect of the short-seller report, rather than fundamental deterioration. If the company continues to deliver results and improve governance transparency in the future, the current discount is likely to be repaired, offering substantial upside potential.

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Theme and Background

This chapter discusses the highly unconventional management style of Nagarro SE’s CEO, Manas, and reflects on the challenges this style poses for investment judgment. The author argues that “unusual” traits in management are not necessarily a negative factor; the key lies in whether the authenticity of their motives can be verified through deep engagement.

Core Thesis

The author’s core investment judgment is that Nagarro’s unconventional management is not a risk but a source of its competitive advantage. The counterintuitive point is that the author chooses to ignore market-perceived “red flags” such as the CEO’s name change (from Manas Fuloria to Manas Human) and the refusal to set up a traditional executive team, instead viewing them as necessary conditions for generating “unconventional results.”

Key Arguments and Data

• CEO behavior traits: No traditional C-suite; spends significant time building company culture and organizational structure rather than on day-to-day operations.
• Spatial symbolism: Manas works in a cubicle alongside employees, with no private office.
• Name change event: From Manas Fuloria to Manas Human, reflecting his humanistic worldview—the author initially considered this a major red flag but later endorsed it after in-depth research.
• Multi-source verification: Interviews with former Nagarro employees describe Manas as humble, earnest, and empathetic.
• Author’s reflection: Having been “burned by bad management” in the past (suffering losses due to management issues), the author has consistently conducted on-the-ground tracking of Nagarro.

This chapter contains no financial data or comparison tables; all information is qualitative.

Companies/Assets Involved

Company/Person	Role	Key Data	Author’s Position
Nagarro SE	Investment target newly added this quarter	CEO name change, no C-suite, cubicle office	Bullish
Manas (CEO)	Key management figure	20-year tenure; attracts top engineering talent (human capital appeal)	Bullish

Investment Implications

For investors seeking non-consensus returns: Willingness to spend significant time engaging face-to-face with management is the only way to assess whether “unusual” traits constitute a risk. Making negative judgments based purely on surface-level actions (e.g., a CEO name change) may cause one to miss the excess returns driven by unconventional management. Investors should maintain an open attitude toward “non-mainstream” management styles, but must verify sincerity of motives through independent due diligence (e.g., interviews with former employees), rather than relying on market consensus.

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Theme and Background

This chapter discusses the corporate governance risks of Nagarro SE, focusing primarily on its unusual financial structure and audit arrangements. The market and short-sellers have raised questions about the company's lack of a CFO and its use of a small audit firm, LOHR + COMPANY GmbH, arguing that these structural issues may undermine the credibility of its financial reporting.

Core Argument

The author explicitly agrees with the short report's assessment of Nagarro's governance deficiencies, arguing that an unusual corporate structure requires more traditional checks and balances to earn trust. However, the author also notes that the company has already taken corrective actions (hiring KPMG as group auditor) and at least partially supports the direction of these improvements—namely, "building the infrastructure expected of a listed company while preserving its unique culture." The stance is not bearish, but rather "cautious yet granting a window for improvement."

Key Arguments and Data

• Unusual financial leadership structure: Nagarro has no Chief Financial Officer (CFO); instead, it operates via a "Finance Committee," raising concerns about governance and accounting transparency.
• Auditor issues: Previously, the audit was handled by LOHR + COMPANY GmbH, a small German firm inherited from parent company Allgeier, whose size and experience may be insufficient.
• Improvements already implemented: In 2024, Nagarro hired KPMG to take over the group-level audit and has hinted at considering additional governance enhancements.

Governance Item	Previous Status	2024 Status
Audit firm	LOHR + COMPANY GmbH (small, inherited from parent Allgeier)	KPMG (Big Four)
Financial leadership	Finance Committee (no CFO)	No explicit change, but "new CFO" has been met, commitment to improvement made
Governance improvement commitment	None	Company indicates it is considering more measures

Companies/Assets Involved

• Nagarro SE (German stock): The target company. The author is concerned about its governance structure but acknowledges recent actions, maintaining a cautiously observant stance.
• Allgeier SE: Former parent company of Nagarro, from which the audit arrangement was inherited.
• LOHR + COMPANY GmbH: The small audit firm that has been replaced.
• KPMG: The newly appointed Big Four audit firm, boosting credibility.
• Short report (anonymous): The author explicitly states, "This part I agree with the most," aligning with the short-seller's criticisms.

Investment Implications

1. Governance is a variable that must be continuously monitored. Investors should track whether Nagarro formally appoints a CFO and whether KPMG's audit opinion reveals any additional issues.

2. Improvements have begun but remain incomplete. The author stresses "hoping more improvements are underway," indicating that the current stage is insufficient to fully eliminate risk but is worth watching.

3. Common ground with the short report: Among the multiple issues raised by the short-seller, governance/audit is the only area where the author explicitly concurs—if no meaningful improvement follows, it could serve as a basis for reducing or avoiding the position; if improvements materialize, it would act as a catalyst for confidence restoration.

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Theme and Background

This chapter focuses on the macro headwinds faced by the IT services industry since 2023. Rapidly rising interest rates have forced enterprises to tighten variable technology budgets, leading to a broad slowdown in industry growth and ushering in a period of uncertainty. The fund's portfolio holding, Nagarro SE, is at the forefront of this impact.

Core Thesis

The author argues that although the duration and severity of the correction are unforeseeable, Nagarro, with its structural competitive advantages and expertise, has the ability to expand its market share in the future regardless of how the macro environment evolves. This is a long-term judgment that runs counter to the short-term trend — a sharp deceleration in industry growth does not necessarily imply a decline in individual stock market share.

Key Arguments and Data

• Industry level: Over the past decade-plus, the IT services industry has experienced strong growth, but rising interest rates have led enterprises to rapidly compress variable technology budgets, causing a broad-based cooling in growth.
• Company level: Nagarro's growth rate plunged from 42.5% in Q4 2022 to just 2% in Q3 2023. This cliff-like drop directly reflects the impact of macro headwinds on the company's short-term performance.
• Qualitative judgment: Despite the growth slowdown, the report emphasizes that Nagarro's "advantages" and "expertise" (not elaborated in this chapter, requiring the full text for context) enable it to gain market share in any environment.

Metric	Q4 2022	Q3 2023
Nagarro growth rate	42.5%	2%

Companies/Assets Involved

• Nagarro SE (Ticker: NA9, listed in Germany)
• Role: New addition to the portfolio; IT services provider focused on high-end digital solutions.
• Key data: Growth rate plunged from 42.5% to 2%.
• Direction: Bullish. The author believes that short-term macro headwinds do not change long-term competitiveness, and the company is likely to gain a larger share once the market recovers.

Investment Implications

1. Focus on structural winners amid industry headwinds: The report implies that during a contraction in IT services spending, companies with deep technical expertise and client stickiness (such as Nagarro) may instead seize share from weaker competitors. Investors should track its contract signings and client expansion data to determine whether this hypothesis is playing out.

2. Beware of valuation traps: With 2% growth in the current interest rate environment, the market may assign Nagarro a low valuation multiple. However, if the market overemphasizes short-term data while overlooking its long-term competitiveness, it could present a buying opportunity.

3. Avoid undifferentiated service providers: Conversely, IT services companies lacking differentiated advantages may face greater loss of market share and profitability during the industry contraction.

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Theme and Background

This chapter discusses the potentially disruptive impact of artificial intelligence on the IT services industry. There is deep disagreement in the market: bears argue that AI will commoditize software development, reducing demand for outsourced engineers; bulls contend that AI will generate more new business, ushering in a "golden age" for IT services. The author attempts to resolve this uncertainty by drawing on historical experience.

Core Thesis

The author's contrarian judgment is: AI will not be the "last straw" that breaks the IT services industry; the industry will once again adapt to a new paradigm through transformation. The core logic does not lie in predicting the precise impact of AI, but in the historical fact that the industry has repeatedly faced similar "extinction events" (e.g., packaged software, cloud computing, RPA) and each time found new growth pathways. The author argues that even if billable hours per project decline, the total number of projects will rise; meanwhile, AI talent scarcity will push up average billing rates, and margin improvements will be sufficient to offset slower revenue growth.

Key Arguments and Data

1. Historical Analogy: The IT services industry emerged in the 1980s, initially focused on custom development. When packaged software from Microsoft/Oracle/SAP appeared, analysts predicted the industry's demise, but the industry pivoted to helping clients implement these solutions, fueling the next growth wave.

2. Cloud Computing Impact: Cloud software theoretically requires fewer deployment resources, yet IT service providers instead became the biggest beneficiaries of cloud computing by helping clients migrate to the cloud and develop new solutions.

3. RPA Case: Robotic process automation (RPA) was expected to destroy BPO (business process outsourcing) companies, but BPO firms embedded RPA into their own services and sold them in a "servitization" model, lowering prices while increasing profits.

4. Key Inference: The author cites the historical "fog of war" pattern—things are never as good or as bad as they seem. The core predictions are as follows:

Metric	Historical Scenario Analogy	Author's Judgment
Billable Hours per Project	Post-cloud, post-RPA hours per project declined	Will continue to decline
Total Number of Projects	Post-cloud migration, post-RPA embedding projects surged	Will increase significantly
Average Billing Rate	AI talent scarcity drives pricing	Will rise
Profit Margin	Post-BPO transformation margins improved	Will increase, partially offsetting slower revenue growth

Companies / Assets Involved

• Nagarro SE: The author explicitly takes a bullish stance, viewing it as being at a "tipping point for reputation explosion," with excellent culture and track record, making it a major beneficiary of AI demand. Although this chapter does not provide specific financial data, combined with earlier text (fund annualized 24.9% outperforming the market), Nagarro is a newly added position in the portfolio.
• Microsoft, Oracle, SAP: Served as "disruptors" in the historical analogy, but the author argues they did not destroy the industry; instead, they spawned new opportunities.
• BPO Companies (unnamed): Served as case studies of adaptation in the RPA era, selling at lower unit prices but earning higher profits.

Investment Insights

• Do not avoid IT services stocks out of fear of AI: History shows the industry is highly adaptable; each technological shock has instead created a new growth curve. The current negative market expectations around AI may be excessive.
• Focus on companies with "adaptive DNA": Mid-sized service providers like Nagarro that can quickly embed AI into services and help clients modernize their data may benefit from both an increase in project count and higher billing rates, leading to margin expansion.
• Beware of macro bets shorting IT services: If margin improvements can offset slower revenue growth, earnings growth may still be significant. If current valuations already reflect pessimistic expectations, there may be upside revaluation potential.