Infosys has come to be the gold standard in the Indian IT industry’s success. From humble beginnings in 1981, the company today is the second largest exporter of software services from the country. It is known globally for its world-class management practices and work ethics. It has been making conscious and constant efforts to move up the software value chain and offers services like software development, maintenance, technology consulting, testing and package implementation. Infosys offers all these services through its highly integrated and widely acclaimed global delivery model. The company’s revenues and profits have grown at average annual rates of 26% and 27% respectively during the last five years (FY05-FY10).

Reasons to buy

	New initiatives to drive future growth: We had last recommended Infosys in December 2009. At that time things had just started to turn around and the IT sector had started to look more promising. As of now, the sector has started exhibiting strong growth signals despite the overall global economic concerns. Thus, there's a reason to hold on to the stock or buy more if you are fine with an average annual return of around 10% over the next 2-3 years. This is what we expect the Infosys stock to deliver during this period. Now it is not just the improved outlook for IT services that makes us positive on Infosys. We are also enthused by the 'change' the company is working on. From providing plain-vanilla software development services, Infosys has come a long way to now delivering some high-end services as well to its clients. And it is not stopping here. As mentioned by the top management in a recent analyst meet, Infosys is investing aggressively for the future while strengthening its core. The company is working on new engagement models (NEMs). In simple terms, NEMs mean offering high-end solutions to clients without having to deploy additional software engineers. What Infosys is aiming through its NEMs is to increase the share of high-end solutions like IT products in its total revenues. Such initiatives will make its overall business more profitable and sustainable. We see these initiatives as being key drivers for Infosys's growth in the future. The company's focus on software products and other non-linear initiatives will especially be beneficial for its margins. We see Infosys's operating margins to average around 33% over the next 2-3 years. Average annual sales growth is expected to be around 16% during these years.
	Improving demand environment: The global IT industry is witnessing a turnaround in demand. The companies in US have started to witness stronger cash flows and are now opening up their purse strings to spend on IT. The current quarter has seen a surge in volumes of leading Indian IT companies as demand for IT services from the US has revived. IT giants like Infosys are already seeing robust deal pipelines and faster decision making from clients. Europe has been a cause of concern but key players like Infosys are investing in Europe to capture the advantage when the conditions improve.
	'Cloud computing' - The next big thing: Cloud computing is an easy and cost effective way to access data and applications via the internet. It is the new age of technology that is expected to drive the next phase of growth for the Indian IT sector. As per Gartner, revenue from 'cloud computing' will top US$ 14 bn by 2013 and by 2012, India-centric IT services companies will represent 20% of the leading cloud aggregators in the market (through cloud service offerings). Companies like Infosys have already started to secure huge orders in this area. These will start yielding results in the coming years.
	BPO represents huge opportunity: BPO (Business Process Outsourcing) represents 15-20% spend for the clients. As per global research firm Gartner, the market for BPO services is expected to be US$ 50-70 bn at present and is expected to grow by 25-30% annually till 2013. This segment represents a huge potential for growth. The demand is not just for plain vanilla voice services but also for higher end knowledge based services. The Indian IT companies have invested heavily into their BPOs both in terms of manpower as well as in terms of training and are now well positioned to reap the benefits from their investments.
	Managerial excellence: Comparing the management at Coca-Cola to a winning team, Warren Buffett once said, "If you have the 1927 Yankees, all you wish for is their immortality." Nothing explains the importance of good managements than this. Infosys has had its share of visionary leaders. These peoples have driven the company through thick and thin over the years. The present management that has steered the company through the deadliest storm is nothing short of exemplary. Near the end of 2008, the Indian corporate sector was hit by the Satyam scandal. Even recently, there have been several other instances where managements of large companies have taken minority investors for a ride. In such times (and even otherwise), the need for investors to stick to strong and ethical managements is important. Infosys has a highly competent management team that is capable of envisioning future trends in the industry. Its solid depth of experience gives the company a clear competitive advantage over its peers. The company has also set best standards in corporate disclosure and human resource management. Considering the knowledge-intensive nature of the software industry, the ability to attract and retain the right talent gives Infosys an edge over other companies from and outside the software industry.

Reasons not to buy

Currency risks: We are no experts in predicting the future movement of the rupee vis-à-vis the US dollar. But given that dollar is expected to get hit under the weight of US’ huge deficits, the rupee is expected to appreciate in the medium term. Infosys’ management also has a view that while the dollar could appreciate against all global currencies in the short term (as it is doing now), in the long term, the dollar could weaken as the world starts focusing on the currency’s intrinsic weakness. In addition to this the recent crisis in Europe has weakened the Euro as well. This would certainly be a negative for Indian exporters, including IT companies like Infosys. While the company is taking steps to hedge its currency risk, the fact is that it is still, to a large extent, dependent on the US dollar and the Euro. This makes it vulnerable to rupee’s volatile movement against these currencies.

Managing a huge workforce: Infosys has been one of the best employers in the Indian IT industry. However, with improving growth in the IT industry and regular poaching efforts of competitors, the company has witnessed a sharp increase in its attrition levels. It is making efforts to retain its employees through offering salary hikes and bonus shares, but still the positive impact of these remains to be seen.

Capex

We expect the company to spend on an average 3%-4% of its consolidated revenues in capital expenditure over the next three years.

Views on News New Commerce: Everything is going nano (Jul 30, 2010) IT Stocks: Ready to move up? (Jul 20, 2010) Infosys: Weak first qtr, expects a better year (Jul 13, 2010) Infosys vs. TCS: Round 4 (Jul 8, 2010) Infosys vs. TCS: Round 3 (Jul 1, 2010) More Views on News

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