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 23.6% and 22.7% respectively during the last five years (FY06-FY11).

Reasons to buy

	Long term story is promising: After the downturn in year 2008, software sector started turning around in the second half of 2010. Again the sector looked promising. During the last financial year 2010-2011, a lot of things improved. The global IT spending revived. The top honchos of almost all IT majors appeared a lot more upbeat and confident of the recovery in IT spending. Though the recent crisis in the US as well as in the European regions is a cause of worry for the whole sector, these companies are confident of continuing their growth story especially over the long term. Recently Infosys, India's second largest software company has restructured their whole business. Keeping the long term growth prospect in their mind, the management of the company has made several changes in the organization. The whole business was restructured into four industry verticals and three service lines. Now the company is focused towards the go-to-the-market strategy with the offering of end-to-end solutions. The company is also focusing on high end services like consulting and system integration. As more and more clients are looking for increase their business efficiencies, the efforts towards consulting services are paying well for the company. It is helping in increasing their business from the existing clients. At the same time, it also helps the company to retain its clients. Due to recent crisis in US and European reasons, there are worries with regards to delays in decision making of the clients especially with respect to awarding larger deals. This will hurt the short term prospects of nearly all Indian IT firms. As a result, short term pains for Infosys are also expected to be intensified as well. The sentiment in the software industry continues to be a negatively biased. However, on the street the picture is not too bleak. As per most of the IT companies, the IT related budgets for most of the clients are either flat or marginally up. Pricing environment is stable. However, these would not lead to the spectacular growth rates that most companies have been used to seeing in the past. Concentration on higher end work is the norm of the day and we believe that this bodes well for companies like Infosys. In the long run, we believe that the volatility in the demand environment would fade away. That would present a better demand environment for the software sector both in terms of volumes as well as in terms of pricing. And that would catapult the growth momentum of the Indian IT majors like Infosys.
	'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.
	Offering end-to-end solutions is the key: After the restructuring, the company now has three service lines- 'Consulting and System Integration', 'IT services' and 'Product and Platform Services'. Now on the company would offer end to end solutions in the name of service line "IT services" for each of the four industry verticals. This helps the company in getting more business from the new as well as the existing clients. It also helps in building deeper client relationships. In addition to this, as the clients look to enhance their competitive advantage in the market using more technologies, they would demand service lines like consulting and system integration. These bode well for the future growth prospects of the company.
	New initiatives to drive future growth: Now it is not just the long term 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. 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 32% over the next 2-3 years. Average annual sales growth is expected to be around 13% during these 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-a-vis the US dollar. But given that dollar is expected to get hit under the weight of US’ huge deficits and debt crisis, the rupee is expected to appreciate in the medium term. The Indian rupee has been very volatile against the US dollar over the past few years. In 2007, rupee touched a high of nearly 38.5 against the dollar but after that is started depreciating and hit a low of nearly 51 in March 2009. Since then, the rupee has again appreciated by around 10%. This kind of movement of the rupee has added to volatility in IT services exporters' revenues. In addition to that, the fact that many companies enter into hedges also adds to their risk on the profit and loss account and balance sheet. Source: Trend 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. The company has around US$ 742 m of hedges outstanding at the end of 30th September, 2011 to manage its currency risk. 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. Its headcount stood at a whopping 141,822 as at the end of the September 2011. The company has a plan to hire around 45,000 employees in the current financial year 2011-12. Managing this workforce is a humongous task in itself. Acquiring and retaining the talent, therefore, becomes a huge risk for the company. Although attrition rates have come down in absolute numbers over the last two quarters, but it still remains a cause of concern for the company. The demands of managing this work force would soon start to tell in the personnel costs of the company, which would put a dent in its margins. Especially in the near term, with sluggish volume growth, margins would remain in the pressure due to higher employee costs.
	Delay in spending decisions: Though IT budgets have been finalized for most clients. However, clients are awarding mostly short term projects. They are not opening up much on the long term projects. One of the major reasons for this could be the uncertainty at the client level. Recent crisis in the US and some of the European countries has increased the volatility and uncertainty in the whole economic environment. As a result, there could be delays in spending decisions which would affect the company adversely.

Capex

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

Views on News Infosys: Rupee depreciation saves the day (Jan 12, 2012) Infosys: Volumes & rupee drive gains (Oct 12, 2011) Infosys: Research Meet Extracts (Sep 7, 2011) Are investors overcautious on Infosys? (Aug 23, 2011) Infosys: Disappoints on profit front (Jul 12, 2011) More Views on News

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Disclosure: The analyst and dependent family members do not hold shares in this Company. Please read QIS' Share Trading Guidelines.

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