With offshore outsourcing gaining ground, Infosys is all set to post a strong performance for the quarter ended December 2002 (3QFY03). The growth in 3QFY03 as seen in the past is likely to be driven by the need for corporates to get more from their existing investments in IT.
This means increased demand for services like package implementation, enterprise application integration and maintenance. These areas are traditional strongholds of the Indian IT services companies. Let us take the example of package implementation. During the IT spending frenzy a large number of corporations had spent significant amounts in buying ERP and CRM packages like SAP and Siebel with a significant number of licenses. However, inspite of buying a large number of licenses, these organisations today are using only a few. But to get more from their existing investments they would like implement these packages for as many users as possible. Thus, the spending is directed towards getting more from existing systems rather than buying new software and licenses. And the Indian software companies score over the foreign counterparts in cost arbitrage. Consequently, the demand for services like package implementation has been growing swiftly.
During the quarter, the company strengthened its presence in the banking solutions business by acquiring more customers from its flagship product 'Finacle' and also sought to allay customer concerns by setting up a disaster recovery centre in Mauritius. The list of clients added for Finacle included Kakawa Discount House (Nigeria), Bank of Bahrain and Kuwait B.S.C. (Bahrain) and The City Bank, Bangladesh.
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Infosys has in the recent past made acquisitions to extend the addressable market of its core-banking product. In June 2002 the company acquired Trade IQ. The acquisition was made to extend the product for the wholesale and investment-banking segment. The treasury system of the existing product was also enhanced. After extending the functionalities of Finacle, the company now plans to focus on the treasury and wholesale banking businesses in the European markets. This is likely to generate strong growth in revenues for the product going forward.
The possibility of an Indo-Pak war stopped business flow to Indian software companies earlier this year. The clients were concerned about the possibility of Infosys' facilities being attacked and therefore, the order flow was affected. To allay these fears, Infosys decided to set up its first disaster recovery centre in Mauritius. The centre will be on stand by to take over client projects from across the globe, in case of any emergency. It will serve as an alternate location in case of a disaster in other Infosys development centres. The proposed centre is expected to be operational from January 2003.
Considering the fact that there has been so significant change in the operating environment, the company should be able to post a performance very similar to that seen in the previous quarter. However, the expectations are significantly higher given that the company's guidance of 3% sequential growth in revenues and an 11.2% sequential growth in net profits. This is due to the fact that Infosys has repeatedly beaten its own guidance by a wide margin except for a few occasions. We therefore, expect an 11% growth in topline mainly driven by a 12% sequential growth in volumes. We have factored in a marginal decline in billing rates. In the previous quarter the company saw a jump in billing rates as a large number of onsite project started. This caused the blended billing rates to be on the higher side. However, a large number of onsite project starts in this quarter could once again cause the billing rates to be on the higher side.
At the current market price of Rs 4,796, the stock is trading at P/E multiple of 33x our FY03 estimated earnings. Thus, valuations for Infosys point to expectations of strong growth in earnings, on the back of increased interest in offshore outsourcing. Unfortunately, only death and taxes are certain, outsourcing deals are not. If due to some unforeseen reason, the outsourcing order flow stops, then these stocks are likely to take a severe beating on the bourses. And valuations could revert back to 20-22x. Therefore, while investing at such high valuations, if the time frame for investing is short, the element of risk increases considerably. Consequently, it is advisable to invest with a long-term perspective (three to five years).
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