Infosys: Paranoia strikes - Views on News from Equitymaster

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Infosys: Paranoia strikes

Feb 22, 2001

On the 20th of February, Infy fell below Rs 6,000. Intra day it had reached to Rs 5,900 before recovering and finally closing at 5,925. The question is what happened all of a sudden. Did the fundamentals change? Though we must take into consideration that for quite sometime there has been uneasiness in the market about the performance of the technology sector due to a slowdown in the US. And to add to this there were some particular concerns about Infosys, with one of its clients Nortel posting losses. First of all let us look at the issue of the US economic slowdown. The situation is still not clear. But one thing is for certain. Software companies are witnessing a slowdown in business. But the reason behind this is that the US clients are adopting a cautious approach till they get clear signals as to which way the economy is heading. The situation will become clear in some time to come (after the rate cut takes effect).

Considering that the size of IT spend in the US was about US$ 300 bn in FY01 and assume it does not grow at all and software accounts for 20% of the IT spend. Then the total US market comes to around US $ 60 bn. Infy’s revenues for FY01 are estimated to be US$ 379 m (US$ 0.3 bn) and for FY02 (at a 100% growth rate) it would be US $ 0.6 bn. These translate to be 0.5% and 1% of the total US markets. A conservative estimate is that the IT spend will grow at least by 5% in FY02. Another factor in favour of Infosys is that it has already an established brand name in the United States and with offshore capabilities it just might see an increase in business. The companies also might reduce the number of vendors and give the existing ones more business to cut costs and work more closely.

Coming down to Nortel, which employs about 76,000 people. That is about 9 times that size of Infosys. Nortel’s revenue’s worldwide were US$ 8 bn. It had an operating margin of about 9% not considering expenses like amortisation of goodwill and stock compensation from acquisitions and divestures. Considering Infosys has only 3 clients that contribute more than 5% to its earnings. If Nortel is to be one of them the contribution would be around US$ 15 m. That is 0.17% of Nortel’s earnings. Nortel’s R&D expenses have seen a 590% jump YoY. This is an indication of the company’s commitment to R&D. Infy and Nortel are to set up a wireless centre of excellence in Bangalore. It is very unlikely that Nortel is going to decrease business in this area. It may however consider reworking the billing rates, and this is what is worrying the markets.

We are not saying that Infy will be isolated in case of a slowdown. It will be impacted. But the impact is likely to be less than what the market seems to be expecting.

It seems that there is paranoia about tech stocks. It was because of the unrealistic valuation to tech companies seen last year. But were fundamentals even looked at then? If yes that would pose a serious question considering valuations certain companies got. They say ‘Cash is king’ and a ‘Rupee today is worth much more than a rupee tomorrow’. Infosys with a brilliant performance and management is a perfect example. Then why the paranoia?

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