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Infosys Vs Cognizant - Views on News from Equitymaster

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Infosys Vs Cognizant

Apr 8, 2005

The Indian software industry has grown by leaps and bounds over the past few years. It is one truly global industry that has given India global recognition, fame and acknowledgement. With its unique geographical location, global delivery model pioneered by Indian companies, labour cost arbitrage, strong English-speaking skills, highly skilled technical and managerial talent and ability to execute complex projects at optimal cost and highest quality on time, it comes as no surprise that Indian firms have been giving their global competitors sleepless nights. However, is all this hype justified? After all, India accounts for just around 3% of the global industry and global giant IBM earns annual revenues that are nearly 5 times the size of the entire Indian IT industry put together, hardware included! So is it right to give so much attention to these firms? The answer would lie in a comparison of these firms with their global competitors, in order to separate the music from the noise. We analyse how favourably (or unfavourably) industry bellwether Infosys compares with Cognizant Technology Solutions, a comparable US-based offshore outsourcing firm, engaged in providing application development and maintenance, BPO and consulting services to clients around the world.

If you would like to compare Infosys with any of its Indian peers, please click here.

Financial parameters – A no-brainer?

As can be observed from the table, Infosys scores over Cognizant on most of the parameters used for comparison. It is close to three times the size of Cognizant in terms of revenues. However, it needs to be noted that this size advantage has slightly reduced over the years. In FY02, it was nearly 2.5 times the size of Cognizant. Cognizant has, in fact, grown at a faster CAGR over the time period taken for comparison, increasing its revenues by almost 55% a year on an average. Infosys has managed a pretty impressive growth as well at nearly 43%, though it has not managed to grow at the same pace as Cognizant.

In terms of operating margins, Infosys enjoys far superior margins when compared with Cognizant. However, the margins for both companies have been falling over the years. This can be attributed to the gradual movement of both companies up the software value chain, because of which there has been pressure on margins. There has also been hiring at a frenetic pace by both companies in order to scale up operations at a rapid rate in order to execute projects from clients, present and future. This has put pressure on margins of both companies. But it should be noted that margins for Cognizant have not fallen as much as they have for Infosys over the years. Still, Infosys in FY05, is expected to earn margins that are almost 10% higher than Cognizant.

Infosys earns slightly higher revenues per employee than Cognizant. However, the gap has been falling over the past few years. Even though Cognizant has been hiring at a rate slightly faster than Infosys over the years, it has still managed to maintain the revenues per employee at a stable level. This has been mainly due to the fact that it has grown its revenues at an almost equal rate over the years. Infosys on the other hand, has been hiring at a more rapid rate as compared to the growth rate in revenues. Therefore, revenues per employee have come down considerably, from US$ 51,000 in FY02 to an expected US$ 41,400 in FY05. There has been an increasing trend of hiring a greater number of campus recruits, with entry level salaries. This has resulted in a decreasing cost per employee, and is one of the levers that Infosys has used to keep costs under check.

On the return parameters, Infosys wins hands down. Its return on equity has consistently been higher than that of Cognizant. This shows the value that Infosys has created for its investors over the years, and at expected levels in FY05, is almost double that of Cognizant.

Miles ahead, but catch up is on…
  Infosys Cognizant
(US$ m) FY02* FY03* FY04* FY05** CAGR CY01* CY02* CY03* CY04** CAGR
Net sales 545 753 1060 1583 42.7% 159 209 366 587 54.6%
Operating profit/(loss) 222 269 355 514 32.3% 42 53 84 134 47.2%
Operating margin 40.7% 35.7% 33.5% 32.5%   26.4% 25.4% 23.0% 22.8%  
Profit after tax 174 197 272 395 31.4% 22 35 57 100 65.7%
Net profit margin 31.9% 26.2% 25.7% 25.0%   13.8% 16.7% 15.6% 17.0%  
No. of employees 10,738 15,356 25,634 38,500 53.1% 3,926 6,168 9,241 15,300 57.4%
Revenue per employee
(US$ '000's)
50.8 49.0 41.4 41.1   40.5 33.9 39.6 38.4  
Profit per employee
(US$ '000's)
16.2 12.8 10.6 10.3   5.6 5.7 6.2 6.5  
Return on Equity (RoE) 47.8% 38.3% 39.8% 43.5%   26.9% 26.2% 26.1% 22.1%  
* The fiscal year ends on March 31 for Infosys and on December 31 for Cognizant.
** FY05 figures are estimated.

Geographical break-up

Both companies have a high reliance on North America for revenues. However, while Infosys has reduced dependence on this region over the years, Cognizant has actually increased it dependence from 85% in CY01 to 88% in CY03. This is a risk according to us, since it exposes the company to risks in that particular region. In case of any adverse event occurring in North America, Cognizant would get affected to a greater degree than Infosys.

Onsite-offshore mix

In terms of onsite-offshore mix of revenues, Cognizant has consistently maintained around 70% offshore revenues. In spite of this, margins have not improved, which could be a matter of concern. Since the company has been moving up the value chain, the margin contraction can be understood. However, even though it has maintained such a high proportion of offshore revenues, margins have fallen. Going forward, there does not appear to be much scope for increasing the offshore component. This gives rise to margin concerns, as these will either remain stagnant, or even fall marginally from current levels.

Infosys on the other hand, has seen a slight bias towards onsite work, as it moves higher up the value chain. However, going forward, as the company builds stronger competencies in high-end services, it will be able to execute them at its offshore development centres around the globe. This will result in a bias towards offshore revenues. Given the current levels of onsite to offshore revenues, there is ample scope, going forward, to increase the offshore component of revenues, and thus, protect margins.

Cognizant CY01 CY02 CY03
Onsite 30.0% 30.0% 30.0%
Offshore 70.0% 70.0% 70.0%
Infosys FY02 FY03 FY04
Onsite 50.8% 58.3% 55.1%
Offshore 49.2% 41.7% 44.9%


Infosys compares favourably with Cognizant on most of the parameters discussed above. In terms of size, profits, margins, revenue per employee and return on capital, Infosys scores over Cognizant. However, Cognizant has managed to maintain a better growth rate than Infosys. As a result, the gap in terms of size has reduced over the years.

But it needs to be seen in another context. Infosys, when it was of a similar size as Cognizant is now, grew at a similar rate. In fact, from FY00 to FY03 when it was of a similar size as Cognizant is today, in rupee terms, it grew revenues by as much as 60% CAGR, while in dollar terms, the rate was 54.7%. Therefore, it remains to be seen as to how Cognizant manages to maintain the scorching pace of growth it has seen over the past few years.

Overall, Infosys has time and again proved its ability to grow at a fast clip even in times of a downturn. Its scalable business model, highly competent and visionary management and a highly skilled and dedicated workforce make it the star that it is. It is also making efforts to reduce its dependence on the key US market by diversifying its client base into other geographies like Europe. Going forward, given these factors, we expect the company to continue on a high growth path and it remains one of our top picks in the sector.

At the current price of Rs 2,153, Infosys trades at a forward price to earnings ratio of 19.9 times estimated FY07 earnings. Our PE band for the stock is in the range of 18x to 24x earnings. For FY07, our sell limit for the stock is thus, Rs 2,653, which is a 23.3% return from current levels. Cognizant, which is listed on the tech-heavy NASDAQ, trades at around 68 times CY04 earnings. This premium is due to the fact that it is listed on the NASDAQ. In the US markets, generally, stocks get higher valuations. Infosys’ ADR is also trading at a much higher PE ratio of 52.6 times earnings on the NASDAQ. This is possibly a reflection of the fact that it is a slightly more mature company than Cognizant and due to its considerably bigger size, investors do not expect it to grow at a similar rate to Cognizant.

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