Infosys’ performance in FY02 was once again brilliant. But this time performing too well seems to be a problem for the company. The company at the end of fiscal ‘02 had Rs 10 bn (US$ 204 m) in cash and equivalents compared to Rs 5 bn (US$ 102 m) in FY01. This translates to a growth of 78%. Plenty of cash is taking a toll on Infy’s profitability measures. Thus, the million, in fact 200 million, dollar question is what will the company do with the huge cash inflows?
According to the sage of Omaha, Mr. Warrant Buffet, the best business to own is one that over a period can employ large amounts of incremental capital at very high rates of return. With the largest market, the US, slowing down achieving returns on incremental capital, like those seen in the past will be a very tough job for Infosys and other software companies that are generating handsome cash flows.
It will be very interesting at this point to take a deeper look into how so much of cash flow has become a problem for the company. One of the measures of performance is return on equity, which tells us how much return the company generated for Rs 100 invested by the stockholder. The returns in FY02 fell to 38% from 45% in FY01. ROE figure however, does not paint a very clear picture. This is due to the fact that the historical investments continue to generate a very high rate of return. However, it is the additional capital employed that is generating lower returns.
The incremental return on equity, which measures how profitably additional capital has been employed, determined by calculating the ratio of how much incremental return (profit) has the company generated and the incremental capital employed. For example Infosys, employed additional capital (increase in net worth compared to FY00) of Rs 5 bn in FY01, on this the additional net profits (increase in net profits compared to FY00) were Rs 3 bn. The return works out to be 60%. However, the incremental return on equity for FY02 declined sharply to 26% due to slow down in the US economy, which resulted into lower topline and bottomline growth.
Increase in Networth
Increase in net profits
Increase in cash
Inc in networth - inc in cash
The cause for concern is the kind of money the company is holding as cash and bank balances. If we exclude the increase in cash the incremental ROE jumps up to 59% for FY02.
So what are the options that Infosys has? Firstly, mergers and acquisitions. The company could add significant pace to its topline by acquiring a company. There has been a spate of acquisitions in the technology sector recently. Polaris acquired Obritech solutions and effectively doubled its topline figure. Then there is the possibility of investing into related business like ITES (IT enabled services). The company’s venture in the area, Progeon, floated in April has already bagged its first order from GreenPoint Mortgage in the US. Though the company has not given any indication about the size of the contract, a leading daily has reported it to be of the tune of US$ 30 m. The company could also spend to strengthen its banking product Finacle. In 4QFY02, Infosys had purchased a CRM product called SimpleRM for US$ 1 m (Rs 49 m). The product will enhance the CRM features of Finacle. Considering the steep fall in incremental return on equity, the company could be expected to make a move in the near future.
However, one thing is for sure at least shareholders can rest in peace that the company will not get into something very ‘creative’ with the excess cash it has. It is very unlikely that Infosys will venture into a greeting cards business or do an Indiaworld. In the worst case it could return the money to shareholders. In FY02, the payout ratio improved from 11% in FY01 to 16%, while total amount paid out as dividends increased from Rs 442 m (US$ 9m) to Rs 1094 (US$ 22 m).
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