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All that cash with nothing to buy

Jun 10, 2010

HCL Tech and Axon. Tech Mahindra and Satyam. TCS and Citi Group Global Services. Wipro and Infocrossing, CITOS. Most top Indian IT companies have been in the news for big ticket acquisitions in the recent past.

One name is however missing from the list. Infosys being the number two player in the industry has been guarding its cash. Its unused cash balance (including liquid investments) at the end of FY10 stood at Rs 143 bn (almost US$ 3.2 bn). The only acquisition it made this fiscal was McCamish Systems. And the previous one was seven years ago. McCamish is a US based business process solutions provider acquired for a measly Rs 1.7 bn. This cost approximately 1% of Infosys's total cash at the end of the year!

Infosys's dividend payouts have averaged around 30% for the past 5 years. The massive pile of cash earns only 6-7.5% interest in fixed deposits. The company is currently running out of ideas to profitably utilise its cash. To achieve a push in revenues and access to new clients and geographies, tech companies have constantly been looking around for inorganic growth. Infosys is finally waking up to the fact that it needs to do the same.

It achieved a revenue growth of around 5% in FY10. The management has guided for almost 3 times this growth in FY11. We believe that it should deploy some cash towards acquiring a company with good valuations and strong fundamentals. This will benefit it in terms of sustained revenue growth.

There has been recent news that Infosys is planning for buyouts in a range of US$ 500 m (around 10% of its revenues). This is a good size as it will be easier to integrate a smaller company. The acquisition can be in any geography, preferably non-English speaking Europe across any vertical.

Too conservative for its own good
Infosys is a strong contender as an acquirer. But it is vehemently opposed to aggressive bidding. It dropped out of the race for Axon against HCL Tech in 2008. Then, it did not want to get into a price war. It wants to make a friendly acquisition of a company willing to be taken over. This can only happen in a distressed sale, where the seller needs cash quickly to pay off creditors. However, since most tech companies are cash rich, finding a distressed buyout opportunity may be tough. Though the current debt crisis in Europe may provide some options with low valuations, finding companies willing to be acquired will still prove difficult.

Infosys has reached critical mass organically. It has over one lakh employees and revenues close to US$ 6 bn. Speculation is rife about the company finally making an acquisition this year. Although it may have the cash, Infosys doesn't have the necessary aggression to get into a battle for quality assets. If any of the Indian IT majors or global players gets a whiff of which company Infosys is looking at, they will not hesitate to get into a bidding war. And since Infosys is opposed to hostile bids, it may lose out!

Infosys has top quality management and we believe any company that it gets into its fold will thrive. It may need to sacrifice its 30% operating margins a bit in the short-term for a European fit. But, in the long run a good acquisition will propel it much further.

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