Is Infosys now open to acquisitions? - Views on News from Equitymaster

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Is Infosys now open to acquisitions?

Jun 19, 2013

It is a widely known fact that Infosys is a conservative company. That is the reason why it has generally shied away from acquisitions in the past. However, the stance has changed recently with the acquisition of a Swiss company, Lodestone at a consideration value of US$345 m. Lodestone is focused on IT consulting assignments with dominance on SAP related offerings. The acquisition is a part of the Infosys 3.0 strategy. The strategy involves moving into higher margins deliverables. Expansion into consulting and systems integration business ensures this. The transaction also gives Infosys an ability to mine more clients in the European region.

With the return of Mr. N.R. Narayana Murthy on June1, 2013, the whole investor community expected some new initiatives and announcements. He has not disappointed on this front. An announcement has been made by Infosys on the 14th of June that the company is earmarking Rs 24-Rs 30 bn for acquisitions in Europe. This should definitely bolster its IT capabilities in the region.

From a strategy point of view, we find the announcement encouraging as Infosys is sitting on a huge cash pile of approximately Rs 240 bn. Most of this cash has been earning a meagre return of approximately 10%. So, acquisitions can meaningfully boost the company's return profile. But, only if the target companies are acquired at cheap/reasonable prices. Overpriced acquisition could be value destructive.

Since the Euro zone is in deep crisis at the moment, we feel that by focusing on Europe, Infosys should be able get some good companies with superior product/service offerings. For the record, Infosys acquired Lodestone at a price to sales multiple of approximately 1.3 times.The effects of the Lodestone acquisition appears to have helped the company. In 3QFY13, the sequential revenue growth in US dollat terms was 6.3% QoQ including Lodestone. Excluding Lodestone the growth was 4.2% QoQ .In 4QFY13, the sequential USD revenue growth excluding Lodestone was 0.8% QoQ , whereas the effect including Lodestone was 1.4% QoQ. While the margins of Lodestone are still in single digits, there is ample room for scalability once the 'off-shoring' model starts taking shape. Besides, the benefits of cross-selling have already started taking shape with five joint deal wins in 4QFY13.

Thus, we believe that if future acquisitions are carried out after a thorough due-diligence in Europe, there is ample room for improving the Return on Equity (RoE) for shareholders. Our belief is based on the premise that acquisitions are done at right prices. Given Infosys' huge cash pile, we see no reasons of Infosys making acquisition payments through issuance of its own shares. Hence if the profitability post acquisition is ensured there would be no fear of earnings per share dilution.

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