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Infosys: Remains in ‘prime’ form - Views on News from Equitymaster

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Infosys: Remains in ‘prime’ form
Oct 5, 2007

As part of the series of article that we have been doing to outline our views on leading software companies, today we cover Infosys, India’s second largest software services exporter, and perhaps amongst India’s most respected companies. Read our views on Wipro 3i-Infotech , i-Flex and Geometric Software.

We had last recommended Infosys in March 2007 at Rs 2,013 with a March 2009 target of Rs 2,640. Since then, the stock is down about 1%. At the outset, we would like to state that we firmly maintain our long-term positive view on the company. Here are the factors in support of our view.

  1. Business momentum remains strong: Despite the concerns raised on the sustenance of string growth in global It spending, Infosys’ management is of the view that the business momentum remains robust as more and more corporations are eyeing the offshoring market to outsource their technology requirements. Another important fact is that Infosys is constantly looking to tap the high value deals that are coming with higher than average billing rates. The share of high value services like package implementation, testing and consulting is constantly increasing and so is the share of these services to the incremental revenues. Regarding the subprime crisis, the company generates less than 0.5% of its revenues from direct subprime mortgage segment, which we believe, is marginal to make any real impact on the company’s performance.


    Digging deeper into the BFSI segment, which investors believe could get affected if the subprime crisis aggravates, we believe that Infosys is well placed to mitigate the impact. The arguments in support of our view are as under.


    Infosys gets 37% of its revenues from the BFSI space (FY07 figures). Of this, around 7% comes from Insurance sector, which will be unaffected by the subprime crisis. Of the balance 30%, about 4% comes from its banking product (Finacle), which again is largely stable, as banks cannot do without a core banking software. This leaves Infosys with 26% to manage, which is then spread across different segments of the financial space like capital markets, commercial banking, wholesale banking and retail banking. As per Infosys’ management, the company gets about 70% of this 26% share from application development and maintenance, which is again stable as it is annuity revenues. So eventually it leaves the company just around 8% to manage. We believe that even if the crisis aggravates, the entire 8% of revenues will not get wiped off. The maximum impact could be around 2% to 3%, which could easily get compensated from other fast growing verticals like Telecom.

  2. Conservative FY08 guidance leaves room for outperformance: Infosys, over the years, has given conservative guidance and has outperformed the same by comfortable margins. We believe that after 2QFY08, Infosys could again raise its dollar guidance by a couple of percent points, as growth in dollar terms remains uninterrupted. This is mainly because of the method through which Infosys gives its guidance. It follows a 2 step process for the same:


    • The confirmed order book gets the maximum weightage as this gives a fare bit of sense regarding revenue predictability.

    • This is then followed by a probability factor of the success rates of deals won in the past and then it is applied to the deals, which Infosys has bid for in the current year.

    This is a very conservative approach because in this process only the bids at the start of the year are taken into account. The deals that it bids for, wins and executes during the year are not taken into account for initial guidance.

  3. Greater sustenance in margins: Infosys has the highest operating margins within its peer group (31.6% in FY07). While rupee appreciation and rising staff costs could pose serious challenges to the company in sustaining these high margins, we believe that this impact can be partially mitigated by improving utilisation, leveraging SG&A and more importantly better costs efficiencies. Although the management has said that it expects a 1.2% YoY contraction in EBITDA margins in FY08, we have factored in a much higher decline mainly due to rising rupee and wage costs. However, we still do not see any other IT company catching up on the margins front with Infosys.

What to expect?
While the appreciating rupee remains our main concern for Infosys’ performance in the short term, competition from MNC players – both for business and talent - is the key long tem issue that we have with the company. The only way to control this is for the company to de-link revenue growth from employee growth as with management as strong as Infosys we can easily see them getting through with the near term concerns.

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