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Infosys: The halo has fallen a tad - Outside View by Luke Verghese
 
 
Infosys: The halo has fallen a tad

It is a watershed year for the company in several respects. But more so as the new CEO now has to grapple with the task of re-engineering its skills, and in doing so by realigning its offerings more closely to the business priorities of its clientele, and to take on the emerging competition.

A watershed year


The year 2012 marks a watershed in the history of Infosys Ltd. Its chief mentor Mr N.R. Narayana Murthy has finally cut the umbilical cord that has bound the company to his coattails from inception in 1981. The corner office that he occupied has a new incumbent -the battle hardened veteran banker Kundapur V Kamath. The latter in his burning desire to retire in a blaze of glory from his long serving job as the CEO of ICICI Bank almost ran the venerable institution up the wall in the process towards the end of his tenure. It appears that Infosys is also at a point of inflexion. And we will now have to wait and see what Kamath has up his sleeve to revive its wavering brand equity and bring about an upward re-rating of its sentimental price earnings ratio. This is not an easy task given its business portfolio of still primarily generating software for third parties, the heightened competition, and the fact that the vast bulk of its succour still accrues from North America and Western Europe - and Europe is in turmoil leaving all concerned flummoxed. India centric revenues are still pitiful - a mere 2.3% in the overall context.

Halo down a tad

It would appear from media reports that this bellwether stock of well over the past decade has sung its swan song - at least for some time to come. And the task of nurturing the company's fallen halo has ironically enough fallen in the lap of the last of the founding sons - S. D. Shibulal. The CEO set the ball rolling by announcing rather matter of factly that there will be no emolument increments in the current year for one. Making a public pronouncement on a matter of such import, calls for more than some spunk, as the company boasted employee strength of almost 1.25 lakh at year end. Employees play a dual role in IT companies in the sense that they constitute both the fixed assets and the current assets of the company. Infosys on its part shelled out some Rs 155 bn during the accounting year for their services. On a rough basis this outflow would work out to an average per employee remuneration of Rs 1.2 m per year! This is the largest single item of expenditure for the company, and by a mile at that. By deferring the increment the company is of course banking on the past goodwill of the promoters in sharing the wealth that it has created with its employees (Is it not ironical that IT software primarily aims to reduce the dependence of human labour in the functioning of enterprises, but its creation requires a surfeit of human hands?) . And, by performance results which are not on keel with the prognostications of analysts on the other. This is further compounded by quarterly management projections of the conservative kind. Infosys however has a history of giving muted outlooks, as the management invariably prefers to err on the side of caution in its public pronouncements of import. And, like in the West, India too has become a slave of the utterings and the crystal gazing 'infallibility' of the analyst fraternity. This is the unfortunate reality of life whether you like it or not.

All weather stock no more

How times change too! Till not too long ago IT stocks were elevated to the medium of all weather stocks, and the IT industry constituted one of the three legs comprising the ICE triumvirate which ruled the markets (the other two being communications and entertainment). All the three counters have now been relegated to the background as the old manufacturing sector has regained its rightful place of honour on the podium. The all weather stocks now stand renamed as fair weather friends.

A finely tuned ship sailing on the high seas

But more to the point, what does the latest annual report of Infosys have to foretell if any. For one it has a rock solid balance sheet - with figures that are difficult to emulate. Consider some of the more telling figures. It has a paid up equity of Rs 2.8 bn, gargantuan reserves and surplus of Rs 298 bn, NIL borrowings, a net fixed asset base of Rs 40 bn which drummed up revenues of Rs 313 bn for the year ended March 2012, trade debtors of Rs 54 bn accounting for 63 days revenues, cash balances of Rs 180 bn, gross current assets of Rs 295 bn and net current assets of Rs 235 bn. The current assets are bloated due to the humungous cash reserves. There are not many corporates in the Indian firmament that can drum up such a delectable frosted cake. It also boasts the most enviable cash flow statement that any corporate can boast of - a surfeit of cash generated from operations. This in turn led to a cash surplus of Rs 43 bn at year end. It also has investments valued at Rs 10 bn in group companies. They comprise among others, nine subsidiaries and not including four step-down subsidiaries (subsidiaries of subsidiaries). The dividend returns from these investments are close to zilch but that obviously was not the objective in promoting the siblings in the first place. These companies collectively clocked a turnover of Rs 42 bn and registered a pre-tax profit of Rs 6 bn. Of this lot, only three companies - Infosys Technologies Australia, Infosys BPO, and Infosys Technologies China amount to anything.

Statistics don't lie

But more to the point, the company has furnished some basic statistics of its historical data. The turnover accelerated by 23.1% during 2011-2012. In the last five accounting years this is the second highest percentage increase in revenues that it has recorded. The highest percentage jump was recorded in 2008-09 - a rise of 29.5%. Equally significantly, the company recorded an operating margin of 32.2% in the latest year. (This operating profit for the year excludes other income, which is significant, and is before deducting depreciation, which is insignificant). The highest return in the five years past was recorded in 2009-10 when it clocked a margin of 34.8%. Other income (basically comprising interest income) is a big ticket item for Infosys and the bulk of the excess moolah is kept in risk free havens. For the matter of record other income at Rs 18.3 bn accounted for 16.5% of the pre-tax profit for the year, against a lower 13% or Rs 11.5 bn previously.

One may however add here that the annual report for the latest year is considerably slimmer than that of the preceding years. But that is basically because the company has deliberately chosen to report only the abridged statement of the full fledged accounts. The strength of the Infosys annual reports till its current decision to curtail the contents was the fact that it used to brim with figures of every hue - and which unintendedly confused all readers. Why the management has chosen the short cut route in the current year is not known. Or was this an attempt to cut down on administrative expenses? If so it makes to look for a very poorly thought out exercise. Not that the annual report is lacking in data though.

The company is faring well rupee wise

S D Shibulal, the CEO, in his letter to the shareholders admits tacitly that the company came up short in its dollar growth projections. Against an estimated revenue growth of 18-20% in dollar terms it could only make do with 15.8%. But what is left unsaid here is that simultaneously it has also exceeded rupee growth projections. For, on an estimated rupee growth of 15.4% to 17.3% the company actually grew 22.7%. But this ludicrous looking mismatch is also due to the depreciation of the rupee and its related consequences. So if the company has come up short in dollar terms, it also stands to reason that it has come up trumps in rupee terms. So what is this hungamma all about? And given the continued precipitous drop in the value of the rupee, the sensible guess here is that the rupee growth in the current year will exceed the rupee growth estimates by a mile and some more. And for the Indian shareholders it is the rupee figures that matter!

The CEO's take

The lengthy directors' report and the Management discussion and analysis consist of a heavy load of tech heavy mumbo jumbo of the company's activities which is totally unintelligible to the lay public. So there is no purpose looking for leads here. One wonders who the company has in mind when mailing out its only public offering of each year's working to its shareholders. Thus one has to go by the more sane verbiage content in the CEO's address to the shareholders.

Shibulal says - 'we had two choices for the road ahead. Continue to play the traditional outsourcing game by commoditising more of the existing business and concentrating on short term growth, or to redefine the industry with a new strategy that addresses the current challenges and enables the company to achieve superior growth in the medium to long term. The company has chosen the latter path - to enable it to balance high quality, industry leading growth, high revenue productivity and relatively superior margins'. Shibulal stops short of saying which garden path it is leading up to, but going to the extent of saying that its endeavour in building tomorrow's enterprise strategy continues to see good traction with its clients.

Our business model he adds 'was built on Predictability, Sustainability, Profitable and De-risking. However this predictability in recent quarters has been impacted by challenges in the global economy coupled with internal organisational changes'. The management he says 'is working harder than before to get back to delivering predictable performance'. For the present though it has predicted a weak performance going by analysts expectations. This has led to a substantial de-rating of its P/E multiple. How soon the predictability pendulum will swing in the other direction is the moot point.

Disclosure: I hold 938 shares in Infosys

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

 

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4 Responses to "Infosys: The halo has fallen a tad"

Equitymaster

Jun 14, 2012

Dear Mr Shah, It is rather unfortunate that there appears to be no common meeting ground between us on the issues that you have raised. However permit me to reiterate my point of view. At the outset I had in my earlier response made it clear that the copy that I pen for Equitymaster cannot be of use to all readers of Equitymaster. It is definitely not meant for enlightened readers like you who have access to reams of data. The figures of 125,000 that I have used is not incorrect information in any way. Both figures are right. I principally write about the results of the standalone company and this figure was used in this context. In the context of the company having announced a wage freeze which has an affect only on the employees of the parent company and not on the group and to make the point that the company is a high wage island by giving the statistics of the average wages per employee. The subsidiaries are separate entities and have a constitution of their own and independent decisions are taken by the boards of these companies. The point is that the management must have been well aware that a wage free would lead to attrition, and affect the fortunes of the company. But the beauty of it all is that the management still decided to go ahead with the wage freeze. Besides I have not read any news reports that the wage freeze has led to massive attrition as yet. It would have made NEWS in Bangalore. The company's brand equity is a trifle too strong here. On the point of consolidated results you have raise the point of Tata Motors. The point is that Jaguar Land Rover is a separate entity and the parent is a beneficiary or otherwise only to the extent of the pickings that it gets from the sibling - dividends/royalties and other interse transactions - which principally benefit the parent. The losses of the siblings are not set off against the parent except for consolidation purposes. The other companies that similarly come to mind are Tata Steel and Hindalco Industries - through Corus and Novelis. Here too the siblings are separate entities with a unique constitution of their own. The liability of the parent is only to the extent of the unpaid amount of the shares that they hold in the siblings and to the extent of the loans and advances that they have advanced to the siblings or may have stood guarantee for or any other liability that the sibling may have racked up and is accountable for by the parent. I again reiterate that the siblings have little effect on the performance results in the secondary market. RIL has 116 siblings and 21 associate companies. I am not aware of the performance results of the siblings having any affect on the parent. Or take the case of United Phosphorus. It has siblings galore - 65 subsidiaries and close to 20 associates and of every hue at that. But the parent continues to sail along merrily. I rest my case Luke

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Harit Shah

Jun 12, 2012

Dear Mr Verghese, I am not disputing the objective of your writing here. What I am merely attempting to suggest is you ought to give a full and complete picture to the readers of your articles. In fact, it is even more important for you to do so, as your own words you attempt to "explain to the uninitiated on the financial well being or otherwise of the company" so thus, this makes it even more important for you to present the correct facts and figures to them. And again I am pointing out the error that you have made - please see page number 27 (Management discussion and analysis), in the "Human Capital" section - it is clearly written, and I am posting directly from the annual report - "As of March 31, 2012, we employed approximately 150,000 employees". The exact figure as I mentioned in my earlier mail is 149,994. Even this figure can be found in the first few pages of the annual report where the key management personnel write their perspectives on how the year went by, under "Nurturing tomorrow's talent" by Srinath Batni, a director of the company. So again, like I said it is vital that you provide a correct picture of the company to readers and I have again shown you that your figure of 124,789 employees is incorrect - that is only the standalone company, but the total employees taken together are 149,994.

And you again make the same points you made earlier - "it takes quite some steel to announce publicly that there will be no salary increment during the year. It also shows the brand equity of the company and its ability to tide over a mini crisis." I am sorry but in this case I entirely disagree with you - this does NOT show its so-called "brand equity" - on the contrary, if you have been following the news or reading the papers or if you are in touch with any placement consultants, you will realise that owing to this so-called "spunky" move of the company of announcing no salary hikes, the company is witnessing a rise in attrition as its competitors like TCS and even a mid sized IT firm like Mindtree are giving out salary hikes. So rather than "spunky", I would call it an extremely foolish move and if anything, it reflects company-specific growth issues at Infosys as compared with peers like TCS, which have been growing at a much faster rate than Infosys (for your information, TCS grew its dollar revenues by over 24% in FY12 versus less than 16% for Infosys and over the past few quarters its growth rate has been steadily falling). So this "spunky" move of not giving salary hikes is actually costing Infosys dearly in terms of higher attrition, thus not reflecting well on its ability to tide over a crisis.

And as far as your point on the subsidiaries is concerned, all investors view the consolidated figures of the company and there is no point arguing on that, I talk very often to major institutional investors who have invested in Infosys like HDFC Mutual Fund, Metlife, Kotak MF, LIC etc and all of them without fail look at the consolidated financials of Infosys as these figures reflect the true picture of Infosys standalone plus its stake in its subsidiaries. So that point is pretty much a no-brainer, the stock price moves based on its consolidated financial performance, which reflects the true picture. And you ask which company in India is moved by the performance of its subsidiares? I will give you just ONE example - Tata Motors!! Its subsidiary, Jaguar Land Rover's (JLR) performance has a major impact on the company and the stock! I can give you many more examples, so it is apparent that you have not fully researched this aspect.

Regards the following statements you have made - "Infosys is one of the most researched companies in the India corposphere. Details of their EPS and return on capital employed and other important P&L and balance sheet ratios are available to see at the flick of a switch. What is the earthly purpose of duplicating such figures please?" I really can't see why you even bothered wasting your time and energy writing that! I never ever wrote anything contesting this, so I can't see the purpose of you writing it. And regards the rupee EPS, I am not denying that the share price trades in rupees and all that, but the fact is that the PE multiple is determined more by dollar revenue growth and NOT rupee EPS. Please understand, share price = EPS x PE multiple. So, while the rupee EPS is determined a lot by the exchange rate, the PE multiple is determined more by "core business growth". IT companies' stock prices go up when the rupee weakens NOT on a PE multiple expansion but only because the EPS will get boosted to that extent! Please note, there is a difference between stocks going up based on PE multiple expansion and stocks going up based on a likely boost to EPS due to currency movements! Similarly, if the rupee appreciates, stocks will fall mainly owing to a likely fall in rupee EPS, they do not fall due to a PE multiple de-rating!

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Equitymaster

Jun 12, 2012

Dear Mr Shah, It appears that you have misconstrued the objective of the copy that I pen for Equitymaster. Please permit me to set the record straight. The write-ups are based on a post facto observation of the annual report of the company in question. My limited objective is to go behind the figures and the written verbiage, and explain to the uninitiated on the financial well being or otherwise of the company. I do not use any other material when doing my post mortem on the company. Obviously what I write cannot be of use to all the readers of Equitymaster. It is aimed at readers who do not have the ability to read through the data contained in the annual report, and independently arrive at a gut feeling conclusion on the advisability or otherwise of being a shareholder of the company. This is my objective. Whether I am succeeding in doing so or not is another question altogether. There also seem to be some mistake at your end in interpreting data. You have stated that the company has 1.5 lakh employees and not 1.25 lakhs. On page 11 of the annual report it is clearly stated there that the company at year end employed 1,24, 789 employees. The point on a non increment to employees during the current year was culled from the takeaway of the CEO to the shareholders stated on page 2 of the annual report. Employees are the bedrock of any IT company and it takes quite some steel to announce publicly that there will be no salary increment during the year. It also shows the brand equity of the company and its ability to tide over a mini crisis. This is the point I was highlighting. I have clearly stated in my write-up that Infosys boasts of one of the soundest annual report that any corporate can muster. I have done so after giving facts and figures. I only concentrate on the standalone figures as shareholders of the parent are only indirect shareholders of the subsidiaries. The working of the siblings is not really germane to the issue here. Tell me how the functioning of the subsidiaries of Infosys has any effect on the secondary market concerns on its stock price? Its subsidiaries in any case add up to very little. Which company in India is moved by the performance of its subsidiaries? In any event I have briefly touched upon the performance of its more germane siblings? To the Indian shareholders it is the rupee figures that count as the data is presented in India rupees. Which is why the share price of IT companies rise when the rupee dollar parity falls? Equitymaster reserves the right to feature or reject any copy that is sent to them for publishing. Even external articles are uploaded on their website only after factual approval. Please also appreciate the fact that Infosys is one of the most researched companies in the India corposphere. Details of their EPS and return on capital employed and other important P&L and balance sheet ratios are available to see at the flick of a switch. What is the earthly purpose of duplicating such figures please? Sincerely Luke Verghese

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Harit Shah

Jun 8, 2012

The author really needs to do a lot more research before writing on a widely read website like this! Infosys had nearly 1.5 lakh employees at the end of the year (149,994 to be precise) and NOT 1.25 lakh as has been mentioned here! Furthermore, he says, "The CEO set the ball rolling by announcing rather matter of factly that there will be no emolument increments in the current year for one. Making a public pronouncement on a matter of such import, calls for more than some spunk, as the company boasted employee strength of almost 1.25 lakh at year end." Apart from the factual error of the number of employees, the truth is that EVERY YEAR Infosys and other IT companies "publicly announce" their salary increases for the year ahead, so what precisely is so "spunky" about this, I simply fail to understand! And they announce salary hikes at the time of the fourth quarter and annual results, which is much before the annual report is published and thus, this is known well in advance of the annual report getting published. Another example of the fact that the writer really needs to do his research before writing! Using big words and fancy language does not cover up for the lack of research that has been done for this article, and seasoned analysts like myself can easily catch any factual or numeric errors in a jiffy! This article appears to be high on style but low on substance.

And another thing - all the figures you have mentioned are for the standalone financials, you should ideally mention the consolidated financials as they give the full picture of the company. Consolidated revenue is Rs 337.34 billion (not Rs 313 billion) and debtors are Rs 58.82 billion (not Rs 54 billion) And a final point - please understand, there is a very valid reason as to why the stock market and analysts look at any IT company's (including Infosys) dollar revenue growth, since they earn a majority of their revenue from the US market and in fact, even some of their revenue in Europe is billed in dollars. So the dollar figures give an idea about the "core business growth", whereas rupee numbers are a function of the rupee-dollar exchange rate, which has become increasingly volatile and unpredictable over the past few years. Thus, I think the writer should make an attempt to understand that the valuation (PE multiple) of any IT firm including Infosys is determined more by its dollar revenue growth rather than rupee EPS, which is inflated owing to the weak rupee. Increase in rupee EPS due to currency is not something that any IT firm will get credit for, and rightly so - what is more important is the re-investment of currency gains back in the business to drive future revenue growth, and specially in this uncertain business environment, this assumes even greater importance. Driving EPS growth through currency is unsustainable, what is more sustainable is EPS growth through better revenue growth. The rupee weakness could be temporary, it can be a double-edged sword and when the rupee turns the currency gains quickly evaporate, thus showing the real importance of "core revenue growth". I hope I have made my points clear.

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