A company which is struggling to keep up with its brand equity- generating revenues and profits ahead of the competition
The company's vision taking an unintended detour
The front cover of the slickly produced annual report and accounts spells out the very raison d'tre of the company's being. The company is driven by its belief that it is 'powered by intellect' and 'driven by values'. Well, considering its end product-- software--it has to be the intellect that drives its growth in the first place. And given its dependence on human resources to earn its succour, values necessarily have to take top spot. It was also driven by a loftier vision when it changed its name plate from Infosys Technologies.
The vision and statements of intent have taken an unintended detour of sorts lately. The blistering pace of organic growth that it registered for over two decades has begun to taper off and the company has been the recipient of high octane diatribes on this account from the media for quite a while now. So much so that the founder ex chairman and high priest N R Narayana Murthy has now anointed his self onto the hot seat suo moto-and unseating the hapless K V Kamath in the process. If nothing else his re-elevation has provided a temporary psychological boost to the share price in the secondary markets. But he will have to work his monsoon magic soon enough or the effect will wane away and that would amount to a hit straight in the gut. His first substantive and visible act post elevation was to very thoughtfully announce a hike in employee emoluments - if nothing else to get the staff to welcome his arrival. His sudden re-incarnation without any forewarning whatsoever sent out very negative signals all around-that all is not well behind the glossy exterior. The apparently alarmed apex regulator SEBI has now sought details of the board meeting in which Murthy's return from retirement was decided and which catapulted him into the hot seat-partly due to the share price rise on the day prior to the announcement.
If indeed the company is passing through a black hole it is not officially taking any note of it. On the contrary the company waxes eloquent on its achievements in its latest annual take home to its shareholders. Infosys - 'a company of relentless innovations on a mission' says one notable bye-line. The spirit of innovation has been an inseparable part of the Infosys journey across three decades says another. The company claims that with consistent client retention rates of over 95% it has proof that its clients and partners have an implicit faith in its ability to innovate and deliver profitable business transformation. Every year the researchers at Infosys Labs make new breakthroughs and secure patents for their innovations, focussed on helping our clients' build tomorrow's enterprise chortles yet another. In Sep 2012 Forbes ranked Infosys 19th among the most innovative companies in the world, and so on and so forth. For the matter of record the research and development expenditure on revenue and capital account for the year amounted to Rs 913 m, up from Rs 660 m previously. There are several other noteworthy blurbs of such nature.
The CEO extols on its virtues
Even the CEO, S D Shibulal, tends to largely give its niggling problems if any, a go by. He prefers to extol on the sunny side of company's wellness. His address to the shareholders exudes bonhomie no less. He begins his address by saying -we are pleased to inform you that we have ended fiscal 2013 with a growth of 19.6% in rupee terms and 5.8% in dollar terms. The consolidated revenues grew 19.6% to Rs 403.5 bn while the profit after tax grew 13.3% to Rs 94.2 bn. The company has expanded its global footprint during the year by opening more cross border offices and the company and its siblings added 235 new clients in the fiscal taking the total client base to 798. The number of million dollar clients has gone up to 448 from 399 previously. In fiscal 2013 it won more than 15 large integrated outsourcing deals worth over a billion dollars in total contract value. The company continues to see momentum in the Products, Platform and Solutions space which accounted for 5.7% of all revenues in fiscal 2013. The company added 37,036 employees-net addition of 6,694-this fiscal and the total employee strength of the company and its siblings numbered 1, 56,688 at year end, and so on and so forth.
He does briefly acknowledge that the journey has not been easy, and that the company has encountered obstacles along the way. The company's resilience has been put to the test time and again, and it has overcome the challenges that would have changed the fate of the organisation. We have passed through one such transformation recently he adds. The new strategic direction has set the company on a journey to redefine the industry for long term sustainable and high quality growth. The company's confidence takes firm root in several aspects he says with almost 98% of its revenues coming from repeat business. This is a testament to the trust that our clients place in us. The encomiums go on and on.
Murthy moves in
But, but, Murthy thinks otherwise. At the just concluded AGM he twisted the knife just a wee bit deeper. Addressing shareholders he said that the task of rebuilding a desirable Infosys (note the lingo) would take alteast 36 months and that it would involve taking 'some tough decisions resulting in pain'. The turn of phrase that he chose to bestow on the august occasion may be likened to a direct hit to the solar plexus of the incumbent management. It appears he has an exact fix on where the problem lies. The current fallout is the net effect of the decision by the management to create Infosys 3.0. It was an attempt to create a strong differentiation in revenue generation from that of its competitors. But with the world economy in a tailspin of sorts, customers have been disinclined to spend on big new IT initiatives or pay premium prices -and prefer to stay with the traditional and cheaper IT solutions. Infosys is now switching back to its traditional space.
It may also be an opportune moment to take a peek at the financials for a direct dekko at any trouble that may be brewing. But one has to make do with the abridged statement of accounts for this purpose. Yes, the company is facing a problem no less. Namely that the revenue expenses are growing at a faster pace than the growth in revenue income. Income from software services and products rose 17.6% to Rs 367 bn from Rs 312 bn previously. (Of this total, income from software services amounted to Rs 351.6 bn and income from software products amounted to Rs 16 bn. In effect this infers that its business profile has not changed aniota-it may still largely be an outsourcing version. The contribution of consulting services is not spelt out separately). The providers of the revenue accretals remain largely unchanged. North America continues to be top gun with a 63.8% share as it has been for eons, followed by Europe with 21.8%, India with 2.3% and the rest of the world -meaning South America, the Asian continent and Australasia- with 12.1%. If it is of any help to the investor the company also provides a breakup of its revenues by product line. At the top of the heap is banking and financial services accounting for 35% of all revenues. Next in line is the retail and consumer goods sector with 24%, followed by the manufacturing sector with 20.8%. Bring up the rear is the utilities and communications sector with 20.4%. A fairly tight fit all around is the message.
But the revenue expenses -- barring depreciation that is -- rose 21.5% to Rs 257.5 bn in the same time span. What is interesting in this income/expenditure mish mash is that the revenue expenses include 'purchase of services' of Rs 5 bn from group companies against Rs 18 bn previously, and revenue income includes 'sale of services' of Rs 5 bn from group companies against Rs 2.7 bn previously. It is not known whether the company consumed these purchased services or whether it was subsequently flogged to third parties. Separately there is 'purchase of shared services' of Rs 720 m and the 'sale of shared services' of Rs 390 m.
Significantly, the largest revenue expense by far -employee emoluments-- rose 28.8% to Rs 199 bn. It appears that Infosys 3.0 is not falling into place quickly enough. Other income (breakup not known) contributed its mite by ringing in a cash flow of Rs 22.1 bn against Rs 18.3 bn previously, but this was somewhat counter balanced by a sharp drop in dividend income to Rs 830 m from Rs 5.8 bn previously. (Other income accounted for 18% of pre-tax profit against 16.5% previously). The company got a lifeline of sorts through a lower percentage tax provision on pre-tax profit. But at the end of the day it was still out of pocket as post tax profits inched up only 7.6%.
So the crux of the problem lies in getting more bang for the buck from its workforce-the alternative of retrenchments may not seem like much of an option for a company with its ethos. It is no wonder then that Murthy is going back to the old revenue model for more optimum utilisation of the labour lines.
But for all other practical purposes the company's financials spin like a top. The cash flow statement is the best place to look at in this regard. The company generated net cash of Rs 69.4 bn from operations. The company then generously spent Rs 28.2 bn on investing activities and a further Rs 33.2 bn on financing activities. The individual elements in these figures are not readily available. But there was still plenty. Against a paid up capital of Rs 2.87 bn the reserves and surplus amount to a humungous Rs 358 bn. There is no debt, on the contrary there is an embarrassment of surplus cash of Rs 204 bn. Add to this arsenal other liquid assets of Rs18.9 bn and you have a double yum yum. A substantial portion of the other income must surely have been derived from this august source of capital. The trade receivables at year end amounts to 17.3% of revenues from products and services -the same as previously. The trade payables sum is a relatively miniscule figure, but that is largely because the principal revenue expense item relates to employee emoluments.
The investment portfolio
The 'current investments' amount to Rs 15.8 bn, and probably refer to readily marketable securities. The 'non-current investments' amount to Rs 27.6 bn, up sharply from Rs 10.7 bn previously. This investment mix refers to group company investments. There has been a rash of company formations during the year. Infosys boasted of 35 siblings and/or step down siblings at year end against 14 numbers previously. The majority are 100% owned or near abouts. One sibling, Infosys Consulting Inc, based out of the States got merged into the parent. Two of the siblings are incorporated in India. These companies will take time to yield any dividend returns to the parent. But that is the secondary objective in the first place. They will take time to become entities in their own right to start with-if at all. Remember, as a rule, foreign entities are seeded by Indian corporates more for comic humour than in achieving any meaningful ends.
Cumulatively, the 35 siblings churned out revenues of Rs 48.5 bn and a pre-tax profit of Rs 4.2 bn (some have yet to open their account). They collectively employed 30,291 personnel at year end. Of this list, the Lodestone group with the name prefix Lodestone accounts for 20 companies. The parent company Lodestone Holdings AG is holed up in Zurich, but that could be for tax purposes. Its writ runs across Europe, Asia and North America it appears. The top gun in respect of revenues, profits and employees was Infosys BPO Ltd. On a paid up capital of Rs 340 m the company rustled up revenues of Rs 18.3 bn, pre-tax profits of Rs 5.54 bn and had 21,875 employees. One will notice that the pre-tax profit of this company was more than the combined pre-tax of all the siblings put together, and it also accounted for 72% of all employees. Next in line in terms of revenues was Infosys Public Services Inc a US dollar denominated company with Rs 6 bn followed by Infosys Technologies (China) Ltd with Rs 5.7 bn. The sibling with the highest paid up capital of Rs2.31 bn however is Infosys Technologies (Shanghai).It has two companies functioning out of the mainland.
The Lodestone acquisition
The Lodestone group going by the brief financials on tap appears to be some sort of a joke as yet. Some four of the companies have registered revenues below Rs 10 m or have yet to open theiraccount. Another eight companies have registered revenues between Rs 10 m and Rs 100 m each. Collectively the Lodestone group registered revenues of Rs 7.5 bn (with three group siblings accounting for the vast bulk of the revenues) and a pre-tax loss of Rs 22 m. Infosys has its task cut out for it and hopefully the management is up to the task. For the present it is difficult to see what the management saw in the parent Lodestone and its many offshoots.
I had mentioned much earlier on that the dividend receipts of Infosys had fallen to Rs 830 m from Rs 5.78 bn previously. That is a very sharp drop in dividend income accretals. It appears that just one of the siblings declared a dividend in both years and that sibling is Infosys Australia. Atleast this is what the schedule shows. This sibling is a total oddball of sorts. To start with, the company has a paid up capital of Rs 40m and reserves and surplus of Rs 350 m. It toted up revenues of Rs 20 m but anted up a pre-tax profit of Rs 60 m. After tax provision it generated a post tax profit of Rs 20 m. It is not known what magic mantra the company adopted to generate profits which are larger than its revenues. (I am assuming here that the revenues of Rs 20 m include all receipts of a revenue nature). It is simply impossible to churn out such incredulous results. Secondly, how does a company with post tax profits of Rs 20 m pay out a dividend of Rs 830 m? This payout again on the face of it represents the impossible. Given such working results for the year how did Infosys Australia pay out a gargantuan dividend of Rs 5.78 bn in the preceding year? This is stretching the realms of incredibility. Or have I perhaps got it wrong somewhere down the line?
Besides, the company is now being merged into the parent company. A pity that 'Infosys down under' will not be able to generate such magic mantra in future.
Disclosure: I hold 938 shares in the company
This column Cool Hand Luke is written by Luke Verghese. 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.