• JANUARY 10, 2003

Infosys: Keep faith!

While Infosys' revenue growth was strong, a sharp decline in operating margins disappointed the markets. Consequently, the stock price has taken a beating on the bourses. After three quarters of strong growth in volumes, as growth in business ceases to be a concern, the question is how much of the growth in revenues will flow to the bottomline.

As far as the steep decline in operating margins is concerned, Infosys lost 1% due to investments in buying software, benefits of which will accrue going forward. Also, the company's sub-contracting charges for hiring people with specialised skills went up, taking off 0.5% from the operating margins. In the recent past Indian IT services companies have been employing senior employees from global IT services companies to gain better access to larger clients in the west. Thus, the pressure on margins is due to a conscious effort by the company as opposed to competitive pressure. However, going forward the company is more likely to face pressure on margins due to global IT services majors setting up shop in India.

For Infosys' 3QFY03 results click here.

Let us take a look at the detailed look at the growth in revenues.


The revenues from all geographies except India increased on a sequential basis. The revenues from the Indian geography declined due to the lower number of client acquisitions for the banking product 'Finacle'. Almost all revenues that Infosys gets from the Indian geography are on account of its banking product. For 9mFY03 the revenues from the US geography have grown by 39%. Consequently, the share of the US geography has once again inched up, stressing the need to put a strategy in place to de-risk the company's revenue stream. However, considering the company's skill sets and the size of the projects, not many economies offer such large size projects, as do the US markets.

(Rs m) 2QFY03 3QFY03 Change 9mFY02 9mFY03 Change
North America 6,491 73.8% 7,113 74.2% 9.6% 13,734 71.4% 19,131 73.5% 39.3%
Europe 1,451 16.5% 1,572 16.4% 8.3% 3,732 19.4% 4,503 17.3% 20.7%
India 220 2.5% 115 1.2% -47.7% 404 2.1% 469 1.8% 16.0%
Rest of the world 633 7.2% 786 8.2% 24.1% 1,366 7.1% 1,926 7.4% 41.0%
Total 8,796 100.0% 9,586 100.0% 9.0% 19,235 100.0% 26,028 100.0% 35.3%

As expected, the fastest growing revenue stream among all service offerings was package implementation. With corporates directing IT spends to get more out of their existing IT investments, services offerings like package implementation and enterprise application integration are in demand. A pleasant surprise was the strong growth in revenues from testing. Also, the company's dominant revenue stream i.e. development grew 14% sequentially. The 9mFY03 growth figure reveals that while performance of the company was fueled by improvement in development and maintenance services, the company has shown significant growth in revenues from its focus area, consulting. The company has been expecting to move up the software value chain by breaking into the traditional forte of large software companies.

(Rs m) 2QFY03 3QFY03 Change 9mFY02 9mFY03 Change
Development 2,744 31.2% 3,144 32.8% 14.6% 6,174 32.1% 8,433 32.4% 36.6%
Maintenance 2,533 28.8% 2,675 27.9% 5.6% 5,540 28.8% 7,522 28.9% 35.8%
Re-engineering 528 6.0% 479 5.0% -9.2% 2,077 10.8% 1,432 5.5% -31.1%
Package implementation 853 9.7% 1,055 11.0% 23.6% 1,808 9.4% 2,525 9.7% 39.6%
Consulting 413 4.7% 431 4.5% 4.4% 827 4.3% 1,145 4.4% 38.5%
Testing 264 3.0% 336 3.5% 27.2% 558 2.9% 859 3.3% 54.0%
Engineering services 237 2.7% 230 2.4% -3.1% 481 2.5% 703 2.7% 46.1%
Other services 739 8.4% 824 8.6% 11.6% 1,058 5.5% 2,238 8.6% 111.6%
Total services 8,312 94.5% 9,174 95.7% 10.4% 18,523 96.3% 24,857 95.5% 34.2%
Products 484 5.5% 412 4.3% -14.8% 712 3.7% 1,171 4.5% 64.6%
Total revenues 8,796 100.0% 9,586 100.0% 9.0% 19,235 100.0% 26,028 100.0% 35.3%

Outsourcing, that is expected to drive the company's revenues going forward, grew steadily. The company also managed to add clients in the application outsourcing space. However, the management has termed the size of the contracts to be 'small to medium'. The recent interest in software stocks like Infosys has been on the back of expectations that these companies will bag multi-million dollar contracts. While the company does not classify this service offering separately, revenues of the 'others' head have jumped 111% in 9mFY03. This could point to the company's success on the outsourcing front. On the products front, the company saw a steep decline in revenues on account of a slower pace in client additions.

(Rs m) 2QFY03 3QFY03 Change 9mFY02 9mFY03 Change
Insurance, banking & financial services 3,413 38.8% 3,614 37.7% 5.9% 7,021 36.5% 9,839 37.8% 40.1%
Insurance 1,381 15.7% 1,352 14.1% -2.1% 3,193 16.6% 3,930 15.1% 23.1%
Banking & financial services 2,032 23.1% 2,262 23.6% 11.3% 3,828 19.9% 5,908 22.7% 54.4%
Manufacturing 1,504 17.1% 1,649 17.2% 9.6% 3,289 17.1% 4,425 17.0% 34.5%
Retail 994 11.3% 1,122 11.7% 12.8% 2,327 12.1% 2,993 11.5% 28.6%
Telecom 1,284 14.6% 1,390 14.5% 8.2% 3,020 15.7% 3,826 14.7% 26.7%
Energy & Utilities 273 3.1% 249 2.6% -8.6% 404 2.1% 703 2.7% 74.0%
Transportation & logistics 581 6.6% 633 6.6% 9.0% 481 2.5% 1,718 6.6% 257.2%
Others 748 8.5% 930 9.7% 24.4% 2,693 14.0% 2,525 9.7% -6.2%
Total 8,796 100.0% 9,586 100.0% 9.0% 19,235 100.0% 26,028 100.0% 35.3%

A small decline in revenues from the insurance segment caused revenue contribution from the BFSI (banking, financial services and insurance) space to decline marginally. The company won a mandate to implement an ERP (enterprise resource planning) system for 'Swiss Re insurance Company' for its Asia Pacific and Middle East operations. Infosys also saw a strong growth in revenues from the telecom vertical. While the telecom equipment manufactures continue to be in a tough spot, focusing on telecom service providers might have helped the company post the strong growth in numbers. During the quarter, Infosys entered into a 3-year strategic sourcing contract with AT&T wireless. The company also bagged a development project for 2.5 G mobile phones from TTPCom. The strongest growth for 3QFY03 came from the retail sector. Recently, an economy incentive plan has been unveiled in the US. This is likely to benefit the financial, telecommunications and utilities sectors. Thus, if the business prospects of these sectors revive companies like Infosys could benefit considerably.

At the current market price of Rs 4,471, the Infosys is trading at a P/E multiple 31x its FY03 estimated earnings. The selling that was seen today was partly due to unwinding of speculative positions built to take advantage of a favourable result and partly due to nervousness stemming from a steep decline in operating margins. However, if the company had not spent 1% of revenues on the aforesaid software, the results would have been in line with market expectations. The point we are trying to make is that there is a strong growth story in the making, the management is making all the right moves and finally, the company has Rs 14 bn in cash. This is almost 39% of Infosys' FY03 revenue guidance for the full year. Thus, at 1x market cap to sales, the company can add almost 39% to the topline through the inorganic route. However, at such high valuations we would like to reiterate that it is advisable to invest in Infosys from a long-term perspective (three to five years) rather than for a short term.

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