CLSA in a recent report has highlighted concerns of more than 100 investors on Infosys’ recent financial performance. In the note, which is in the form of a letter to Infosys CEO SB Shilbulal, a CLSA analyst has appraised him of three key investor concerns, including loss of revenue/ebit market share, reduced business predictability and lack of clear road map for cash usage. Excerpts:
Dear Shibu,
I hope this letter finds you well. I would like to start with an apology, for sharing what should have been a communication from one individual to another with 600+ investors. The genesis of this letter is the conversation I have had with over 100 investors post Infosys? 4QFY12 results. I am just acting as a channel for communicating the consolidated thoughts of institutional investors, who have ~$15 billion invested in the company.
After talking to Infosys shareholders, I fee they have grown a bit impatient with its underperformance in the past few years. The Infosys brand in terms of corporate governance, best management practices, investor communication, societal contact and the ?larger impact? is unparalleled in corporate India. However, the key question on every shareholder?s mind is what is troubling the company, which has been the flag-bearer of the Indian IT industry globally and single-handedly raised the profile of Indian equities among foreign institutional investors.
I entirely accept that you should not run the business to appease near-term shareholder returns. However, at the risk of being bold, I will run through the external perception and investor concerns of the situation at Infosys at the moment.
Loss of revenue and EBIT market share
A key investor concern on Infosys is the gradual loss of revenue market share c.f. Tier-1 sector peers over the last 4 years. While the last decade of hyper-growth in offshore IT Services meant Infosys could pick and choose its business and still manage to grow in-line to better than peers, you will appreciate that times have been much different post the 2008 slowdown. Client focus remains excessively on cost-cutting and Infosys may not find enough deals which satisfy its threshold pricing criteria. Combine that with the new found aggression among Infosys? peers and greater hunger for acquisitions, reasons for the loss of revenue market share become clearer
I somewhat agree with Infosys? contention that some of your competitors are driving themselves to the bottom and the race to the bottom might just show enhanced short-term top-line and might not be sustainable. I also appreciate that Infosys is on a difficult transformational journey and some bumps are inevitable in the process. However, investors in Infosys remain worried about the adverse impact Infosys? current strategy is having on your growth trajectory and relative positioning within strategic clients. Infosys has also lost EBIT market share in this process and that is a bigger concern.
I worry that sustained market share loss could further push Infosys into a revenue-margin trade-off ahead limiting shareholder returns.
Just like you, most investors also believe in the philosophy that ?Long-term is a series of short-terms? and in this context, I am sure you will appreciate the investor apprehension on revenue and EBIT underperformance which has impacted stock returns.
Reduced business predictability
As a college student more than a decade back, I recollect reading Infosys? mantra for success: PSPD, which meant building a revenue model which is predictable, sustainable, profitable and de-risked. As an analyst, I have always marvelled at Infosys? ability to stay true to these roots and still outperform peers by a margin. Infosys walking away from business at BT despite it being a significant contributor only served to increase my respect for your company. However, a few fault lines seem to have emerged off late.
I am especially worried on the ?predictability? part and my disquiet is shared by a number of Infosys? shareholders. For much of last decade, Infosys? guidance has been a line in the sand to gauge not just company growth but also sector-wide growth. Unfortunately, the divergence in actual performance and guidance over the last 18-24 months has meant that investor confidence in your guidance has gone down. The big miss in the latest quarter has only served to further that sentiment. I hope the recent miss was a blip after 47 straight quarters of meeting quarterly guidance.
I appreciate that we are living in times never seen before and volatility in the business environment could result in such swings. However, Infosys had negotiated the guidance issue most successfully in even the most trying times during the global financial crisis. Investors are wondering whether the review process which leads to the guidance has been compromised somewhat off late.
Lack of a clear road map for usage of cash
A key area where I think shareholder interests are being ignored or perhaps just misunderstood is Infosys? inability to articulate a road map for usage of the cash. At over $4.1 bn, Infosys? cash balance has multiplied 12x in the last 9 years. A number of reasons drive me to believe that cash accumulation is value-dilutive for share-holders and returning cash (either through dividends or buy-backs) would be the correct thing to do.
Infosys? business model is neither capex nor working capital heavy and my belief is that it is unlikely to change anytime soon. Infosys? own acquisition policy has revolved around filling up geographical or capability gaps and this precludes a large acquisition. With Infosys? growing scale and greater reliance on developing capabilities organically, with every passing year, probability of making a large acquisition seems to be going down. The number of targets is also shrinking. The homogeneity and lower propensity for disruption in the IT Services space precludes the need for large acquisitions for Tier-1 IT vendors.
Cash on Infosys? books is earning just a 6-7% yield c.f. implied cost of equity of 12-13%. Infosys? ROE has also deteriorated significantly (down 15 ppts over FY06-12) over the years due to this cash accumulation. This implies that benefits of the high margins and ROIC which Infosys has is not seeping down to shareholders due to Infosys? unwillingness to pay-out the cash.
I disagree with the notion that elevated dividend pay-out implies moderating growth ahead. Given the low capex/working capital needs in IT Services, I do not think a higher dividend pay-out or buy-back will be construed by investors as a precursor to lower growth prospects ahead.
I would be curious to know if for any reason you think returning cash to shareholders is not the best method of capital management for the business.
Stock valuation multiple c.f. peers and history is often seen as a reflection of investors? comfort with a company?s business and management. For many years, Infosys has been the platinum standard of valuation multiples in IT Services and I am sure it will not have escaped your notice that Infosys? multiples have corrected significantly c.f. peers in the past 12-15 months.
Many a times around the world, when a company has hit rough weather (as most companies do), founders have come back to steer companies to greater glory. High profile examples which come to mind are Howard Schultz at Starbucks or Steve Jobs at Apple. Infosys has the unique advantage of not just a co-founder like you being the CEO but also the benefit of getting advice from two other co-founders (Narayan Murthy and Kris Gopalakrishnan) who have been Infosys CEOs in the past and are still associated with the company.
It would be fantastic for myself and shareholders to get a feel for how you view this mind-set versus how you view Infosys yourself. At any stage should you wish to discuss this in person, I would relish the opportunity to sit down with you and understand more about your plans for Infosys.
Yours faithfully,
Nimish Joshi
(Joshi is a CLSA analyst)
