Infosys: Continuing to Hold Serve

By Peter Pham - October 29, 2012 | Tickers: QGEM, INFY, IBM, SPY | 0 Comments

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Bangalore based Infosys (NYSE: INFY) posted disappointing results for its second quarter with an unchanged annual revenue outlook of $7.3 billion despite the $349 million acquisition of the Swiss management consultancy firm Lodestone Holding AG about a month ago.  The company’s shares have fallen by more than 8.5% in the week ending Oct. 12 after the results were made public.

The company’s CFO quickly pointed out that the actual acquisition isn’t complete yet, therefore its outlook was not included in the future guidance. The potential for there to be something positive for investors to look forward to heading into calendar year 2013 is high.

Net income for the quarter ending September 2012 increased by 3.6% sequentially and 4.9% from the same quarter last year, to $431 million. Revenues increased by 2.5% sequentially and 2.9% from the same quarter last year to $1.79 billion. While revenues and profits have increased, albeit marginally, gross profit margin has slipped from 42.9% in Q3 2011 to the current 37.45% as the company finds it increasingly difficult to generate higher margins amid sluggish economic growth of Europe and North America.

Infosys has long been criticized by its shareholders for its risk-averse strategy. The company has been piling up cash reserves, which have increased from the previous quarter by 15% to $4.2 billion. Its investments in liquid debt mutual funds reached an all time high of $563 million. According to the Q1 2012 data, Tata Consultancy Services (TCS), Infosys’s main rival and India’s biggest outsourcing firm, which has significant representation in EGShares Technology GEMS ETF (NYSEMKT: QGEM), has $1.2 billion in cash and short term investments. At the same time, the smaller Infosys had more than three times more, i.e. $4.06 billion. 

On the other hand, the industry leader and Infosys’s much bigger rival, IBM (NYSE: IBM), has been able to maintain its gross profit margin. The competitive advantage of most Indian companies has come from higher margins, but Infosys, which is known for attracting the brightest minds in the Indian IT sector due to its unrivaled compensation packages, is clearly an exception. In the past 52 weeks, IBM’s lowest margin has been better than Infosys’s best.

Despite the pending Swiss acquisition, its biggest to date, Infosys is still playing it safe, rather too safe for shareholders’ liking, who have been vocal in their desire to see management be more aggressive. Since the beginning of the current year, Infosys has fallen by 13.8%. On the contrary, TCS has risen by 12% in India’s National Stock Exchange (NSE). Similarly, QGEM, in which TCS has 6.6% representation, is up 10% since January. IBM, however, has had a solid year by improving 13.3% in the same period, close to the SPDR S&P 500 ETF, which is up 13.9% since January.

*Conversion rate: 1 Indian rupee = 0.0189 US dollars

Infosys, with its current strategy, or lack thereof to be frank, is providing investors cash but no growth, and a company like this is good for its management, employees and bondholders but not its shareholders. Although Lodestone has the possibility of being accretive to the overall profit margin, most of it should be nearly priced in at this point.  And then there is the issue of the integration of the Indian Infosys with the Swiss Lodestone, a different type of firm that operates in an entirely different sector with a different culture.  Infosys needs to be either aggressive in M&A activity, as it doesn’t seem to be growing organically, or provide a better yield to shareholders.

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