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Corporate Jun 1, 2013

Narayana Murthy’s return means Infosys is responding to investor concerns

By R Jagannathan

Last year, when Infosys Technologies seemed to be stuck in a quagmire of poor results and weak leadership, Nimish Joshi, an equity analyst with CLSA, made an impassioned plea for the return of Infosys' founders to restore the market's faith in the company.

NR Narayana Murthy's return as Executive Chairman after today's board meeting seems like an answer to his plea.

In fact, unusually for an equity analyst, Joshi wrote an open letter to Infosys' CEO SD Shibulal after the company's poor fourth quarter results last year, which aptly summed up investor concerns at this point of time. As Firstpost wrote at that time, Joshi raised several questions to the management at that time. Three in particular were important:

1. What is Infosys doing to correct the loss of revenue and falling share of operating profit compared with peers?Infosys has always been harping on maintaining its margins, or profitability, on its contracts. That has caused it to lose deals that have lower margins and, subsequently, market share compared with peers like TCS, HCL Tech and Wipro.

The share of Infosys in the entire industry's earnings before interest and tax is also declining, and that,according to Joshi, is a bigger concern. He writes: "History is replete with multiple examples where loss of market share impaired pricing power over time and ultimately led to convergence of cost-structures and margins across companies." In other words, there could be decline in shareholder value over time.

For Murthy, though, the challenge this time is as big as the one he had in the 1990s when the company was just making its presence felt.

For Murthy, though, the challenge this time is as big as the one he had in the 1990s when the company was just making its presence felt.

2. Is Infosys' extraordinary ability to predict its own business and manage industry-best operations declining? Forget the8-10 percent growth estimate for the current year, most investors are starting to worry about Infosys's inability to stick to previous targets. For instance, the company missed even its lowered growth estimates for the past financial year.

Joshi says, "Infosys' practice to give a financial outlook is driven by your (Shibulal's) desire to have symmetry of information between shareholders, employees and management and has been one of the cornerstones of Infosys' hallowed status." But Infosys has not matched its own estimates in the past 18-24 months. That inability could lead to a loss of shareholder confidence in Infosys' ability to predict its future performance. That could cause a drop in the price-earnings multiple, a measure of a share's valuations, that investors assign to Infosys' shares.

3. Isn't it necessary for a cash-rich company like Infosys to articulate a clear policy for cash usage? The third issue deals with Infosys' inability to deal with its huge treasure chest of cash.

As at the end of March 2013, the company had a huge hoard of cash. Cash and cash equivalents went up from Rs 22,501 crore to Rs 23,958 crore between Q3 and Q4 2013. At the current market value of Rs 1,38,000 crore (or thereabouts), cash represents 17.5 percent of Infosys' share value. Infosys's problem has always been its conservatism, as it could not find ways to use it s cash for growth.

CLSA's Joshi said last year in his open letter that company's business model is neither capex nor working capital heavy. He was worried that Infosys'growing scale and emphasis on developing capabilities organically made a large acquisition unlikely. Nevertheless, the company did make an acquisition in Europe late last year of Lodestone, at a cost of a mere $350 million - a fleabite in its cash hoard.

Joshi wrote then: "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. Infosys needs resolution on the above issues to regain investor faith and its premium valuation multiple."

The return of Narayana Murthy as Executive Chairman shows that Joshi's call has been heeded. For Murthy, though, the challenge this time is as big as the one he had in the 1990s when the company was just making its presence felt.

by R Jagannathan

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