Infosys’s fourth-quarter numbers were on expected lines although the guidance for FY19 points to accelerated investments. And while that is essential for the company to adapt to a fast-changing technology environment, it could depress near-term earnings.
The sudden disposal of recently-acquired Panaya and Skava only adds to the controversy that has dogged these acquisitions. It also indicates that Team Salil Parekh is charting its own path with the founders’ blessings and adopting a service led-growth model as opposed to his predecessor’s strategy of emphasising on products. Infosys shareholders will have to be content with single-digit earnings growth for a while although the hefty pay out could limit downside for the stock.
Quarter at a glance
Infosys delivered an in-line performance in the seasonally soft January-March 2018 quarter.
The margin improvement could have been due to cross currency tailwinds (as dollar depreciated against major global currencies), tad higher share of offshore effort and continued high level of utilisation as well higher share of digital (where gross margin is higher) at 26.8% in Q4 FY18. The management said sequential growth in digital business was 3.6%, much higher the overall growth.
The geographical and segment-wise break up of revenues suggests continued softness in North America as well as in the pivotal financial services vertical. The company, however, expects a better performance on both counts in FY19.
Infosys said continued challenges in retail, (due to the Amazon effect), softness in manufacturing and the trend of in-sourcing (where clients are increasingly adopting captive solutions) was impacting financial services clients in North America. Management sounded optimistic on verticals like energy and utilities as well as telecom. Deal wins remain healthy – 10 large deals worth $905 million during the March quarter took the overall addition in the year to $ 3 bn.
The soft guidance
For FY18 full year, operating margin of 24.3% was within the guidance range of 23%-25%. However, it has been revised down for FY19 as it steps up investments to be ready and relevant in the digital world.
Investments to remain relevant
Infosys has chalked out plans to substantially ramp up digital revenue from the current level of $2.8 bn (25.5% in FY18) and is looking to spend more to move up the learning curve. Increasing the share of digital lies at the core of this strategy as the company sees the market size of this fast growing piece in the range of $180-200 billion.
Infosys aims to spend more to automate its traditional services, reskill employees (incidentally the company has set aside bonus pool of $ 10mn for employees in light of the high attrition rate) to be future ready, increase localisation in core markets like US, UK, Australia that would warrant more investment –hiring as well as training and back end infrastructure and finally revving up its sales engine to bag more high value deals.
The journey has started with the workforce growing by 1.9% against 7.2% jump in revenue in FY18 thereby leading to 6% jump in revenue per employee (from Q1 FY18) at $54,600. This matrix will have to be tracked closely in this transformation journey of the company.
The stamp of the new management
Infosys, therefore, is not digressing totally from the transformation path that was charted by the ex-CEO, although Mr Parekh is making his own modifications to it. The fire sale of recently acquired businesses like Skava (April 2015 for $120 mn) and the much controversial Panaya (February 2015 for $ 200 mn) are examples of this. The management mentioned negligible contribution from these businesses and has recognised an impairment loss of Rs 118 crore in respect of Panaya for the quarter. The corresponding write-down in the investment value in the standalone financial statements of Infosys is Rs 589 crore. The haste in disposing off these businesses leaves many questions unanswered.
The board has decided to retain the policy of returning up to 70 % of the free cash flow and in addition, pay up to Rs13,000 crores ($2 billion) in FY19 partly as special dividend of Rs 10 per share while the modes operandi for disbursing the remaining Rs 10,400 crore will be decided later. As on Mar 18 the Infosys has cash equivalent of Rs 31,765 crore.
While the hefty pay out is music to the ears of shareholders, Infosys investors would have been better off with meaningful acquisitions that would have put the company on a faster growth trajectory. The company recently announced a small acquisition of WongDoody Holding Company, Inc. -US-based digital creative and consumer insights agency (consideration of up to $75 mn).
While the high pay out limits downside, given the single digit near-term earnings trajectory and the significant outperformance of the stock (13.4% against 0.2% for Nifty in calendar 2018), further upside is contingent on behaviour of the currency (rupee depreciation) or a stronger earnings visibility due to inorganic moves.