Adding weight: Will Infosys make a bounceback?
If Sebi approves, the weight of Infosys in major indices will increase, making it crucial to deciding the future of major indices.
Its listing on the U.S. stock exchange NASDAQ in 1999, the first Indian IT firm to do so, and the tech bubble at the time led Infosys shares to hit the roof. The counter generated an annualised return of 162% in the first seven years of its listing, compared to a moderate 11% return generated by Sensex during this time period.
Though the share price crashed after the dotcom bubble burst in 2000, Infosys continued to clock a fast growth. Its revenue zoomed 10-times in the next five years, from $100 million in 1999 to $1 billion in 2004.
By 2007, its quarterly revenue crossed the $1-billion mark and, by 2008, its annual net profit crossed the $1-billion mark. Its share price, however, did not mirror this rapid growth because of sky-high valuations—PE of above 100—owed to the dotcom bubble.
Infosys underperformed during the stock market rally of 2002-2008. Since March 2001, it has almost been moving in tandem with the benchmark index. The company, however, has just started outperforming again.
Slower growthAfter nearly 25 years of spectacular growth, Infosys’s earnings momentum has slowed. There are several reasons for it, the primary being its larger base. “Largecap companies can’t grow as fast as small-cap companies. Horses can gallop not elephants,” observes Kishor Ostwal, CMD, CNI Research. A lack of direction and promoters’ exit from the management is also said to have contributed to a slower growth.
Infosys just concluded its first annual general meeting (AGM) without any of its promoters on board. All promoters attended the AGM as shareholders. Infosys is now under the leadership of Vishal Sikka, who, prior to joining Infosys, was the executive board member at German software major SAP.
New goalThe new management has already put out an ‘aspirational’ revenue target of $20 billion by 2020. For this to happen, the company’s top line needs to grow at around 18% annually. Infosys is yet to bring out a clear roadmap to achieve this target, but analysts expect that around $1.5 billion will come from new acquisitions—revenues from companies acquired by Infosys; around $2 billion will come from new initiatives such as development of new platforms, new applications, startups, etc; and the remaining from the existing IT services business, meaning an annualised growth rate of around 13%. This growth rate is significantly higher that what the company has guided for 2015-16—6.2%-8.2%.
Can Infosys achieve its goal of $20 billion revenues by 2020? Experts aren’t willing to stick their necks out. The general answer we got is: you need to wait and watch. “A company of this size needs time to turn around. It is not right to sit in for judgement after 6-12 months,” says Bharat Shah, Director, ASK Group.
Shah is a veteran in the Indian investment industry, and was among the pioneers who got into the IT theme well before others in the late 1990s. “Sikka is taking a lot of new initiatives. The direction of the company is shifting to more innovative solutions, from services to products, acquiring startups and building a startup culture, etc.
These are long-term objectives, so we need to give him time,” says Vinay Khattar, Senior VP and Head, Research, Edelweiss. The first signs emerging show that things are improving. “Things are definitely improving, but you have to give some more time to assess whether they will be able to achieve the 2020 target,” says Sudip Bandyopadhyay, MD & CEO, Destimoney Securities.
Infosys’s management overhall has implications for broader indices. This is because the company has asked Sebi’s permission to re-classify all the earlier promoters as public shareholders. And if Sebi approves this, its public shareholding will go to 100%.
Since most Indian indices calculate weight based on free float capital of a company, that discounts holdings by promoters or strategic investors, this will result in a jump in Infosys’s weight. And with a high weight like this, Infosys will be one of the stocks that will decide the future direction of these indices.
Index funds and other investors who follow benchmarks closely may be forced to increase their Infosys holding due to the change in its index weight. There may be further increase in holding by foreign institutional investors and mutual funds in the near future.
What should investors do?
The market has already factored in the possibility of Infosys’s higher growth and pushed up its stock price. However, analysts are circumspect.“You may not see changes in the quarterly numbers,” says Khattar. Others agree: “The best strategy for investors now is to stick with their holding and don’t put in more money.
We need to wait for the results,” says Rakesh Goyal, Senior VP, Bonanza Portfolio. Since Infosys is treading a new path, investors should also be ready for bumps in its earnings trajectory and also in its share price. The results for the first quarter of 2015-16, to be announced on 21 July, will be watched closely by the analysts. “Expect a huge volatility—a 10% swing, either way on the results day,” says Ostwal.
Since the new management is also focusing on inorganic growth, hopes of a share buyback or a dividend payout, because of Infosys’s huge cash pile have got dashed.
TCS is still better
Though TCS was always the biggest IT company in India, Infosys stole the limelight as TCS was not listed. Infosys’s faster growth rate was another reason. Investors were even ready to pay a premium to buy Infosys compared to TCS after its listing.
However, due to a slowdown in Infosys’s growth, currently, TCS quotes at higher multiples. TCS’s market cap is 120% higher than that of Infosys and it is almost 60% bigger than Infosys both in terms of revenue and net profit.
The situation, though, is slowly changing again. Several analysts who used to vouch for TCS earlier have started favouring Infosys now. “I like Infosys now because of the changes happening there—new management, new focus, etc.
While TCS is at its peak, Infosys is improving—profits can increase, margins can improve—so there is scope for a further re-rating of the counter,” says an analyst with a foreign brokerage. But can it catch up with TCSs in terms of valuation? Though experts are hopeful that the gap will come down, they reckon that Infosys’s multiples may not be able to match those of TCS.
Given size has become an issue for large IT companies such as Infosys and TCS, should investors search for the mid- and small-cap IT companies with a potential to become future a Infosys or a TCS? Though there are some probable candidates, experts are not able pick any company. This is because of the problems faced by these secondrung companies.
“We are a bit cautious on this segment now because the mid-cap IT companies are under pressure and large-cap IT companies are snatching away orders from them,” says Bandyopadhyay. The environment that enabled Infosys and TCS to grow so big is no longer there.
The Indian IT industry was at a nascent stage when Infosys and TCS started, but the market has matured now. Chinese companies are also giving competition now. “It is difficult for the smaller companies to show 100%-kind of revenue growth reported by Infosys and TCS in their initial years,” says Goyal.