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Road ahead: Infosys says it will continue to shoot for best margins

Road ahead: Infosys says it will continue to shoot for best margins
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First Published: Mon, Sep 01 2008. 12 12 AM IST

View from the top: Gopalakrishnan says IT is one of the few sectors that is still creating good paying jobs. (Harikrishna Katragadda /Mint)
View from the top: Gopalakrishnan says IT is one of the few sectors that is still creating good paying jobs. (Harikrishna Katragadda /Mint)
Updated: Mon, Sep 01 2008. 12 12 AM IST
S. “Kris” Gopalakrishnan is the quiet self-confessed technology geek who took over the mantle of CEO and MD of Infosys Technologies Ltd in June 2007. Unlike his two predecessors, N.R. Narayana Murthy, who has moved effortlessly into the role of an elder statesman for the IT industry and industry as a whole, and Nandan M. Nilekani, the articulate quintessential big-picture man, Gopalakrishnan is more of a back-room doer. And even now he exudes a sense of having been thrust into the spotlight.
Under his leadership, however, Infosys has made the boldest move in its 27-year existence when, on 25 August, it announced an offer to acquire UK-based IT consulting firm Axon Group Plc. for $753 million, or Rs3,310 crore. In the past, Infosys has preferred to make small, niche acquisitions and has done only two of these—Expert Information Systems Pvt. Ltd and the back-office services assets of Royal Philips Electronics.
The Axon deal bears Gopalakrishnan’s imprimatur although, characteristically, he claims “it is a collective decision”. Having “observed” Axon over the last “three-four years”, Gopalakrishnan says the deal was consummated in just a few weeks.
Known for his fondness for gadgets, Gopalakrishnan’s newest plaything is the Apple 3G iPhone which has just been launched in India. In an interview, Gopalakrishnan spoke on the deal, the challenges posed by a slowing global market and Infosys’ game plan to tackle it. Edited excerpts:
With cash of $1.8 billion on your books, were you, in a sense, compelled to make a buy soon; was the offer to acquire Axon a considered deal?
We have a dedicated group, look(ing) out for an acquisition candidate, and we have several parameters: strategic fit, (it should be) complementary in terms of customers and industry base, ability to integrate, well run, well managed, leadership..., the right valuation. Therefore, it is a deliberate (move). It has taken time for us because of that. We are growing—this year, industry will grow 20%, Nasscom (the IT industry lobby group) says; we are also growing 20%.
But a section of analysts says that at 20 times net earnings, 13 times Ebidta (earnings before interest, depreciation, taxes and amortization—a measure of operating profit), two times revenues, Axon is expensive.
We believe it is a fair value...it will help Infosys... If you look at growing our business in the transformation services side, growing our Europe business—it will give us access to Axon’s clients which we can cross-sell. So, there are multiple objectives that are being met with this acquisition.
Infosys is viewed as cautious, even conservative, when it comes to mergers and acquisitions. In this case, there is the possibility of a counterbid for Axon. How will that play out?
Whenever you look at an acquisition, there is always a possibility of a counter bid. Whenever you look at a public company, there is always a possibility of a counter bid. We knew that.
But have you factored that into your calculations...
It is a fair valuation—that is all I can say. Because anything (beyond that) is speculation at this point of time.
Infosys has said it never looks at acquisitions for scale, but to add value. Aren’t you buying Axon exclusively to add scale and size to your SAP practice (companies buy the business software of SAP to manage their companies but this software is usually so complex that they have to hire a consultant to help them implement it)?
No, no, I gave you many reasons why we are buying. Of course, we will grow in an acquisition. Acquisition has to give us growth, right. There are many strategic reasons: cross-selling in their accounts, Europe business, high-end transformation business. (Axon has a) centre in Malaysia, another offshore delivery centre.
You get 62-63% of your revenues from the US. Axon still gets 35% from North America. So, how does this broadbase your revenue, given your size?
First, you said isn’t it too big, and now you are saying it is too small.
Given Infosys’ $4 billion plus revenues, is an acquisition the size of Axon (£204.5 million of revenue in 2007) sufficient to broadbase revenues?
View from the top: Gopalakrishnan says IT is one of the few sectors that is still creating good paying jobs. (Harikrishna Katragadda /Mint)
We always said (we will look at something) close to 10% of our revenue. This fits all of those. It doesn’t add too much risk, something that we can add and digest. So, there are multiple parameters we have, it is a very very considered and thoughtful decision. We are still a company that is deliberate, cautious, I wouldn’t use the word, conservative. We are still a company that would take a decision after considering as many things as possible—there are many unknown things still.
Infosys has always been a pioneer: We were the first to move to Electronic City (in Bangalore) to a campus-like environment; we were the first to move in a major way into multiple locations in India; we were the first to list on Nasdaq; we were the first to start BPO (business process outsourcing), (to start) consulting differently. We were the first to venture out and do significantly large secondary ADS (issue).
Infosys is very protective of its margins and this acquisition could see margins being eroded.
Any company we look at will be margin dilutive…but over the long term, we have also stated that we will drive towards the best margins in the industry. BPO is a good example: nobody has the margins Infosys BPO has.
We could have left it and said, “We have good margins, leave it.” What drove us? So, the direction in which the company will continue to move is always towards the best margins. How can we get better margins in this business? We are very early in the game; we have just made the offer, when we close this, when we give guidance, we will give indications of how the margins will move...
Between growth and margins, there is always a trade off. In the past, you have erred on the side of protecting margins…
...it has always been profitable growth. It is a balance between profit and growth. And the philosophy again, let me reiterate, is the best margins in the industry. We are still very selective in the business we (do)…
You have walked away from deals in the past…
We still walk away, those things have not changed. Those are what I would call the most fundamental principles of the company.
One of the moves you emphasized after taking over last July was to drive the consulting business to a greater extent. It is not yet making money...
It is still in the growth stage. If you ask me whether it has reached a scale it should, I would say it has not. We need to continue to recruit people…the consulting piece combined would be around 800 people. Total revenue...we don’t now break it up, but consulting and enterprise solutions is 24%...(consulting is approximately 8% of Infy’s revenues). We are still in recruitment mode; (the) subsidiary has made money; it is in break-even mode…
When you meet customers in the US, do you get a feeling that there is still considerable pain left?
That is beyond IT services industry—it is the whole economic environment and there is still lot of uncertainty left. There is bad news, which is coming every day, every week. There is still uncertainty and pain at the macroeconomic level. Now, the impact on IT services is actually less. This industry is growing, is still profitable, considering many other industries—if the Indian IT industry grows this year by 20%, it is not bad.
Most international firms would say that is a good rate.
Exactly. In spite of challenging environment, the Indian IT industry is growing at 20%. That shows its resilience, its ability to adapt. That shows the strength of the model and it is still creating jobs…that also, you need to reinforce. This is one of the few sectors that is still creating good paying jobs…
Axon has 2,000 employees. Is cross-cultural integration the key challenge?
We did the Philips integration—1,400 people in multiple locations, but that was more at the BPO end. People are people, we need to make the integration work, and that is a challenge. We add 10,000 people every quarter…there are challenges about integration, making sure you explain this value to the clients, integrating go to market teams...but we are confident that we can make it happen. One key thing you should remember here is the management is fully supportive, and that they have actually given hard irrevocables.
That is for the 18.1% stake they have ?
That is all they have, they have put it on the table. They are fully supportive and that is the reason why we went ahead.
Are there services that are not impacted by the slowdown?
That will change quarter to quarter…see, the slowdown is not because these services have maxed out or there is no demand for these services. The slowdown is because of a very different reason. Our model is dependant on higher repeat sales. Last quarter if you look at it, we had 99% repeat sales—that means most of the revenue and growth must come from existing customers. So, when your existing customers slow down, you slow down…there are huge opportunities in the market out there, many companies that we don’t work with, there are markets we don’t operate in (yet)...the market share is very small, even for the Indian IT industry. The model is very strong, that is the reason this model is growing faster than global IT services...
You said that you are hiring 10,000 people (actually 8,000) a quarter...which is a large number. Will this translate into more revenues?
That will happen; it will happen over time...and we have started.
What steps have you taken to ensure that?
We recently launched Shopping 360, it is offered as a managed service…they pay for using the service. Based on reports, based on information delivery...pay per use.. there are some other projects that are outcome based...in the infrastructure management space, we charge on number of instances we close. So, we are changing the pricing model where applicable, independent of the efforts...
Have you ever looked at domestic market as a significant opportunity?
In November, we announced an India business unit...and we are focusing on the domestic market.
What about the creation of IP? Have you been able to monetize it?
It is very early stage. So, there is not much to show. These things will change over five-seven years. If you look five years back, our revenue from application, development and maintainance was 90%; today it is 47%. The revenue has changed significantly in the last five years. So, changes happen over three-, five- to seven-year period in the business. The company has changed significantly—we have started many centres outside India, begun new services, grown at 35% CAGR (compounded average growth rate) in the last few years, invested in infrastructure and yet maintained margins. Over time, we will learn, we will figure out and change the company. It will take time—not in the next quarter, but three-four years.
But, can you give an indicative deadline...
We have said 40:40:20, that is 40 (% revenues) from North America, 40 from Europe and the remaining from rest. We have not set a date for this, that is the direction we want to go. Also, one-third revenue from consulting and business transformation, one-third from maintainance and services, and the rest from solutions such as IP.
The model may not be that we sell licences, the model may be that we sell software as a service, subscription model or so...that is the direction the industry is going
Infosys will soon have more than 100,000 employees. Is managing them becoming complex?
Yes, it is, but we have a larger (management) team. We are also investing in systems and processes, so, right now, we have a full-fledged SAP rollout happening. The best form of leadership is by example. If I get a mail from any employee, I reply as soon as possible. It doesn’t matter where I am, (I reply) within 24 hours and, given the size of the company, I get more and more mails. I do reply.
There are murmurs in the US again of a coming backlash on outsourcing…
Typically, this happens when the Democratic primary is going on. But when the actual race starts, it kind (of) dies down. In reality, there is a shortage of skilled people. Go to the US and see how many Cobol programmers there are. Actually, sometimes the answer is zero. Because most of the Cobol programmers have retired or are either retiring— some are dead—and there are no new Cobol programmers coming. But there are a trillion lines of Cobol codes that are running mission-critical applications, same thing with newer technologies. (The shortage is there) because computer science is not seen as an attractive career in the developed world.
So, the reality is that there is shortage of IT professionals, experienced professionals, and that is the reason why it is not just offshoring, even captives are growing, R&D in India is growing. If you look at the top firms—Intel, Texas Instruments, GE—their R&D is growing here.
K. Raghu contributed to this story.
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First Published: Mon, Sep 01 2008. 12 12 AM IST
More Topics: Infosys | Acquisition | S. Gopalakrishnan | IT | Axon |