Betting on Nandan Nilekani’s Infosys
With Infosys Ltd now back from the brink, the moot question for investors is: is it worth betting on the company? Infosys’s iconic status may be of interest to corporate watchers of a certain vintage, but what matters to investors is the performance of the stock.
The valuation discount vis-à-vis peers (see chart), the stock’s recent underperformance and the promise implicit in Nandan Nilekani’s return certainly provides both comfort and opportunity. Many analysts are pleasantly surprised with the alacrity with which things changed at the company. This could trigger hope trades.
But when we cut out the noise from recent events and look at the raw data, the outlook for the longer term looks decidedly less rosy. Change will be slow to come by.
While things looked promising in the first half of former chief executive officer (CEO) Vishal Sikka’s three-year tenure, which helped Infosys shares close the valuation gap with bigger rival Tata Consultancy Services Ltd (TCS), the trend reversed in 2016.
The company has grown by leaps and bounds during Nilekani’s March 2002-April 2007 tenure as CEO. However this coincided with a boom in the global economy and growing demand for information technology (IT) services, and it is premature to expect a repeat in the current environment, where demand is slowing. As Nilekani moved on from the CEO role and the IT services industry began to see transformative changes, Infosys’s growth rates began to lag.
A comparison of stock returns shows that the company has delivered lower returns than TCS and HCL Technologies Ltd in the past five years and also over the last one year, even before the latest plunge in the Infosys stock. The Nifty index has beaten the Infosys stock hands down over the past one year.
Interestingly, companies that delivered leading growth rates have one common trait—longer CEO tenures.
Cognizant Technology Solutions Corp., whose revenues expanded at an average annual pace of 25% in the last decade, has seen no CEO change. TCS, which has seen two CEO changes, saw its revenues rise 20%. HCL Tech has seen more CEOs in the last decade. But most of the past decade was served by two CEOs and revenue during the past 10 years on an average was up around 22%.
In comparison, Infosys, which saw three CEOs after Nilekani first relinquished that position, has seen its revenues expand around 17% per annum in the past decade.
Clearly, companies with relatively stable managements delivered better growth and Infosys has to regain investors’ confidence that it has one in place.
Nevertheless, there is little doubt, not only from Nilekani’s days at the helm of Infosys, but also from his success with rolling out Aadhaar (the unique identity number), that he is an excellent manager. Anyone deciding to take a punt on Infosys now will essentially be betting on Nilekani.
But the challenge will be tough, not least because Nilekani will have to tread on eggshells in balancing so many interests, some of which may be in conflict. Even if he succeeds in finding the right CEO, it has to be seen how durable the new team will be and whether they will be able to push through the changes the company needs.
Another challenge will be to establish Infosys on a self-sustainable path where it can handle issues like churn in senior management and take care of founders’ egos without fissures. Past events prove that no non-founder chairman was able to see through a shake-up at the company.
“Over a longer term, they (board) will need to create mechanisms to shield management from external noise as has been the case here (Sikka’s exit),” Jefferies India Pvt. Ltd said in a 21 August note on Infosys, before Nilekani become chairman of the company. “In the backdrop of industry changes and slowing growth across the sector, the time taken for resolution of these, especially the new CEO appointment, will be key.”
That brings us to a more fundamental question for investors. Given the enormous challenges ahead and general slowdown in the traditional IT services industry, would it be prudent to bet on this sector in the first place? The sector’s growth rates have slowed and it is not yet clear which company is best placed to capture the current changes in the industry.
And even if one has to invest in IT, investors would be better off staying with companies that are handling the industry transformation and management changes better than Infosys or at least till the time the firm demonstrates its wherewithal.
Of course, Infosys’s valuation provides opportunity. But as past experience has often shown, it is better to pay a premium for an outperformer than get stuck in a valuation trap.