After years of sitting on piles of cash, Infosys Technologies Ltd has decided to use some of it to buy UK’s Axon Group Plc. for $753 million (Rs3,283 crore). At the end of June, Infosys had at least $1.7 billion in cash. Also, the technology services provider generates some $300 million from operations every quarter, so it will still have cash on its books after the buyout.
Analysts have complained about the firm’s stance of being overly cautious about acquisitions and not returning sufficient cash to shareholders. The large Axon deal would put these complaints to rest. In fact, one would have imagined investors would react positively to the change in Infosys’ stance towards acquisitions.
But instead, Infosys American depository receipts, or ADRs, traded on the Nasdaq, opened 2% lower soon after the deal was announced. Most analysts were surprised, since Infosys doesn’t seem to have overpaid. Axon has been valued at 20 times earnings till December and less than 15 times earnings estimates for the current year. UK brokers expect Axon to report a 28.6% growth in earnings in the current year, but estimate growth would slow to 8.4% in 2009. Infosys trades at higher valuations—22 times past earnings and 17 times estimated earnings.
For a UK-based firm, Axon has healthy net profit margins of 10% and for a consulting firm, its staff costs are relatively low at 48.3% of revenues. Helped by acquisitions, its revenues have grown at a compounded average annual rate of 53.4% in the three years till December, and operating profit has grown by 74% annually during the period. Axon’s shares have risen by 10 times since December 2002, outperforming other technology stocks on the London Stock Exchange.
What’s more, the company does not have debt and sits on cash and cash equivalents worth $46.8 million on its books. In 2007, free cash flow from operations was about 10% of revenues, which again is healthy.
While the financials seem reasonable, the acquisition makes business sense, adding strength to Infosys’ consulting division.
Axon’s 2,000 employees are more than four times Infosys’ employee strength in consulting. Besides, its list of clients is impressive, and analysts are hoping some could be sold many of the Indian firm’s other software services offerings.
Axon also gets about two-thirds of its revenues from non-American geographies, which will help the firm better diversify its revenue base.
Given the list of positives, it seems surprising that Infosys ADRs fell after the news.
Perhaps the markets are worried about the timing of the acquisition. One mutual fund manager says that consulting can be a cyclical business, and since the world economy is slowing, it may be a while before rewards from the acquisition can be reaped.
The strange attraction of the American stock market
One of the strange features of the synchronized global crash of stock markets has been the relatively little impact it had on the US market, despite the crisis originating there.
The US market has been hit to a relatively smaller extent.(click here)
A look at the MSCI indices shows that the US MSCI index is down a comparatively tame 7.8% in the three months to 22 August, while the MSCI world index is down 9.9% over the same period. As on 22 August, US MSCI is down 11.6% year to date, compared with 15.5% for the world index. Despite being the originator of the mortgage and credit crisis, the US seems to have got away rather lightly.
However, emerging markets have been badly bruised. The MSCI emerging markets index is down 20% in three months to 22 August and 22.9% year to date. The EM Asia, EM Europe and EM Latin America indices have fared much worse than the US market this year. The reason is the rise in risk aversion. Just as the dollar smile theory says that the greenback actually strengthens during a global recession because capital seeks a safe haven in the dollar, does capital flee from emerging stock markets to find a home in the US?
Bear market guru Marc Faber argues that it does. The point he makes in a recent report is that despite the US economy being in deep trouble, this is now widely known, whereas investors are only now beginning to realize that other parts of the world, such as the commodity producers, the UK or the euro zone are also in trouble.
The newfound strength of the dollar will be another factor that would benefit US equities. That’s why, says Faber, US stocks will continue to outperform foreign equity markets as they have since the start of the year.
It’s worth noting that Citi Investment Research has a year-end target of 13,250 points for the Dow Jones Industrial Average, almost 14% higher from current levels.
Putting money in US stocks at a time when the economy is likely to contract sounds bizarre, but that’s what seems to be happening. Fund tracker EPFR Global points out that “among the fund groups geared primarily to developed markets, it was US equity funds that continued to shine heading into mid-August. Those tracked by EPFR Global recorded inflows for the sixth time in the past seven weeks...”
Perhaps it’s not so bizarre after all, because while the economies of France, Germany and Japan had contractions in the second quarter compared with the first, the US economy was the best performing among G-7 nations, with GDP growth of 0.5% in the second quarter over the first.
Or perhaps, the reason why developed stock markets are not falling so much is simply because they hadn’t gone up so much in the first place. Over the last five years, for instance, the annualized return from the MSCI India index has been 27.36%, compared with just 5.66% for US MSCI. Annualized returns over the last 10 years have been highest for the Russian market, at 28.75%, compared with India’s 18.32%. The 10-year annualized return for US MSCI was 1.6%.
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