Infosys stock slumps 21% on FY14 guidance7 min read . Updated: 13 Apr 2013, 12:37 AM IST
Forecast of 6-10% below industry guidance; firm concedes timing of 3.0 strategy hurt ability to regain momentum
Bangalore: Nearly two years after S.D. Shibulal, 58, became chief executive officer (CEO) of Infosys Ltd and adopted the company’s controversial 3.0 strategy, India’s second largest software exporter conceded that the timing of the strategy coincided with a tough macroeconomic environment and hurt its ability to reap early benefits of its deployment.
As part of the 3.0 strategy, Infosys expects to garner at least one-third of its revenue from new areas such as mobility, cloud computing and Big Data analytics, thereby reducing its dependence on commoditized information technology (IT) services projects for clients. The company is sticking to its 3.0 strategy and said it would set aside up to $100 million (around ₹ 545 crore) to invest in products and platforms associated with it.
“There’s no doubt that the volatility impacted our revenue, which did not allow us to benefit from 3.0. Usually when you put a new strategy in place, you can get some early benefits out of that," said Shibulal in an interview. “When you’re in a stable environment, you can much easily take the low-hanging fruits. When you’re in a volatile environment, you have no low-hanging fruits."
The earnings announcement on Friday by Infosys exposed the failure of its new business strategy to recapture past glory as the once-storied stock suffered its worst single-day drop in a decade.
Experts also said that Infosys chose the wrong time to switch tracks.
“They made significant changes to their business model at the worst possible time. If you’re in a position of strength and you’re making changes, then it makes sense," said Partha Iyengar, vice-president at technology researcher Gartner Inc. “But if you’re in a weak position, then you shouldn’t be making such drastic changes."
The results also proved several analysts wrong, many of whom had even expected Infosys to lead the performance of the IT sector this quarter in terms of sequential revenue growth, ahead of the likes of Tata Consultancy Services Ltd (TCS) and HCL Technologies Ltd.
The results and the outlook blunted investor expectations of a turnaround this year at the company, putting more pressure on CEO and managing director Shibulal, the last of its seven founders to lead the company.
The Bangalore-based company, which won contracts from BMW AG during the fourth quarter and counts Apple Inc., Bank of America Corp. and Harley-Davidson Inc. as clients, said the global economic climate was a cause for concern. Investors in India’s $108 billion IT sector were hoping for a recovery in discretionary spending by clients this year.
“The economic environment continues to be volatile and there’s uncertainty all around us," Shibulal said at a post-earnings press conference. “I don’t believe that this is something we can wish away."
Analysts and experts tracking the sector said the current macroeconomic environment in key markets such as North America was not as weak as it was a year ago and Infosys’s performance in the latest quarter should have been better.
“We’re not seeing any demand side weakness as such in the markets," said Iyengar of Gartner. “In fact, there’s a lot of clarity in the US market right now, especially with decision-making on the political front, whether it’s the H-1B visa issue or immigration. Infosys’s performance in this quarter isn’t really justified by the broader economic conditions."
The company’s better-than-expected results in the December quarter and increased revenue outlook of $7.45 billion for 2012-13 had raised expectations that Infosys was indeed turning a corner and its so-called 3.0 strategy was working.
Infosys surprised analysts at the time with a 4.1% sequential organic growth in dollar revenue, the currency in which it earns more than half its business. Analysts and experts tracking the sector had said the results marked the beginning of a return of momentum for the company, whose fortunes were battered for the better part of 2012.
Revenue from products and platforms contributed 5.7% of overall revenue in the March quarter, virtually unchanged from the 5.8% it contributed last year. Shibulal said the company will make more investments to stimulate growth in that area and would look at acquisitions as well.
“On the products and platform side, it is not going to move overnight," he said. “It requires inorganic growth, otherwise it will not grow. It will take years to move from this to wherever it needs to go, unless we take an inorganic approach. If products and platforms has to move to double-digit growth, then that will happen only if we do an acquisition... This is a time when we need to make more investments on that side."
Infosys, until recently seen as the sector’s bellwether, reported Q4 sequential revenue growth in dollar terms at 1.4%, against expectations of at least 3% growth.
“These results are very disappointing. If you look at the guidance in particular, that is really disappointing and that’s reflecting on the stock," said Ankur Rudra of Ambit Capital Pvt. Ltd. “Clearly, the market had set very high expectations for the sector’s growth this year, Infy’s results in particular."
Infosys forecast revenue growth in 2013-14 at 6-10%, less than the 12-14% that industry lobby Nasscom has forecast for the sector this fiscal. This is the second consecutive time Infosys has forecast annual revenue growth at lower than average industry expectations.
“After 3QFY13’s (third quarter, fiscal 2013) positive surprise, we believe expectations of a turnaround were firmly set. Today, its 4QFY13 results confirm our worst fear of its last quarter’s performance being one-off and highlight the risks with its growth strategy," Sandeep Muthangi of India Infoline Ltd said in a note.
Quarterly net profit rose 3% to ₹ 2,394 crore, beating market estimates. Revenue rose to ₹ 10,454 crore from ₹ 8,852 crore a year before. Analysts expected a net profit of ₹ 2,305 crore on a revenue of ₹ 10,703 crore, according to Bloomberg.
“Infosys’s extremely poor result across top line (revenue) and margins should take the stock back to its pre-December 2012 report levels," CLSA analysts Nimish Joshi and Arati Mishra said in a note after the results were announced. “This volatility in Infosys’s financial performance is even worse than a tier-II IT company and the Street will rightly punish it with a massive de-rating."
Infosys recommended a final dividend of ₹ 27 a share.
The company also said it has appointed Leo Puri as an additional director effective 11 April. Puri is a senior adviser to consultancy firm McKinsey and Co.’s Asia-Pacific financial institution practice and was previously a managing director with private equity firm Warburg Pincus, the IT company said.
Infosys’s total headcount stood at 156,688 employees on 31 March, having added 8,990 in the just-concluded quarter. The company and its subsidiaries added 56 clients in the quarter.
The annual revenue forecast is also lower than that of US-based Cognizant Technology Solutions Corp., which forecast a revenue growth of 17% for fiscal 2013 and is increasingly being seen as one of the sector flag bearers.
Cognizant has beaten Infosys in the last three quarters in terms of revenue and has a good chance of repeating the feat when it announces March quarter results next month, thereby overtaking Infosys for the first time in terms of full fiscal year revenue. Cognizant beat Infosys in terms of calendar year revenue in 2012.
Infosys also fell short of the annual guidance of 5% organic growth. Excluding its Lodestone Holding AG unit, annual growth came in at 4.2%. Many brokerage firms, including JPMorgan Chase and Co., UBS AG, Barclays Plc and Nomura Holdings Inc., had expected the company to post in-line results and give a revenue guidance of 10-12% at least for the 2013-14 fiscal.
“The big question now is how will TCS perform? TCS is expected to post a growth north of 16%—all that optimism will be washed away with this (the Infosys result)," said Rudra of Ambit Capital.
Infosys has lagged behind TCS and Cognizant for the better part of the last two years. Last year, Infosys missed the lower end of its revenue forecast at least twice and stopped giving quarterly guidance.
The sluggish growth rates and increasingly impatient investors prompted Infosys to re-examine strategy and it started cutting prices for select clients. The company also entered into revenue-sharing agreements with firms such as IPsoft Inc. to drive up business volumes, even at the cost of margins.
Analysts and experts from outsourcing advisory firms say the new strategy will continue to hammer the company’s margins in the near term and it might show no signs of improving in the near term.
“They’ve (Infosys) traditionally not taken risks or been aggressive on pricing—now they’re changing track and taking an aggressive posture and taking risks. And that risk is hitting the margins because when you take risks, sometimes bad things happen," said Peter Bendor-Samuel, CEO of outsourcing advisory firm Everest Group, in a recent interview.
Infosys ended Friday at ₹ 2,295.45 a share on BSE, having lost ₹ 622.40 during the day. TCS fell 1.63% to ₹ 1,511.30 and Wipro Ltd dropped 4.72% to ₹ 383.30. The Sensex ended 1.62% lower at 18,242.56 points.