On 23 April, Infosys Ltd’s chief executive officer (CEO) Salil Parekh told investors the company needed some time to recover from the chaos it was thrown into after former chief executive Vishal Sikka quit in August last year, amid an ugly spat with founder shareholders.
Parekh sought three years to restore Infosys’s former position as the bellwether of India’s $167 billion technology industry, dashing hopes of a quicker turnaround among analysts and investors gathered at Taj Land’s End hotel in Mumbai to hear the new CEO outline his strategy.
To the 40-odd people who were present at the meeting and hundreds of others who had logged on to a webcast of the event, Parekh said a return to faster growth will take until at least 2021.
Over the past few years, Infosys, which ended fiscal 2018 with $10.94 billion in revenue, has been steadily falling behind bigger rival Tata Consultancy Services Ltd (TCS).
With Mumbai-based TCS’s revenue at $19.1 billion in the same period (see table 1), the gap between the two firms has widened to $8.15 billion. That will only widen further in the coming months, with TCS expected to clock a double-digit growth in the current financial year and Infosys expected to grow its dollar revenue between 7% and 9%
For this reason, many believe Infosys under co-founder and non-executive chairman Nandan Nilekani and Parekh have one last chance to salvage brand Infosys and put the firm back on the global software map before it is relegated as an also-ran IT services firm. Can Parekh and Nilekani deliver?
“Internally, we’ve set a three-year road map where we want to do all these changes in a step-by-step way. The first year in fiscal 2019 will be to stabilize where we are. The second year, we will start to build momentum. And the third year, start to accelerate where we can have more and more share of our clients’ relevance. And that will translate overall to a better Infosys," Parekh told a gathering of analysts and investors.
Parekh and his senior management declined to clarify whether the three-year journey implied that Infosys will only start posting industry-matching growth from the third year. Analysts present on the call interpreted it as an admission that the company needs to stabilize first for the next two years.
“Over the past 12-24 months, there has been a lot of change… For this reason, we have said FY19 will be year of stabilization, and all the investments we have spoken about, we expect to see momentum on this from FY20," Parekh told analysts.
“I agree that this is the last chance for us because we cannot again have another change at the top… we need stability," said a senior executive at Infosys on condition of anonymity. “All of us recognize this and if you read the management’s commentary, our strategy is not significantly different."
“We believe the most distinct change in INFY’s strategy is moving away from software and focusing on digital services," Keith Bachman, an analyst with BMO Capital Markets, wrote in a note dated 23 April.
“In some respects, we think INFY strategy discussed at the analyst event is replicating the strategies of competitors. We think improvement in revenue trajectory will take some time, if it materializes. We forecast less than 7% y/y CC (constant currency) growth in both FY19 and FY20. Despite incremental investments, we could envision scenarios in which the current revenue trajectory is the new normal, meaning new revenue sources are offset by weakness in legacy areas."
Infosys’s cautious approach is understandable. It reported a 7.2% dollar revenue growth and an operating margin of 24.3% in the year ended 31 March. In comparison, TCS reported an 8.6% dollar revenue growth at an operating margin of 24.8%.
But for much of the previous fiscal year, Infosys appeared to be relatively better placed than TCS. Clients were trusting Infosys, as reflected by the 7.4% dollar revenue growth in the year to March 2017. This was higher than the 6.2% dollar revenue growth reported by TCS.
Employee morale was still unscathed by the constant bickering between founder N.R. Narayana Murthy and Sikka.
In February last year, TCS decided to elevate chief financial officer Rajesh Gopinathan as chief executive officer, replacing N. Chandrasekaran, who was appointed chairman of Tata Sons Ltd, the group holding company. This development then made some analysts uneasy, with a few of them even wondering whether TCS’s growth will slow further. Already, dollar revenue growth at TCS had fallen from 15% in 2015 to 6.2% even as Infosys managed to accelerate its growth from 5% to 7.4% during that time.
Still, in what can be termed as the biggest reversal of fortune at corporate India last year, TCS ended last year by adding $1.5 billion in incremental revenue, more than twice the $741 million added by Infosys.
Unsurprisingly, TCS now comes across as a more confident and better-run unit than its smaller peer Infosys.
Sample this: in the first week of March, about 700 of the senior-most executives of TCS got together at Novotel Hyderabad to brainstorm about business. Over two days, the senior management, led by chief executive Gopinathan, held multiple discussions, strategizing how to better win large mega deals (IT contracts greater than $500 million in value).
“Billion is the new million," Gopinathan remarked in one his many interactions with his senior team, according to an executive who was briefed by the CEO.
This statement was in reference to company’s three large deal wins, including two more than $2 billion, multi-year outsourcing contracts from television ratings measurement firm Nielsen and Transamerica Life Insurance Co., a unit of Dutch insurer Aegon NV.
“The statement was also to get the senior leaders to get more such large deals as only large deals can move the needle," said the executive cited above.
So, how does TCS manage to win large, mega IT outsourcing deals even as others struggle?
“The top teams meet once in every 40 days, where we share and see how we can make each of these smaller deals bigger and where is the opportunity. Because we have a visionary management team, almost all of them who have stayed with the company, these people know what our customers want, and we are able to scale up larger deals," TCS’s chief operating officer N. Ganapathy Subramaniam said in an interview last month.
In the January-March quarter, TCS claims to have won more than 450 small digital deals with a combined value of more than $1 billion, according to Subramaniam. TCS’s deal wins in digital—the fuzzy umbrella term that each company uses to classify revenue generated from areas generally classified as social, mobile, analytics, cloud computing and Internet of Things—is higher than the $905 million worth of total deal wins, including re-bids and new wins, by Infosys in the fourth quarter.
At Infosys, Parekh and Nilekani have three challenges that need to be addressed swiftly.
Firstly, Infosys needs to retain the trust of its employees. Last year, Infosys’s attrition rate was 20%, as against 11% at TCS. Put simply, this means one in five employees left Infosys last year.
Secondly, Parekh needs to quickly see that the business gets stabilized and the company does not lose customers.
For now, Infosys continues to get more business from its largest 10 clients, as business from this segment grew faster than the company’s overall growth of 7.2%.
However, 10 months after Sikka’s resignation, one big challenge faced by Infosys is retaining some of its smaller but marque clients.
One of them is PepsiCo, which first outsourced application development and maintenance work to Infosys in 2004.
Earlier this year, Pepsi decided to streamline the number of IT vendors it does business with, and consequently, Infosys lost at least $20 million in business, according to two executives in the know.
“PepsiCo’s IT application maintenance work has been handled by third-party vendors across many regions for some time," a spokesperson for PepsiCo said in a statement in response to Mint’s questionnaire. “In an effort to improve effectiveness, we have decided to consolidate application maintenance work with TCS in India. This move will not impact PepsiCo associates in the US."
Infosys has seen a loss of at least $30 million in 2017-18, compared with last year, hurt by less business from three other customers, including Kraft Heinz Co., Mondelez International Inc. and Procter and Gamble, according to three other executives familiar with the development.
Infosys declined to comment if the company had seen loss in business from the four customers mentioned.
In stark contrast, TCS has continued to win not just larger clients but even retain and win smaller marque customers, including Lloyds Banking Group, Rolls Royce Group, and Marks and Spencer.
Finally, even as TCS’s market capitalization crossed $100 billion, Infosys faces the test of shareholder confidence as over the past 12 months, foreign institutional investors (FIIs) have trimmed their holdings in India’s second largest IT outsourcing company.
At least three of the company’s long-standing foreign investors, including Oppenheimer Developing Market Fund, Abu Dhabi Investment Authority, and Government of Singapore, have pared their holdings, even as FII holding in Infosys dropped to 35.24% at the end of March 2018 as against 38.31% at the end of March 2017, according to the company’s shareholding pattern for the quarter ended March 2018.
“I think Infosys is at a crossroads, with some tough decisions to make," said Rod Bourgeois, founder and head of research at US-based DeepDive Equity Research LLC, adding that TCS’s recent contract signings strength reflects market-share gains rather than cyclical demand improvement. “An improving demand cycle would be icing on TCS’s already-good cake of FY19 revenue growth prospects," said Bourgeois.
Most worrying for Infosys’s investors is the management’s decision to lower the profitability outlook to 22-24% for 2018-19, as against 24-26% two years ago. Infosys said the reason behind the lowering of profitability is to plough back the savings to invest in digital technologies.
Further, Infosys expects savings to cover costs related to hiring more locals in US and to pay more to hire the brightest engineers. Again, TCS outlined a positive outlook towards profitability, as the management said it expects to operate between 26% and 28% operating margin in the current fiscal.
“Infosys needs to get its new strategy working effectively to win over some concerned investors," said Phil Fersht, chief executive officer of US-based HfS Research, an outsourcing research firm. “The new focus on digital business models and moving away from products is the right direction for the firm—now they have a critical 12 months ahead to prove they can stick to this plan, make the right acquisitions, evolve their workforce and global presence. It’s no surprise that some investors are skittish after all the public nonsense last year and departure of Sikka."