Photo: Mint
Photo: Mint

Disproved charges may still have a bearing on Infosys’ valuation

  • Infosys’s discount has widened to as much as 25%, even though its revenue growth has been faster than that of TCS in recent quarters
  • In the December quarter, Infosys reported constant currency revenue growth of 9.5%, which translates to growth of about 8% in organic terms

Just before an anonymous whistleblower alleged serious misconduct by Infosys Ltd’s top management, the company’s shares were trading at an 11-12% discount to the price-earnings multiple of market leader Tata Consultancy Services Ltd (TCS).

Since then, Infosys’s discount has widened to as much as 25%, even though its revenue growth has been faster than that of TCS in recent quarters. On Friday, with the company issuing a detailed statement, offering a point-to-point rebuttal to the allegations, it seemed reasonable to expect the company’s shares will rally.

Graphic: Sarvesh Kumar Sharma/Mint
Graphic: Sarvesh Kumar Sharma/Mint

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But when trading resumed on the New York Stock Exchange on Friday, investors appeared to be lukewarm to the news. While the shares rose about 6% in the early hours of trading, they ended at $10.65, only 1.6% higher than the previous day’s close.

Perhaps, when trading resumes in India on Monday, the shares might increase at a higher rate of 4-5%. “It’s unlikely the shares will rise higher than that," said an analyst at a domestic brokerage on condition of anonymity. “We expect a mild positive reaction to the stock post the results," analysts at Emkay Global Financial Services said in a note to clients.

But that would still leave Infosys’s discount at about 22% to TCS, nearly double the levels before the whistleblower complaint.

If a thorough investigation by an independent auditor has disproved the allegations and the company’s board is solidly backing its management, why aren’t investors ready yet to ascribe it better valuations? “A 5% rally will take Infosys shares to about 775, higher than where they were before the whistleblower complaint," said the analyst. To that extent, valuations are back where they were in mid-October.

As far as the valuation relative to TCS goes, a higher discount perhaps makes sense. “Given Infosys’s history of boardroom drama, a reasonable discount to TCS makes sense, notwithstanding the latest clean chit to the management," said the analyst. While the Tata group has had its share of drama at the top, this hasn’t affected the functioning of TCS, where the leadership transition has been smooth.

Infosys, however, has had multiple CEOs in recent years, and the latest episode with the whistleblower complaint gave the impression that some among the powers that be at Infosys weren’t pleased with its new CEO and his style of functioning. So, while the allegations may be disproved, they have still left their scars on the company.

Thankfully for the company and its investors, financial performance hasn’t been affected as a result of the distractions in the past three months.

In the December quarter, Infosys reported constant currency revenue growth of 9.5%, which translates to growth of about 8% in organic terms. TCS is estimated to report growth of about 6.8%, according to analysts at Kotak Institutional Equities.

In the September quarter, Infosys’s revenues had grown about 9.9% in constant currency terms after excluding the impact of acquisitions. This was on the back of strong growth in nearly all of its business verticals. At TCS, growth in constant currency terms fell to 8.4% in Q2 from double-digit growth in the June quarter.

Infosys’s growth is being driven by digital services, which now account for 41% of revenue, up from 26% two years ago. Of course, overall growth is slowing and has now fallen to single-digit levels. But given the higher furloughs and softness in banking and financial services business verticals, the sequential slowdown was more or less along expected lines.

The 20-basis point sequential improvement in operating profit margin to 21.9%, however, was lower than Street expectations. Large deal wins stood at $1.8 billion. Even so, they are lower than the $2.7-2.8 billion worth deal wins in preceding quarters.

All told, Infosys has been doing relatively well under tough circumstances for the industry. But internal conflicts have been one too many, which is likely to weigh on investors’ minds for some time to come.

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