Infosys Ltd’s shares fell 16.2% on the National Stock Exchange on Tuesday, even after investors had a day to sleep over news of a whistleblower compliant that alleged aggressive accounting practices and attempts to blindside the board. A number of senior analysts covering the stock have refrained from putting out notes to clients on the development, saying that the content of the complaint letters can be categorised as hearsay at this point.
In that case, what explains the sharp drop in the company’s shares? To start with, the markets have been fragile, and investors now tend to act first and ask questions later. Besides, not so long ago, Infosys had a murky tussle between the board and management. So fears of a repeat were enough to hit investor sentiment.
But what about the charges regarding aggressive accounting? Do Infosys’s recent financial statements give any clues about this?
Interestingly, in the company's conference call with analysts earlier this month, an analyst had questioned the company about an unusual jump in unbilled revenues and whether there was a change in accounting policy. Unbilled revenue is revenue that is recognized before being billed to the client. In terms of incremental sales, unbilled revenues jumped to almost 24-25% in the first six months of this fiscal, compared to 10-11% in fiscal 2018-19, he pointed out in the call. One way to look at this is that it somewhat reflects the aggressive revenue recognition policies the whistleblower spoke about.
The company answered that there was no change in accounting policy, but that there were a few clients where there was a difference in timing with regards to revenue recognition and actual billing milestones reached for clients. This is true for all IT firms, and in Infosys’s case, it may be pronounced because the proportion of fixed price projects had risen to over 53% of revenues in FY19, from 49% in FY17. With large fixed price projects, the company exercises discretion on when to recognise revenues.
Besides, the company’s recent acquisitions such as HIPUS and Stater have higher receivables positions, and are bound to impact overall trade receivables of the company. But they also have high account payables, which nets out when it boils down to cash flow generation.
They key, then, is to check of the increase in accounts receivables and unbilled revenues is resulting in lower cash flow generation. Infosys’s conversion of net profits into free cash flow has remained fairly steady at about 79% in the first six months of this fiscal.
“If, as the complainant alleged, revenue recognition was inappropriate, this would have reflected in lower cash flow conversion ratios," says an analyst at a domestic institutional brokerage.
From the available data, claims of malfeasance are exaggerated, most analysts say. The main worry for investors is the alleged attempt to hide information from the company’s board. Another tussle between the board and the top management is the last thing investors want for a company that has barely healed from a similar recent episode.