Infosys Technologies: A Wait That Wasn’t Worth It

Most of the major software companies reported relatively stable performances
in the quarter ended December 2002 and it was expected that the fourth quarter
might see a revival in the fortunes of the IT companies. The gradual
appreciation of the rupee in the early part of the quarter and the war in Iraq
in the later part has had some repercussions on the Indian IT sector especially
with respect to fresh order intakes. The recent performance of the services
segment of MphasiS and Mastek were disappointing and it seemed that a revival is
still some time away. However, like always, the most awaited result by the
market was that of Infosys Technologies (Infosys) and while this major IT
company did not disappoint with its fourth quarter performance, the guidance for
the first quarter of fiscal 2004 did not go well with the market. Until now,
Infosys was known for its ability to show better growth compared to its peers
and the sector. The challenge in the future would be its ability to grow amidst
increasing competition and declining margins.

Bangalore-based Infosys provides software and consultancy services such as
custom application development and re-engineering, package implementation,
engineering, business-technology and business services. The company provides
these services in the area of Banking, Financial Services and Insurance (BFSI),
manufacturing, telecom and retailing segments.

Infosys reported a turnover of Rs 3,622.69 crore and a net profit of Rs
957.93 crore in the full year ended March 2003.

While
the revenues were up 39%, the net profit was up by 19% during the year. Software
exports formed 98% of the total revenues with the balance coming from domestic
sales. BFSI formed 38% of total sales, manufacturing 16%, telecom 15%, retail
11% and 20% coming from other segments. The company received 77% of its total
revenues from development, maintenance, package implementation and
re-engineering.

The company witnessed a dip in the operating margins from 38.85% last year to
35.11% in fiscal 2003. This was largely due to the higher sales and marketing
(S&M) costs and employee outgo. S&M costs were 7.4% of total revenues in
fiscal 2003 compared to 4.98% last year.

Progeon, the Business Process Outsourcing subsidiary formed during fiscal
2003 closed the year with revenues of $4.40 million or Rs 20.90 crore and net
loss of $6,53,000 or Rs 3.1 crore. With a number of companies that have started
BPO operations yet to break-even, we feel that Progeon has performed well.
Progeon has received a funding of Rs 49 crore from Citicorp International
Finance Corporation, USA.

In the fourth quarter ended March 2003, Infosys reported revenues of Rs
1,019.85 crore, up 6% q-o-q and 50% y-o-y. Net profit in the same period stood
at Rs 259 crore, up by around 1% q-o-q and 23% y-o-y. Infosys’ operating
margins declined from 34.78% in the third quarter ended December 2002 to 33.37%
in the fourth quarter ended March 2003.

Infosys added 28 new clients during the quarter to take its active clientele
list to 345. Infosys’ banking division too performed well with its product
Finacle went live Union Bank of India and Bank of Bahrain and Kuwait, India and
the company signed with Canara Bank and a private bank in Mumbai during the
quarter.

The company added 1,298 net employees during the quarter and currently has
15,356 employees with 14,001 being software professionals. It’s utilization
rate, excluding training stood at 82.1% and the company plans to continue to
hire in line with the business needs. The company plans to add 800-1,000 persons
in the first quarter ended June 2003. Onsite component have remained stable at
around 56%.

Infosys 6% sequential growth in revenues and 1% sequential growth in the net
profit in the fourth quarter was short of market expectations. The company
admitted the tough environment had affected its performance with clients
delaying their IT spends and also forcing price cuts. Infosys witnessed a price
reduction of 5% onsite and 3% offshore on a 12% volume growth during the
quarter. The company acknowledged that pricing pressure is a reality and would
hurt margins if costs were not kept under control.

Infosys’ has issued guidance of revenues at Rs 1,043-1054 crore and net
profit of Rs 257-259 crore in the first quarter ended June 2003, which
translates to a sequential growth of 2% in sales and flat net profit. In the
full year ended March 2004, Infosys expects revenues of Rs 4,484-4,565 crore and
net profit of Rs 1,085-1,095 crore. Infosys’ revenues from onsite operations
currently stand at 55% and these are expected to remain at these levels as the
company adds new clients to arrest pricing pressure. Moreover, Infosys achieved
14% of total revenues in the fourth quarter from package implementation and 4%
from consulting, which will also lead to higher onsite revenues in the coming
period. The company’s future estimates are based on worst case scenarios
wherein it expects further pricing pressure and delay in some of the fresh
orders due to the impact of SARS. Salary costs are also expected to rise as the
company has held back promotions over the past two years.

Nevertheless, the company is hopeful of revival in the situation and
confident of maintaining costs to ensure better margins and profitability.
Infosys expects its banking unit, which has 60 global clients, to post revenues
of Rs 176 crore in 2004.

On the BPO front, Progeon is expected to report revenues of $16-18 million
and net profit of around $1.7 million, although it is still early days the
company. Progeon was also chosen by British Telecom as one of the two preferred
suppliers of business process outsourcing services from India. Progeon had an
employee strength of 539 at the end of fiscal 2003.

Going ahead, we believe that the margins of most of the Indian software firms
would decline due to the increasing competition from global IT players.
Traditionally, Infosys has been conservative in issuing guidance and has so far
managed to beat its estimates. While we believe that pricing pressure is here to
stay, we expect the company to gain from new client additions and ramp-up of its
clients during the fourth quarter. Infosys estimates a quarter on quarter
decline in the net profit in the first quarter ended June 2003 due to lower
operating margins. Overall, we expect Infosys to achieve its estimated numbers
on the basis of high volume growth and tapering price decline.

Infosys currently trades at Rs 2,618 discounting our estimated March 2004 EPS
by 16 times and March 2005 EPS by 14 times. Infosys guidance of 13% EPS growth
for fiscal 2004 led to a re-rating of the stock. The share price of the company
plummeted by more than 40% within 2 days of the announcement of the results. We
believe that the stock is fairly valued and do not expect further decline in the
stock price. We believe that Infosys would beat its estimates and its
forthcoming quarterly results would act as a catalyst to the improvement in the
share price. Market Outperformer.

Sushanto Mitra

is the founder of Technology Capital Partners

The views reflected here are of the author and not of this publication. No
liability is accepted for losses based on the information presented here