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UBS Investment Research
Infosys Ltd
Addressing the key concerns on Infosys
„ Will FY12 revenue guidance be difficult to beat?
Infosys has embarked on a company-wide reorganisation as part of its Infosys3.0
initiative, which is expected to be completed by July 2011. There are concerns that
this will impact near-term revenue growth. We expect Infosys to continue its track
record of beating its FY12 revenue guidance of 18-20% YoY growth, but expect
the extent of beat to be lower due to the ongoing internal changes in the company.
„ Is the margin lead over peers finally eroding?
Infosys margin guidance of a 300bp decline in FY12 has raised concerns that its
lead over peers is eroding. We believe that all large Indian vendors will lose 300-
400bp in operating margin over the next five years, and we expect Infosys to
maintain a lead over its competitors. We also view Infosys’ FY12 margin guidance
as being conservative, with ample room for upside.
„ What are the catalysts for stock price performance?
We expect Q1 to be the last muted quarter for Infosys, and believe that strong Q2
guidance, followed by a beat would act as positive surprises for the stock. Betterthan-expected Q1 margin performance (we expect a 290bp drop in EBITDA) could
also help assuage margin concerns and act as a trigger for stock upsides.
„ Valuation: maintain Buy, negatives priced in, downside protection likely
We believe the negatives are fully factored into the current stock price, with
valuations at a 15% discount to 5-year average trading multiples. We see limited
risk to our earnings estimates and expect better downside protection in a volatile
market. We maintain our Buy rating with a 1-year view and DCF-based price
target of Rs3,550.
\Will FY12 guidance be difficult to beat?
Reorganisation to create 5 business units
Our recent interaction with Infosys’ senior management leads us to conclude
that Q1 FY12 could be muted on account of the ongoing internal changes due to
the implementation of Infosys3.0—the ambitious new strategic initiative
unveiled a few months ago. This realignment will result in a decentralised and
simplified organisational structure with five large business units with
independent P&Ls in the company. The business units will be aligned to specific
industry verticals as outlined below:
— Financial Services and Insurance (FSI)
— Manufacturing (MFG)
— Energy, Utilities, Communications and Services (ECS)
— Retail, CPG and Life Sciences (RCL)
— Public Services (US subsidiary)
The services offered by the company will be grouped into three categories,
namely: a) Business Transformation, b) Innovation, and c) Business Operations
within each business unit. This would necessitate the creation of business unitspecific resource pools, except at the entry level.
Realignment to be complete only by July 2011, likely to impact Q2
The organisational changes necessary for the transition to Infosys3.0 were rolled
out in April 2011 and are expected to be completed by the end of July 2011.
April-June and July-September are seasonally strong quarters for Infosys and we
are concerned that a significant part of the seasonal strength in business
momentum could be lost due to the ongoing realignment. Based on our recent
interactions with investors, we believe that the buy-side consensus for Q1 FY12
revenue growth does not factor in a beat to the guidance of 2.6-3.6% QoQ
growth. Investors also remain concerned that the reorganisation could impact Q2
FY12 as well, although management remains confident of a robust Q2.
Without a strong Q1, we believe that the chances of Infosys beating FY12
guidance of 18-20% YoY dollar revenue growth remain slim. Our analysis
indicates that Q2 revenue growth (seasonally the strongest quarter in terms of
QoQ growth) of 8-10% will still put FY12 revenue at 18-21% YoY, if followed
by an average of 4% QoQ in H2 FY12. Our current estimates factor Q1 FY12
revenue growth of 4% QoQ, and full-year revenue growth of 22% YoY in FY12.
Is the margin lead over peers finally eroding?
We expect Infosys to retain margin lead
If Infosys meets its FY12 EBIT margin guidance of a 300bp decline, it could
lose its status as the most profitable IT services vendor in India to TCS. This,
along with Infosys’ management commentary on the erosion of pricing premium,
has led many to perceive this as a sign that Infosys’ margin leadership is finally
ending. We expect the large Indian vendors to lose 300-400bp in operating
margins over the next five years. However, we view Infosys’ FY12 guidance as
excessively conservative given the strong pricing tailwind and reasonably strong
revenue growth expected in FY12.
Is FY12 a sign of slower growth ahead?
Revenue impact of reorganisation likely to be short lived
One of the key reasons for our cautious view on the company in 2010 was based
on our industry view that the current business model would need to be redefined
for sustaining industry leadership and market share. With Infosys3.0, the
company seems to be acknowledging this view with ambitious plans to reduce
the traditional applications business to just one third of revenue by 2017. We
view the management and internal changes at Infosys as a temporary issue for
the company and do not share the view that Infosys could structurally grow
slower than its India-listed peers such as TCS over the medium term.
Muted expectations could favour Infosys over peers
Contract awards over US$25m as monitored by TPI, a leading third-party deal
broker, have declined sharply on a YoY basis over the past two quarters. TPI
reported that the quarters ended December 2010 and March 2011 were the
weakest over the past 10 years.
We believe that sudden weakness in contract signings could be early indications
of moderation in demand growth for the global IT services sector.
Macroeconomic data has also remained weaker than expected, with the banking
and financial services sector in developed economies beginning to show some
moderation versus street expectations. We think that this could result in slower
growth for Indian IT services vendors, which is likely to impact earnings growth
in H2 FY12. We view Infosys as a safe haven in such a scenario as it is the only
stock where consensus earnings growth estimates have seen sharp cuts so far.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Infosys Ltd
Addressing the key concerns on Infosys
„ Will FY12 revenue guidance be difficult to beat?
Infosys has embarked on a company-wide reorganisation as part of its Infosys3.0
initiative, which is expected to be completed by July 2011. There are concerns that
this will impact near-term revenue growth. We expect Infosys to continue its track
record of beating its FY12 revenue guidance of 18-20% YoY growth, but expect
the extent of beat to be lower due to the ongoing internal changes in the company.
„ Is the margin lead over peers finally eroding?
Infosys margin guidance of a 300bp decline in FY12 has raised concerns that its
lead over peers is eroding. We believe that all large Indian vendors will lose 300-
400bp in operating margin over the next five years, and we expect Infosys to
maintain a lead over its competitors. We also view Infosys’ FY12 margin guidance
as being conservative, with ample room for upside.
„ What are the catalysts for stock price performance?
We expect Q1 to be the last muted quarter for Infosys, and believe that strong Q2
guidance, followed by a beat would act as positive surprises for the stock. Betterthan-expected Q1 margin performance (we expect a 290bp drop in EBITDA) could
also help assuage margin concerns and act as a trigger for stock upsides.
„ Valuation: maintain Buy, negatives priced in, downside protection likely
We believe the negatives are fully factored into the current stock price, with
valuations at a 15% discount to 5-year average trading multiples. We see limited
risk to our earnings estimates and expect better downside protection in a volatile
market. We maintain our Buy rating with a 1-year view and DCF-based price
target of Rs3,550.
\Will FY12 guidance be difficult to beat?
Reorganisation to create 5 business units
Our recent interaction with Infosys’ senior management leads us to conclude
that Q1 FY12 could be muted on account of the ongoing internal changes due to
the implementation of Infosys3.0—the ambitious new strategic initiative
unveiled a few months ago. This realignment will result in a decentralised and
simplified organisational structure with five large business units with
independent P&Ls in the company. The business units will be aligned to specific
industry verticals as outlined below:
— Financial Services and Insurance (FSI)
— Manufacturing (MFG)
— Energy, Utilities, Communications and Services (ECS)
— Retail, CPG and Life Sciences (RCL)
— Public Services (US subsidiary)
The services offered by the company will be grouped into three categories,
namely: a) Business Transformation, b) Innovation, and c) Business Operations
within each business unit. This would necessitate the creation of business unitspecific resource pools, except at the entry level.
Realignment to be complete only by July 2011, likely to impact Q2
The organisational changes necessary for the transition to Infosys3.0 were rolled
out in April 2011 and are expected to be completed by the end of July 2011.
April-June and July-September are seasonally strong quarters for Infosys and we
are concerned that a significant part of the seasonal strength in business
momentum could be lost due to the ongoing realignment. Based on our recent
interactions with investors, we believe that the buy-side consensus for Q1 FY12
revenue growth does not factor in a beat to the guidance of 2.6-3.6% QoQ
growth. Investors also remain concerned that the reorganisation could impact Q2
FY12 as well, although management remains confident of a robust Q2.
Without a strong Q1, we believe that the chances of Infosys beating FY12
guidance of 18-20% YoY dollar revenue growth remain slim. Our analysis
indicates that Q2 revenue growth (seasonally the strongest quarter in terms of
QoQ growth) of 8-10% will still put FY12 revenue at 18-21% YoY, if followed
by an average of 4% QoQ in H2 FY12. Our current estimates factor Q1 FY12
revenue growth of 4% QoQ, and full-year revenue growth of 22% YoY in FY12.
Is the margin lead over peers finally eroding?
We expect Infosys to retain margin lead
If Infosys meets its FY12 EBIT margin guidance of a 300bp decline, it could
lose its status as the most profitable IT services vendor in India to TCS. This,
along with Infosys’ management commentary on the erosion of pricing premium,
has led many to perceive this as a sign that Infosys’ margin leadership is finally
ending. We expect the large Indian vendors to lose 300-400bp in operating
margins over the next five years. However, we view Infosys’ FY12 guidance as
excessively conservative given the strong pricing tailwind and reasonably strong
revenue growth expected in FY12.
Is FY12 a sign of slower growth ahead?
Revenue impact of reorganisation likely to be short lived
One of the key reasons for our cautious view on the company in 2010 was based
on our industry view that the current business model would need to be redefined
for sustaining industry leadership and market share. With Infosys3.0, the
company seems to be acknowledging this view with ambitious plans to reduce
the traditional applications business to just one third of revenue by 2017. We
view the management and internal changes at Infosys as a temporary issue for
the company and do not share the view that Infosys could structurally grow
slower than its India-listed peers such as TCS over the medium term.
Muted expectations could favour Infosys over peers
Contract awards over US$25m as monitored by TPI, a leading third-party deal
broker, have declined sharply on a YoY basis over the past two quarters. TPI
reported that the quarters ended December 2010 and March 2011 were the
weakest over the past 10 years.
We believe that sudden weakness in contract signings could be early indications
of moderation in demand growth for the global IT services sector.
Macroeconomic data has also remained weaker than expected, with the banking
and financial services sector in developed economies beginning to show some
moderation versus street expectations. We think that this could result in slower
growth for Indian IT services vendors, which is likely to impact earnings growth
in H2 FY12. We view Infosys as a safe haven in such a scenario as it is the only
stock where consensus earnings growth estimates have seen sharp cuts so far.
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