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Technology
India
What’s ailing Infosys? Our analysis of relative revenue, EBITDA, net income, and
market cap market shares of the top-5 Indian offshore names reveals a rather sobering
story for Infosys – it has lost leadership on all these counts. More importantly, (1) its
relative market share across all these parameters is at multi-year lows, and (2) bulk of
the decline has happened in the past two years. The jury is still out on whether this is a
temporary dislocation or a structural damage. We believe it is temporary and expect a
trend reversal in the coming quarters. Infosys and TCS are our top picks.
Our analysis methodology
We have looked at relative market shares of the top-5 companies (TCS, Infosys, Cognizant, Wipro,
and HCLT) within the top-5 composite across four parameters – (1) revenues, (2) EBITDA, (3) net
income, and (4) market cap. We used quarterly numbers for operational parameters while market
cap figures used for the analysis were period-end. We used September 2004 to June 2011 as the
period of the analysis – starting date was driven by TCS’ listing date. We also note that we have
not made any adjustments for various acquisitions across companies (Wipro, TCS, and HCLT have
been the most active on this front; Infosys the least). In addition to the relative market shares, we
also present three derived metrics
EBITDA market share/revenue market share – this metric essentially captures the relative
profitability at the EBITDA level.
Net income market share/revenue market share – same as above, but at the PAT level.
Market cap market share/net income market share – this metric captures the relative PE
premium or discount versus the peer group.
Infosys’ recent fall from the perch stands out
Infosys’ relative market share across all the parameters considered for our analysis is at multi-year
lows. Even as the company’s relative revenue share has been declining consistently (peaked in the
March 2005 quarter at 25.3% of composite), the decline on other parameters has been more
recent and sharper. Its relative EBITDA market share has fallen to 24.4% in June 2011 after hitting
a peak of 30.7% in December 2008. Net income share has fallen to 24.8% in June 2011 from a
peak of 33.6% in March 2009 while market cap relative share has declined to 25.2% from 37.5%
in March 2009. Relative PE (defined as market cap share/net income share) is down to 1.02 versus
a peak of 1.26 hit in June 2010. Even as part of the answer lies in superior revenue
(TCS/CTSH/HCLT) and margin (TCS) performance of peers and movement in tax rates (Infosys has
seen the sharpest rise in the past two years across the peer group), certain Infosys-specific factors
are also to blame –
Poor response to demand recovery post downturn. The problem was at multiple levels – (1)
relatively lower aggression on the front-end; meaningful deal losses, especially in Europe, (2)
poor bench management (composition of bench was the issue, not utilization levels), and (3)
relatively lower flexibility on pricing and deal structures.
Troubles at the erstwhile top account, BT. Even as Infosys has done a commendable job of
mitigating the impact of sharp revenue loss at BT, it has impacted relative performance.
Stretched reorganization phase, which led to a loss of focus at times.
Excessive focus on certain type of deals (high value-add, consistent with Infosys 3.0 imperative).
Key question – is Infosys’ underperformance temporary or structural?
Relative underperformance on operational parameters has also led to a fall in Infosys’
relative positioning on the Street – it has lost its bellwether positioning to TCS. Even as a
modest PE premium to the peer group composite still exists (and is justified, despite
operational underperformance, given superior balance sheet quality, cash flow generation
and fiscal discipline), outperformance going forward would certainly demand a reversal in
relative operational performance trends. Failure to deliver, and the window is short in our
view, could lead to further relative de-rating.
Having said that, we note that some of the issues that plagued Infosys’ relative operational
performance over the past two years are either history (BT’s contribution to revenues has
fallen to <2% from 10.3% at its peak, for example), or are being actively addressed (frontend,
bench management, etc.). The key really is (1) the revamped organization structure
needs to deliver, and (2) the company needs to manage the change in stance – some leeway
on pricing/profitability for volumes – well.
We believe the company is making the right moves, as also discussed in our recent
(September 7, 2011) note. We reproduce from the earlier note some of the company’s
moves that underline our confidence of a trend reversal –
Reduced number of P&Ls in the organization – Infosys has reorganized internally into four
large P&Ls along industry verticals. Decision-making authority now lies completely with
these vertical heads. This is different from the earlier unit-level P&Ls across verticals,
geographies, and service lines, with each of these having revenue as well as profitability
targets. The earlier structure led to loss of certain strategic deals (from an overall
perspective) which did not meet the profitability targets of some of the individual units.
Greater focus on volumes – especially increased level of aggression in gaining volume
market share in strategic relationships, even if the same comes with modest hit on
account profitability. The company has had some success in marquee deal wins recently;
however, flow-through impact on financials could take a while.
Multiple changes in roles across the organization and in the front-end, especially in
Europe. In addition to the reorganization-led role changes, Infosys has inducted new
front-end faces in areas where the company has seen a decline in deal participation in
recent quarters.
Better bench management – the company’s assessment of broad-based growth (across
verticals) at the beginning of FY2011 backfired in a way – growth turned out to be
concentrated in select verticals (especially BFSI) and the company ended up with a thin
BFSI bench and very low utilization in some other verticals, especially Telecom. Infosys has
increased focus on this aspect.
Observations on other companies
We will let the charts tell much of the story (see Exhibits 1 to 11). Some key observations –
TCS – flying high
TCS has delivered a remarkable turnaround in its relative operational performance over the
past 2+ years – its relative market shares on EBITDA and net income market share have
jumped to all-time highs from all-time lows hit in March 2009 quarter, even as its relative
revenue market share has been consistent (which is remarkable in itself, given its size).
Operational turnaround has not gone unnoticed on the Street – the company has wrested
back its market cap market share leadership from Infosys and also the industry bellwether
status. We will leave a detailed discussion on what the company has done right for a later
note. Measured aggression in the market place, stable senior management team, revamped
organization structure, supply-side leadership, well-timed acquisitions, and right investments
have all contributed to the recent surge, in our view.
Wipro – consistent underperformer
Wipro has also hit all-time lows on relative market share metrics across parameters. However,
in case of Wipro, relative underperformance is not a recent phenomenon – recent dips only
follow a long-term trend of relative market share loss. FY2010 marked a brief period of
resurgence but the pace of relative underperformance has only accelerated since. We have
written a lot in the past on what we see as the reasons for Wipro’s struggles – the key ones,
in our view, are – (1) poor account management – Wipro has the worst large account
metrics across the peer group, (2) mixed, at best, track record of acquisitions, (3) instability
at the top – in terms of structure, roles, and people, (4) relatively inferior positioning at
campuses as well as laterals market, (5) legacy factors – sub-optimal portfolio mix, especially
on vertical lines, and (6) inability to protect its areas of leadership.
Cognizant – consistent outperformer
The revenue growth leader in the industry, Cognizant has nearly doubled its relative revenue
market share versus peers since 2004. Its EBITDA and net income market shares have also
seen a 50% jump since. The company recently overtook Wipro on revenues and has now
overtaken Wipro on market cap share as well. Cognizant’s surplus (over its stated target
range) margin reinvestment philosophy into chasing revenue growth has clearly yielded
handsome results. We also believe Cognizant’s large account management, aggressive sales
approach, and relentless focus on top campus slots have been key drivers for
outperformance.
HCLT – holding on well despite business model challenges
Credit where it’s due – HCLT has, to our surprise, managed to hold on to its relative EBITDA
and net income market share despite having what we believe is a business model inferior to
larger peers (weak applications positioning, no vertical story). The company has leveraged its
balance sheet to achieve this, to some extent. It has of course also used its horizontal (IMS)
strengths extremely well. In addition, it has chosen an aggressive revenue growth strategy
(through organic as well as inorganic means) at the expense of margins. Its ‘growth at the
expense of margins’ strategy is well-reflected in the revenue and EBITDA market share
divergence over the past 3 years.
Limitations of our analysis
Intermediate qoq movements in EBITDA and net income market shares may reflect
difference in wage hike cycles and forex fluctuations across companies. Nonetheless,
trends over a longer timeframe do carry meaningful insights, in our view.
The ‘relative PE’ derived metric (defined as market cap share/net income share) is a
historical measure – as we divide market cap by last quarter’s net income. Relative PE at
any given point would reflect forward expectations differential. Nonetheless, expansion or
contraction of this metric over time suggests outperformance or underperformance versus
expectations, in a way.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Technology
India
What’s ailing Infosys? Our analysis of relative revenue, EBITDA, net income, and
market cap market shares of the top-5 Indian offshore names reveals a rather sobering
story for Infosys – it has lost leadership on all these counts. More importantly, (1) its
relative market share across all these parameters is at multi-year lows, and (2) bulk of
the decline has happened in the past two years. The jury is still out on whether this is a
temporary dislocation or a structural damage. We believe it is temporary and expect a
trend reversal in the coming quarters. Infosys and TCS are our top picks.
Our analysis methodology
We have looked at relative market shares of the top-5 companies (TCS, Infosys, Cognizant, Wipro,
and HCLT) within the top-5 composite across four parameters – (1) revenues, (2) EBITDA, (3) net
income, and (4) market cap. We used quarterly numbers for operational parameters while market
cap figures used for the analysis were period-end. We used September 2004 to June 2011 as the
period of the analysis – starting date was driven by TCS’ listing date. We also note that we have
not made any adjustments for various acquisitions across companies (Wipro, TCS, and HCLT have
been the most active on this front; Infosys the least). In addition to the relative market shares, we
also present three derived metrics
EBITDA market share/revenue market share – this metric essentially captures the relative
profitability at the EBITDA level.
Net income market share/revenue market share – same as above, but at the PAT level.
Market cap market share/net income market share – this metric captures the relative PE
premium or discount versus the peer group.
Infosys’ recent fall from the perch stands out
Infosys’ relative market share across all the parameters considered for our analysis is at multi-year
lows. Even as the company’s relative revenue share has been declining consistently (peaked in the
March 2005 quarter at 25.3% of composite), the decline on other parameters has been more
recent and sharper. Its relative EBITDA market share has fallen to 24.4% in June 2011 after hitting
a peak of 30.7% in December 2008. Net income share has fallen to 24.8% in June 2011 from a
peak of 33.6% in March 2009 while market cap relative share has declined to 25.2% from 37.5%
in March 2009. Relative PE (defined as market cap share/net income share) is down to 1.02 versus
a peak of 1.26 hit in June 2010. Even as part of the answer lies in superior revenue
(TCS/CTSH/HCLT) and margin (TCS) performance of peers and movement in tax rates (Infosys has
seen the sharpest rise in the past two years across the peer group), certain Infosys-specific factors
are also to blame –
Poor response to demand recovery post downturn. The problem was at multiple levels – (1)
relatively lower aggression on the front-end; meaningful deal losses, especially in Europe, (2)
poor bench management (composition of bench was the issue, not utilization levels), and (3)
relatively lower flexibility on pricing and deal structures.
Troubles at the erstwhile top account, BT. Even as Infosys has done a commendable job of
mitigating the impact of sharp revenue loss at BT, it has impacted relative performance.
Stretched reorganization phase, which led to a loss of focus at times.
Excessive focus on certain type of deals (high value-add, consistent with Infosys 3.0 imperative).
Key question – is Infosys’ underperformance temporary or structural?
Relative underperformance on operational parameters has also led to a fall in Infosys’
relative positioning on the Street – it has lost its bellwether positioning to TCS. Even as a
modest PE premium to the peer group composite still exists (and is justified, despite
operational underperformance, given superior balance sheet quality, cash flow generation
and fiscal discipline), outperformance going forward would certainly demand a reversal in
relative operational performance trends. Failure to deliver, and the window is short in our
view, could lead to further relative de-rating.
Having said that, we note that some of the issues that plagued Infosys’ relative operational
performance over the past two years are either history (BT’s contribution to revenues has
fallen to <2% from 10.3% at its peak, for example), or are being actively addressed (frontend,
bench management, etc.). The key really is (1) the revamped organization structure
needs to deliver, and (2) the company needs to manage the change in stance – some leeway
on pricing/profitability for volumes – well.
We believe the company is making the right moves, as also discussed in our recent
(September 7, 2011) note. We reproduce from the earlier note some of the company’s
moves that underline our confidence of a trend reversal –
Reduced number of P&Ls in the organization – Infosys has reorganized internally into four
large P&Ls along industry verticals. Decision-making authority now lies completely with
these vertical heads. This is different from the earlier unit-level P&Ls across verticals,
geographies, and service lines, with each of these having revenue as well as profitability
targets. The earlier structure led to loss of certain strategic deals (from an overall
perspective) which did not meet the profitability targets of some of the individual units.
Greater focus on volumes – especially increased level of aggression in gaining volume
market share in strategic relationships, even if the same comes with modest hit on
account profitability. The company has had some success in marquee deal wins recently;
however, flow-through impact on financials could take a while.
Multiple changes in roles across the organization and in the front-end, especially in
Europe. In addition to the reorganization-led role changes, Infosys has inducted new
front-end faces in areas where the company has seen a decline in deal participation in
recent quarters.
Better bench management – the company’s assessment of broad-based growth (across
verticals) at the beginning of FY2011 backfired in a way – growth turned out to be
concentrated in select verticals (especially BFSI) and the company ended up with a thin
BFSI bench and very low utilization in some other verticals, especially Telecom. Infosys has
increased focus on this aspect.
Observations on other companies
We will let the charts tell much of the story (see Exhibits 1 to 11). Some key observations –
TCS – flying high
TCS has delivered a remarkable turnaround in its relative operational performance over the
past 2+ years – its relative market shares on EBITDA and net income market share have
jumped to all-time highs from all-time lows hit in March 2009 quarter, even as its relative
revenue market share has been consistent (which is remarkable in itself, given its size).
Operational turnaround has not gone unnoticed on the Street – the company has wrested
back its market cap market share leadership from Infosys and also the industry bellwether
status. We will leave a detailed discussion on what the company has done right for a later
note. Measured aggression in the market place, stable senior management team, revamped
organization structure, supply-side leadership, well-timed acquisitions, and right investments
have all contributed to the recent surge, in our view.
Wipro – consistent underperformer
Wipro has also hit all-time lows on relative market share metrics across parameters. However,
in case of Wipro, relative underperformance is not a recent phenomenon – recent dips only
follow a long-term trend of relative market share loss. FY2010 marked a brief period of
resurgence but the pace of relative underperformance has only accelerated since. We have
written a lot in the past on what we see as the reasons for Wipro’s struggles – the key ones,
in our view, are – (1) poor account management – Wipro has the worst large account
metrics across the peer group, (2) mixed, at best, track record of acquisitions, (3) instability
at the top – in terms of structure, roles, and people, (4) relatively inferior positioning at
campuses as well as laterals market, (5) legacy factors – sub-optimal portfolio mix, especially
on vertical lines, and (6) inability to protect its areas of leadership.
Cognizant – consistent outperformer
The revenue growth leader in the industry, Cognizant has nearly doubled its relative revenue
market share versus peers since 2004. Its EBITDA and net income market shares have also
seen a 50% jump since. The company recently overtook Wipro on revenues and has now
overtaken Wipro on market cap share as well. Cognizant’s surplus (over its stated target
range) margin reinvestment philosophy into chasing revenue growth has clearly yielded
handsome results. We also believe Cognizant’s large account management, aggressive sales
approach, and relentless focus on top campus slots have been key drivers for
outperformance.
HCLT – holding on well despite business model challenges
Credit where it’s due – HCLT has, to our surprise, managed to hold on to its relative EBITDA
and net income market share despite having what we believe is a business model inferior to
larger peers (weak applications positioning, no vertical story). The company has leveraged its
balance sheet to achieve this, to some extent. It has of course also used its horizontal (IMS)
strengths extremely well. In addition, it has chosen an aggressive revenue growth strategy
(through organic as well as inorganic means) at the expense of margins. Its ‘growth at the
expense of margins’ strategy is well-reflected in the revenue and EBITDA market share
divergence over the past 3 years.
Limitations of our analysis
Intermediate qoq movements in EBITDA and net income market shares may reflect
difference in wage hike cycles and forex fluctuations across companies. Nonetheless,
trends over a longer timeframe do carry meaningful insights, in our view.
The ‘relative PE’ derived metric (defined as market cap share/net income share) is a
historical measure – as we divide market cap by last quarter’s net income. Relative PE at
any given point would reflect forward expectations differential. Nonetheless, expansion or
contraction of this metric over time suggests outperformance or underperformance versus
expectations, in a way.
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