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Infosys (INFO)
Technology
Attractively valued, especially on a relative basis. Even as the absolute performance
of the Indian IT services sector will be driven by how FY2013E volume/pricing dynamics
shape up and how the Rupee moves versus the USD, we highlight intra-sector valuation
dynamics of Infosys versus the two other large peers, Wipro and TCS. Infosys, at par
with Wipro and at a 15% discount to TCS on FY2012E EV/EBITDA (similar or worse on
FY2013E), appears attractively valued on a relative basis. We reiterate BUY.
First principles – EV/EBITDA derivation and what does relative premium or discount mean
Before getting into a more specific discussion on current relative valuation of Tier-I Indian IT names,
we discuss out thoughts on EV/EBITDA multiple.
On first principles, a company’s FCF multiple (EV/FCF) is a function of growth and WACC.
Terminal EV/FCF = (1 + terminal growth)/ (WACC – terminal growth).
EBITDA multiple (or EV/EBITDA) can be derived from the FCF multiple by multiplying the FCF
multiple by FCF/EBITDA conversion. Essentially, EV/EBITDA = EV/ FCF * FCF/EBITDA.
This, forward EV/EBITDA multiple of a company, is a function of three parameters – (1) assumed
growth, (2) assumed WACC, and (3) FCF/EBITDA conversion (what % EBITDA converted to FCF).
A relative premium on EV/EBITDA for a company versus another can be justified on higher growth,
lower WACC, or better FCF/EBITDA conversion.
Infosys trades at par with Wipro and at a 15% discount to TCS on FY2012E EV/EBITDA
Infosys trades at par with Wipro and at a 15% discount to TCS on FY2012E EV/EBITDA. We refrain
from using FY2013E as a base for comparison lest the same be attributed to our relative optimism
on Infosys forecasts, especially versus Wipro. Some thoughts (we assume FY2012E as terminal year
for simplicity’s sake in the discussion below) —
Firstly, given Wipro’s inferior FCF/EBITDA conversion as compared to Infosys (primarily on
account of lower EBITDA margin and inferior working capital ratios), at-par EV/EBITDA multiple
for Wipro implies a higher FCF multiple (or EV/FCF). Assuming the same WACC for the two
companies, a higher FCF multiple can be justified only on the back of a higher FCF growth
assumption. This is a risky assumption in our view. One can also assume that Wipro improves its
FCF/EBITDA conversion to bring it at par with Infosys – possible, of course, but a massive
challenge for Wipro and a stretched assumption for an investor, in our view.
Arithmetically, assuming 10% points weaker FCF/EBITDA conversion for Wipro compared to
Infosys, at-par EV/EBITDA multiple calls for almost 1% point higher FCF growth in perpetuity
for Wipro – this is an extremely risky assumption in our view. We note that 10% weaker
FCF/EBITDA conversion for Wipro versus an Infosys is in itself an aggressive assumption,
given the large difference in EBITDA margins of the two companies. We depict how EBITDA
margins have a direct bearing on FCF/EBITDA conversion in Exhibit 1.
On similar lines, the 15% EV/EBITDTA premium for TCS versus Infosys, assuming a 5%
weaker FCF/EBITDA conversion for TCS versus an Infosys (for similar reasons as Wipro –
lower margins and weaker WC management) implies a 1.2% points higher growth in
perpetuity for TCS as compared to Infosys.
Bottomline – we find Infosys attractively valued on a relative EV/EBITDA
multiple as compared to both TCS and Wipro
We do understand the near-term growth dynamics at play. TCS has sustained superior
revenue growth (coupled with a catch-up on margins) versus Infosys for several quarters
now and there is some merit to a trading EV/EBITDA premium for TCS.
However, we are surprised with the at-par EV/EBITDA multiple for Wipro as compared to
Infosys – this should be construed as a premium on FCF multiple. And, as we discussed
above, such premium can be justified only with an assumption of superior relative growth
for Wipro in perpetuity – a story finding favor on the Street within the broader ‘Wipro
turnaround’ thesis. We are believers in the Wipro turnaround story (while being ‘cognizant’
of the risks); however, we believe an at-par EV/EBITDA multiple to a company with superior
FCF generation profile is a stretch, especially when the first signs of turnaround are yet to be
seen.
We do note that we do not intend to get into a discussion on business models and ongoing
transitions in the same for Infosys and Wipro. Our discussion is based on the difference in
FCF profile of the two companies, historically as well as per our forecasts.
What about the excess cash on Infosys’ books – doesn’t that impact
computations?
No, on an EV/EBITDA computations or comparisons, it doesn’t. It does impact relative PE –
and should, if a competitor is putting cash to better use than the 6-7% post-tax yield cash
sitting on the books generates. However, EV is the value of a company’s operations and
EBITDA is independent of the cash on books. EV/EBITDA, thus, reflects only the value being
ascribed to a company’s operations – level of cash on books does not matter when
comparing EV/EBITDA between companies. Moreover, Infosys has a better ROE than Wipro
despite the excess cash on books; option value of cash is higher for Infosys versus a Wipro
which has already exercised a lot of it.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Infosys (INFO)
Technology
Attractively valued, especially on a relative basis. Even as the absolute performance
of the Indian IT services sector will be driven by how FY2013E volume/pricing dynamics
shape up and how the Rupee moves versus the USD, we highlight intra-sector valuation
dynamics of Infosys versus the two other large peers, Wipro and TCS. Infosys, at par
with Wipro and at a 15% discount to TCS on FY2012E EV/EBITDA (similar or worse on
FY2013E), appears attractively valued on a relative basis. We reiterate BUY.
First principles – EV/EBITDA derivation and what does relative premium or discount mean
Before getting into a more specific discussion on current relative valuation of Tier-I Indian IT names,
we discuss out thoughts on EV/EBITDA multiple.
On first principles, a company’s FCF multiple (EV/FCF) is a function of growth and WACC.
Terminal EV/FCF = (1 + terminal growth)/ (WACC – terminal growth).
EBITDA multiple (or EV/EBITDA) can be derived from the FCF multiple by multiplying the FCF
multiple by FCF/EBITDA conversion. Essentially, EV/EBITDA = EV/ FCF * FCF/EBITDA.
This, forward EV/EBITDA multiple of a company, is a function of three parameters – (1) assumed
growth, (2) assumed WACC, and (3) FCF/EBITDA conversion (what % EBITDA converted to FCF).
A relative premium on EV/EBITDA for a company versus another can be justified on higher growth,
lower WACC, or better FCF/EBITDA conversion.
Infosys trades at par with Wipro and at a 15% discount to TCS on FY2012E EV/EBITDA
Infosys trades at par with Wipro and at a 15% discount to TCS on FY2012E EV/EBITDA. We refrain
from using FY2013E as a base for comparison lest the same be attributed to our relative optimism
on Infosys forecasts, especially versus Wipro. Some thoughts (we assume FY2012E as terminal year
for simplicity’s sake in the discussion below) —
Firstly, given Wipro’s inferior FCF/EBITDA conversion as compared to Infosys (primarily on
account of lower EBITDA margin and inferior working capital ratios), at-par EV/EBITDA multiple
for Wipro implies a higher FCF multiple (or EV/FCF). Assuming the same WACC for the two
companies, a higher FCF multiple can be justified only on the back of a higher FCF growth
assumption. This is a risky assumption in our view. One can also assume that Wipro improves its
FCF/EBITDA conversion to bring it at par with Infosys – possible, of course, but a massive
challenge for Wipro and a stretched assumption for an investor, in our view.
Arithmetically, assuming 10% points weaker FCF/EBITDA conversion for Wipro compared to
Infosys, at-par EV/EBITDA multiple calls for almost 1% point higher FCF growth in perpetuity
for Wipro – this is an extremely risky assumption in our view. We note that 10% weaker
FCF/EBITDA conversion for Wipro versus an Infosys is in itself an aggressive assumption,
given the large difference in EBITDA margins of the two companies. We depict how EBITDA
margins have a direct bearing on FCF/EBITDA conversion in Exhibit 1.
On similar lines, the 15% EV/EBITDTA premium for TCS versus Infosys, assuming a 5%
weaker FCF/EBITDA conversion for TCS versus an Infosys (for similar reasons as Wipro –
lower margins and weaker WC management) implies a 1.2% points higher growth in
perpetuity for TCS as compared to Infosys.
Bottomline – we find Infosys attractively valued on a relative EV/EBITDA
multiple as compared to both TCS and Wipro
We do understand the near-term growth dynamics at play. TCS has sustained superior
revenue growth (coupled with a catch-up on margins) versus Infosys for several quarters
now and there is some merit to a trading EV/EBITDA premium for TCS.
However, we are surprised with the at-par EV/EBITDA multiple for Wipro as compared to
Infosys – this should be construed as a premium on FCF multiple. And, as we discussed
above, such premium can be justified only with an assumption of superior relative growth
for Wipro in perpetuity – a story finding favor on the Street within the broader ‘Wipro
turnaround’ thesis. We are believers in the Wipro turnaround story (while being ‘cognizant’
of the risks); however, we believe an at-par EV/EBITDA multiple to a company with superior
FCF generation profile is a stretch, especially when the first signs of turnaround are yet to be
seen.
We do note that we do not intend to get into a discussion on business models and ongoing
transitions in the same for Infosys and Wipro. Our discussion is based on the difference in
FCF profile of the two companies, historically as well as per our forecasts.
What about the excess cash on Infosys’ books – doesn’t that impact
computations?
No, on an EV/EBITDA computations or comparisons, it doesn’t. It does impact relative PE –
and should, if a competitor is putting cash to better use than the 6-7% post-tax yield cash
sitting on the books generates. However, EV is the value of a company’s operations and
EBITDA is independent of the cash on books. EV/EBITDA, thus, reflects only the value being
ascribed to a company’s operations – level of cash on books does not matter when
comparing EV/EBITDA between companies. Moreover, Infosys has a better ROE than Wipro
despite the excess cash on books; option value of cash is higher for Infosys versus a Wipro
which has already exercised a lot of it.
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