| Infosys (INFO IN) Vishal Sikka will be the next CEO of Infosys; this could likely be a long haul even if he's the right man for the job | Overweight Price Target: Rs4,000.00 PT End Date: 31 Mar 2015 | |
· The event: Dr. Vishal Sikka will take over as the CEO & MD of Infosys (from Mr. S.D. Shibulal) on Aug. 1st, 2014. Dr. Sikka was the CTO of SAP and the principal architect behind the enormously successful SAP-HANA (SAP’s analytics engine) (he resigned from SAP in May 2014). Dr. Sikka was also the member of the executive board of SAP and is regarded very highly for his technology skills. Dr. Sikka will be the first non-founder CEO of Infosys. Mr. U.B. Pravin Rao, the current president and whole-time director at Infosys, will be the new Chief Operating Officer (COO) effective Jun. 14, 2014. Notably, Mr. N.R. Narayana Murthy and Mr. S. Gopalakrishnan will step down from the position of Executive Chairman and Executive Vice Chairman, respectively, effective Jun 14, 2014.However, they will continue on the Board till Oct. 10, 2014 as Non-executive Chairman and Non-executive Vice Chairman, respectively. Mr. K.V. Kamath will take over as the Non-executive Chairman of the Board on Oct. 11, 2014. Also, the Executive Chairman’s office will be dissolved effective Jun 14, 2014 and Dr. Rohan Murthy will also quit the company on the same date.
· Our take: Dr. Sikka is a brave, unconventional choice, but his handling of a services business needs watching. We believe Dr. Sikka is a good choice from the perspective that IT Services is increasingly being software-driven or having software-like characteristics in the digital or SMAC (social, mobile, analytics, cloud) age. A service business model is a kind of software-cum-services offering with business process & application services layered on top of that software. Dr. Sikka having been a CTO at a leading, innovative software firm can probably appreciate the changing technology paradigm and articulate business models therein, which is a positive. However, our concern is that Dr. Sikka has been focused more on the R&D/product development side and has presumably not handled large P&Ls/operations. Products, Platforms and Solutions (PPE) accounts for less than 6% of Infosys’s revenues, while 94-95% is traditional IT services. We believe Dr. Sikka is yet to handle traditional IT services business, which is significantly different from products business. Mr. Pravin Rao’s appointment as the COO might help, but how Dr. Sikka handles the services business needs watching. We believe Dr. Sikka’s appointment is a brave, unconventional choice in the SMAC age (i.e. considering technology champions from scale software companies), it also comes with the risk tag of maybe too much of a “technocrat” image and relative inexperience at running services business.
· Assuming Infosys’s key intent of getting Dr. Sikka is to develop maturity and differentiation in products, platforms & solutions (PPS), (which constitutes less than 6% of Infosys’s revenues or a meager 2% excluding its banking product Finacle), it will likely take a relatively long time (may be 8-10 years) and business model transformation for PPS to be a distinctive differentiator (and only will be so, once it reaches critical mass, say 20-25% of overall revenues). For the foreseeable future, it is expected to be the dominant IT Services core (94-95% of Infosys’s revenues) that would wholly determine Infosys’s growth and market share, in our view. Infosys, we believe, cannot afford continued market-share loss in IT Services even as it hopes to scale up PPS under Dr. Sikka. Infosys is predominantly a services company; hence it might be a relatively new business model for Dr. Sikka to handle/operate.
· Infosys’s recovery might get delayed as Dr. Sikka will take some time to understand Infosys. Although Dr. Sikka would bring in fresh thinking to the organization as a technology visionary, but being an outsider he would likely take time to figure out Infosys’s issues, culture, ways of working, politics, competitive landscape, onerous task of rebuilding a team – all of which will take time to show results (given Infosys’s size). We believe Infosys’s expected recovery to industry-level revenue growth by FY16E will likely get pushed out further (maybe to FY17E or even beyond). All in all, we believe the company will take a longer-than-earlier expected time to get back to respectable growth trajectory.
· Dr. Sikka’s appointment might drive another wave of top-level resignation at Infosys. Infosys had been evaluating internal candidates for the CEO position as well. We believe Dr. Sikka’s appointment might drive another wave of resignation from the internal CEO hopefuls. However, the organization will likely stabilize after that. Also, we believe Mr. Murthy’s stepping down should provide significant freedom to Dr. Sikka to rebuild the organization as per his vision, a positive in our view.
· To sum up, we believe two aspects that could likely not work in favor of Dr. Sikka despite his impressive professional pedigree - (a) he is an outsider to Infosys, and (b) he is an outsider to the IT Services industry. Even if he is the right man for the CEO job at Infosys (time will only say so), we believe this might be a really long haul for both Dr. Sikka and Infosys.
· Our estimates are under review post this development.
Investment Thesis
Infosys appears to have more realistic targets in the current environment, which we believe is positive. Its win rates in the bread-and-butter segments (including large deals) seem to be improving. The company has also said it is prepared to temper the near-term margin profile for market share. The growth focus is encouraging, in our view. The other positives are: (a) strong deals wins over the last 3-4 quarters provide some visibility into CY14, (b) meaningful headroom for cost-optimization (and margin expansion) through rationalizing cost structure, increasing offshore effort and taking out redundant onsite costs, (c) management seems committed to bring the company back to industry-level growth rates, and (d) a relatively healthy demand environment in CY14 coupled with improved win rates should boost growth.
Valuation
We stay OW on Infosys with a Mar-15 price target of Rs4,000. Our price target is based on a one-year forward P/E of 16.5x, at a modest (~15%) discount to TCS’s target multiple of 19.0x. We believe the discount is justified as TCS’s revenue growth and margin profile are better than Infosys’s, in our view. Notably, our exchange rate assumption is Rs60/US$ for the next two years (FY15 and FY16).
Risks to Rating and Price Target
Downside risks: Lower-than-expected volume growth, weakness in the demand environment, a meaningful decline in pricing/realizations, an adverse US immigration bill, meaningful rupee appreciation (vs the US$), and higher-than-expected attrition.
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