JPMorgan: Infosys - Dissecting the plusses and minuses of Dr. Vishal Sikka as the Infosys CEO - a great table for you here

Infosys (INFO IN) Dissecting the plusses and minuses of Dr. Vishal Sikka as the Infosys CEO - a great table for you here		Overweight Price Target: Rs4,000.00 PT End Date: 31 Mar 2015

We have compiled below a list of plusses and minuses of the incoming Infosys CEO, Dr. Vishal Sikka, as a table below for your benefit. We have conducted channel checks and primary research in compiling this besides drawing on our understanding of change in management and the products versus services paradigm.

Table 1: Dr. Sikka’s appointment as the CEO & MD of Infosys effective Aug 1, 2014, presents both plusses and minuses – over the near-term, we think the minuses overshadow the plusses, the plusses will take time to show up

Plusses	Minuses
1. Age is on Dr. Sikka’s side – at 47, he is not old for the role	1. Limited P&L management experience; We see Dr. Sikka as an excellent "technocrat" – this new challenge is on an entirely different scale and nature
2. A disruptive innovator – ability to bring fresh & differentiated thinking in the SMAC/digital age when as-a-service business models or productized services gain traction over the next 3-5 years	2. Managing the balance between repairing the core (core will not get displaced in the foreseeable future) and investing to build the next-generation SMAC/digital agenda - Does Dr. Sikka understand the core well enough (or how soon can he appreciate the core well enough) to put in place renewal mechanisms quickly enough?
3. Visibly high profile with proven global connections, access to boardrooms	3. Limited understanding of IT Services which is culturally so very different from products; IT Services still the dominant business for the foreseeable future; Products, Platforms & Solutions (PPS) at just 6% of revenues (2% excluding Finacle) cannot swing the needle over the near-to-medium term
4. Outsider (fresh approach as a technology visionary; no legacy or encumbrances)	4. Outsider (time to adjust to Infosys's culture & politics, reshape the company, rework organization structure, revamp/rebuild people and teams; note that being an outsider is both a plus & minus)
5. Strong entrepreneurial streak that helps creation of new products/revenue streams – Dr. Sikka was instrumental in the founding and development of two start-ups, both of which he sold	5. Managing in an Indian context – Dr. Sikka has only worked overseas in product companies; this requires tremendous cultural adjustment
6. Ability to generate big-bang, blockbuster innovative projects and execute them (e.g. SAP-Hana) – we would note though that SAP provides an eco-system that enables such blockbuster innovations to take root	6. Previous success at SAP achieved using the resources and eco-system available at SAP (product conceptualization & development, marketing, channel-partnerships/alliance building); dramatically different from Infosys whose workforce is not familiar with developing and selling products - in other words, can Dr. Sikka succeed in driving an innovation-centre agenda at Infosys involving resource & eco-system revamp without upending the system? We think there will be some intermediate dislocation costs in attempting to transplant the model to Infosys.
7. The previous Chairman's office has been dismantled; hence Dr. Sikka will have a relatively free hand to redesign/remold Infosys as per his vision	7. Dependence on the COO (Mr. Pravin Rao) to stabilize the core is high – here, Mr. Sikka as the CEO will likely be rather dependent on the COO to handhold him through the core stabilization process
8. Any “power centre” perceived inimical to a clean-up/revamp is now removed. None of Infosys management team (with the exception of Mr. Pravin Rao) remains. Dr. Sikka has a virtually clean slate.	8. A new leadership team at Infosys with expanded responsibilities after significant top-management attrition. The new team will likely take time to hit its stride
	9. Reversing the direction set by Mr. Murthy over the past year. The organization will likely reverse some of the past moves made in accordance with Mr. Murthy’s direction and game-plan.

Source: J.P. Morgan

�� -->

Assuming Infosys’s key intent of getting Dr. Sikka is to develop maturity and differentiation in products, platforms & solutions (PPS), (which constitutes  which constitutes less than 6% of Infosys’s revenues today or a meager 2% excluding its banking product Finacle), it will likely take significant business model transformation for PPS to be a distinctive differentiator. PPS will be differentiating only if it reaches critical mass, (say 20-25% of overall revenues), which requires a long time (may be 8-10 years). For the foreseeable future, the dominant IT Services core (94-95% of Infosys’s revenues, 60%+ is ADM, BPO, testing, IMS) would wholly determine Infosys’s growth and market share, in our view. Infosys, we believe, cannot afford continued market-share loss in the core even as it hopes to scale up PPS under Dr. Sikka. At the end of the day, Infosys is predominantly still a services company – thus, the core will be important for the foreseeable future.


Finally, the message that we draw from Dr. Sikka’s appointment is that Infosys is not shying away from making a brave and disruptive move that might take time to work. We think that Infosys is looking for a different leader and a proven technology wizard (someone like Dr. Sikka) to make longer-term enduring & differentiated impact given where it sees the technology world heading (SMAC, services-software convergence, as-a-service business models et al) and Infosys's desired positioning for differentiation therein. This could involve some business model transformation of a large company in pursuit of differentiation, likely shedding some traditional habits/viewpoints & maybe even de-emphasizing/shedding some business(es).

We believe that the intent is great but it is not without risk in its implementation. It’s perhaps worth noting that despite being a premier enterprise software player, SAP’s current 12-month forward P/E multiple at 16x is similar to that of Infosys (Oracle's one-year forward multple is even lesser at 13.5x).



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.