Infosys Needs to Diversify Out of Body-Shopping

| About: Infosys Limited, (INFY)
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The rupee value may rise making Indian services more expensive, but companies like Infosys adapt. In this piece, we look at what is going on inside the outsourcing giant, and whether their strategy is enough to sustain continued growth.

Infosys (NASDAQ:INFY) delivers information technology (NYSE:IT) enabled outsourced business solutions and provides business process outsourcing (NYSE:BPO) services. In Q2, Infosys achieved $1 billion dollars in quarterly revenue for the first time, growing 37% versus Q1 (annual revenue was $3.1 billion and net income $850 million ended March 2007). Only 3-4% of this revenue comes from the Indian domestic market (63% comes from the US, Infosys’ largest market, 27% from Europe, UK primarily, and the remainder is generated in Asia).

Revenues have risen 10.1% sequentially by the quarter. Infosys improved operating margins to 27.5%, 2.8% higher than Q1. The company recovered from the Indian rupee appreciation impact in Q1, and analysts pegged Q2 growth at approximately 10% versus guidance of a deceleration Q3 sequential growth of 5% to 6%. As a result Infosys is expected to produce 4-5% sequential growth regardless of the rupee value. Supporting this view, Q1 saw the billing rates going up by 1.1% and in Q2 by 1.9%. Simultaneously, staff utilization has increased from 73% to 78%.

Annual growth guidance for the remaining year has been increased by 5% from 30% to 35%. Management assumes no more large deals for the year and no further price increases from Q2.

Infosys has five segments:

  • The Banking/Financial Services/Insurance (BFSI) segment, and largest, grew 11.4%;
  • Manufacturing grew 13.2%;
  • Retail grew 27.3%, attributed to growth of retail and new clients in Europe as companies seek more efficiency in outsourcing;
  • The energy and utility segment grew 19.5%;
  • Consulting is now 5%; and package implementation is 18.7% from 18.4% in Q1, creating a 24% share of company revenue ($241m). No slowdown is anticipated.

New clients/contracts are now won at 3-4% higher than company average and contract renegotiations are 2-3% above average. The top 10 customers grew by 2.7% quarter-on-quarter and the non-top 10 grew 13.7% sequentially. Infosys added 48 new Q2 customers with a company total of 520. Infosys plans projects on a basis of 30% onshore and 70% offshore, showing more offshore reliance to control cost compared to a previous 40/60 split. Fixed prices have increased in Q2 as a company strategic direction, the goal being Infosys value accrual. Management increased attention on increasing productivity in the last year with a current fixed price now being higher than the average margin by 3-4%.

The big question for Infosys is where is the new money coming from and where is it going to go. More new business is coming from Europe now than the U.S., with the United Kingdom fueling the strongest inroads. And more than 43 percent of revenue comes from non-application development, i.e. BPO ventures. Further BPO expansions are being tested through Finacle as a service, which is currently going through validating market demand and formalizing offering strategy. Finacle is Infosys’ Banking solution.

Infosys’ acquisition strategy is also focused on filling in BPO gaps. BPO acquisitions need to provide new platforms for Infosys to base business on or open new markets. The company is cautious in selecting target companies, looking not only for strategic fit, but also overlap of ability to retain employees and alignment of values, culture, and ethics. Infosys does not support hostile takeovers. Acquirees are expected to want to be acquired.

Summary of recent acquisitions:

  • 2006-07: Infosys purchased 3 shared services centers (India, Poland, and Thailand) from Royal Philips Electronics, giving it a large presence in Eastern Europe, the largest of any Indian company in the region.

  • 2003-04: The company acquired Expert Information Systems Pty Limited, a leading Australian IT design, build and integration provider for business solutions.

  • 2002-03: Infosys acquired intellectual property rights in Trade IQ, a U.S. trade management product, Autolay – a commercial software for design of high performance structural systems, and I-Link – a signature display system from India for banking products.

Most of these purchases expand Infosys’ geographic presence. However, with a cash and cash equivalent balance of at least $1.4 billion, and a great market cap, it is unfortunate that Infosys is not really getting into strategic “product” acquisitions. Thus, Infosys’ growth remains head-count-bound, and not much creativity beyond basic body-shopping seems to be going on. Nonetheless, in body-shopping, Infosys is one of the world’s absolute best.

The time has come, though, for Infosys to take a good look at the software eco-system in the US, and decide on a strategy that enables them to play in the more leveraged technology / IP driven business models, and change the business mix somewhat. The company currently lacks excitement, but the right signals along these lines would definitely bring them back to popularity. In fact, the rising wage costs and appreciating rupee can easily be mitigated if the company diversifies its business model out of body-shopping.

Disclosure: no position