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Analysis: Infosys technologies

|Includes: Infosys Limited, Inc. (INFY)

The company declared fairly good results for 2009 with a topline and bottom line growth of around 30%. The ROE has been maintained at 30%+ levels and in addition the company continues to hold almost 10000 Crs of cash on its books.

The company continues to maintain one of the highest net margins (around 30%) in the industry. In the addition the various asset ratios such as fixed asset turns and working capital turns continue to be maintained at very high levels (in excess of 5)

The positives of the company are apparent. The company has very high margins, high returns on capital, has shown extremely high growth rates in the last 10 years and has one of the best managements in the country.

The positives of the company as far as the financial parameters are concerned are also the risks faced by the company. Contrary to the media reports, I don’t consider the recession to be a serious issue for the company in the long run.

The recession is bound end sooner or later. The company has substantial scale to ride out the recession. Inspite of the huge drops in the IT services market the company has been able to maintain its ROE and other financial ratios. At the same time, the company has now grown into a 4.5 billion dollar company and now competes with the likes of accenture and IBM.

Companies like accenture earn net margins in the range of 8-10% (with ROE in excess of 50%). These companies are fairly profitable companies in their own right, however not as obscenely profitable as the Indian vendors such as Infosys.

I personally feel, the tier I vendors have a good business model and will be able to do well in the long run. However their margins and profitability should eventually converge to the same levels as their foreign counterparts as they really don’t have any special competitive advantage over their foreign competitiors.

The above convergence could result in decent topline, but a lower bottom line growth.

Competitive analysis
I wrote about
asian paints in an earlier post. I have worked in asian paints and have worked in infosys too. Both are good companies and have good managements. At the risk of comparing apples and oranges, I think asian paints has a higher competitive advantage over its competitors than a company like Infosys.

I have personally been involved in discussions within the company wherein we would struggle to differentiate ourselves with a competitor. I cannot say that for companies like asian paints (brand, distribution etc).

In spite of the above, infosys is a very good company with a decent business model. The biggest difference between a tier I company such as infosys and any other Tier II company is however the management (which I discuss below).

I personally feel, management quality is extemely important in the IT services business. This business has seen a lot of change and will continue to do so. A superior management will be able to drive the business better than the others.

Management analysis
Infosys is known for its management quality and corporate governance. Lets look at how it fares on the various points

- Management compensation : Management compensation seems to be fair. The CEO and top managers make less than 1% of the net profit. In addition the promoters/ managers have never awarded themselves any stock options till date.
- Capital allocation record : The capital allocation record is extremely good. Infosys is one of the few companies which explicitly state their ROE/ ROC objectives in the annual report (twice cost of capital on average capital employed). In addition, in view of the high cash holdings the company has raised its dividend to 30% of net profit from 2008 onwards. In summary the company has a fairly rational capital allocation process.
- Shareholder communication – The company has one of best disclosures and communication practise. I would advise you to read the annual report for this reason alone. The management has explained each P&L and Balance sheet transaction in detail and given the reasoning behind each. Most companies don’t bother with such disclosures at all.
- Accounting practise : Extremely conservative. Case in point – The company has adopted AS30 standard (mark to market accounting) a year in advance. This is the same standard which a number of other companies are resisting as they are likely to have huge MTM losses in the current fiscal due to rupee depreciation.
- related party transactions : Limited to transactions with subsidiaries.
- Performance track record : Very good. The company has always exceeded their guidance (although they under commit everytime). The company has performed quite well for the last 10+ years and have managed the growth fairly well.

The company currently sells at a PE of around 14-15. I would not consider the company to be highly undervalued. Infosys of 2009 is not the same company as it was in 2000. In 2000, this was a very rapidly growing company, with commensurate risks. The company will have lower growth rate in the future , but at the same time it also has lower risks due to its scale and maturity of its business model.
I would roughly estimate the intrinsic value to be between 2000-2200 per share which can be revised based on how the company fares in the future. However it would be foolish to expect the company to fare as well as it has done in the past.

Infosys is now a mature, well run company with above average growth. It has a shareholder friendly and competent management. The company should provide decent returns in the long run, but one should not expect very high returns.

Some Q&A
- Is it not smarter to invest in a smaller fast growing IT services company?
Yes, but the risk is also correspondingly higher. So it a different risk reward scenario in case of smaller IT services company

- Will cost pressures and other currency related issues not impact the company’s performance?
These issues impact all IT companies. However one can expect the management to respond smartly to these environmental changes by globalizing further. The management has successfully responded to the dot com bust, growth related issues and other challenges in the past. It is logical to expect that the management would continue to respond well to any current and new challenges.

Disclosure : I own the stock.