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The latest numbers don't say much
Infosys surprised the market on Friday with better than expected results. Its share price went up 16% by the end of the day, suggesting that many investors see the third quarter as a turning point for Infosys, rather than seeing it as an exception to its unimpressive performance in several that preceded it. Newspapers picked up the cue the next day. Dalal Street Parties as Infy Rocks in Q3 (Economic Times); Shibulal may have reversed Infosys free fall (Mint); After many misses, Infy is back in the reckoning (Business Standard).
Has Infosys finally got its stride back?
To answer this question, we have to first ask what it means in the context of Infosys.
It’s not about exceeding market expectations. Beating expectations would have been a worthy indicator if the expectations were high. They weren't. Polls ahead of the 3Q results indicated that the company might not even meet its own guidance.
It’s also not about beating its own guidance. One, its guidance was low in first place - a 5% revenue growth, compared to Nasscom projection of 12% for the industry. And more importantly, it’s not just about revenue growth for Infosys. The company could have grown faster by being as aggressive as, say HCL Tech, in pricing. Infosys management has been saying for some time now that it’s not playing that game.
For Infosys, the key metrics to watch should be around its new strategy, the so called Infosys 3.0. This is how Kris Gopalakrishnan explained it to my colleague Mitu Jayashankar in a 2010 interview. “Infosys 3.0 is about business solutions, becoming a strategic partner, understanding clients business much better. Understanding what drives investment in client’s business. Consultative sales — that is what Infosys 3.0 is all about.” More recently, Shibulal described it as having a balanced portfolio - with consulting & systems integration and products & platform leading the growth. The first has high revenue productivity and the second is non-linear (more revenues with less number of employees).
Are there signs that the new strategy has started working? To find out, we have to look at the numbers as well as the management commentary. Let’s take it one by one.
What do the numbers say? Two sets of numbers are relevant here. We have to see whether the contribution from its a) consulting business and b) products & platform business - the future drivers of growth - has increased. We also have to see if its core business has enough momentum. (Core business is important for Infosys 3.0 for two reasons. The new drivers don't have scale yet, and they need the cash generated from the core business.)
Future growth driver 1: Products, Platforms and Solutions
The contribution from this segment - Infosys expects it to contribute a third of its revenues in the future - has remained flat compared to last quarter, and has come down compared to a few quarters earlier. In terms of client additions, there was nothing spectacular, except that it’s steadily adding more clients. This quarter it added 14, and in the last 15.
Finacle, which Infosys treats as a separate business because it has been around for a longer time, fits well into its 3.0 framework. Q3 delivered some good news here. Finacle grew by 8.9% this quarter. However, it’s a choppy business, and there is little evidence that it will continue to show the same growth rate in the coming quarters.
Future growth driver -2: Consulting
Consulting, in some ways, is at the core of Infosys new strategy. It commands better pricing, and sometimes it will lead to more business. It’s an area that Infosys wants to grow, and the recent acquisition of Lodestone came out of that intent. At one level, there was good news there. It grew by 15% this quarter - and even if you take Lodestone out of equation, it grew by 8% - and the contribution from consulting, system integration and packaging is up too. While it's good news for the quarter, it's not clear if it's a secular trend, especially when you look at these numbers in the context of what the management has said about demand situation in general. (The world is exactly what it was: Shibulal)
Core business: Application development and maintenance (ADM)
ADM is Infy’s core because it’s mature, and it accounts for over 60% of its revenues. In Q3, it grew slower than in it did in the previous quarter. Pricing dropped by 3.5%, Rajiv Bansal said.
In short, if you strictly go by numbers, except for one or two bright spots, there seems to be no evidence that its new strategy has started working. We have to wait for some more quarters to draw any conclusion.
What do the leaders say?
Infosys press conference on Friday was unlike any other in the last several quarters. The smiles were back. There were jokes. There seemed to be a sense of relief, and top management seemed to be less defensive. Earlier that day, V Balakrishnan pointed to CNBC that they were smiling, and indeed that seemed to be the overall mood.
However, a granular view presented a different picture.
The positive comments mostly came from the contenders to corner office: BG Srinivas, Ashok Vemuri, V Balakrishnan and Stephen Pratt. They all had a reason to smile. Europe, a difficult market now, had done particularly well. (BG is in charge of it). Manufacturing is seeing a revival in US (Ashok Vemuri is in charge). India business, which was lagging, has done very well (and so has Finacle and BPO) after Bala took over. Consulting did so well that it reversed a rather steep decline in pricing, and Pratt had every reason to smile. (And the impending vacancy in the corner office gives them a strong incentive to sound confident.)
However, chairman KV Kamath, CEO Shibulal and CFO Rajiv Bansal painted a more nuanced picture.
KV Kamath in an interview to ET NOW:
Confidence does not go up by one quarter's results. It goes up with effort put in over a period of time. And effort has been put in for the last three-four quarters and some visible fruit is being seen now. We need to ensure that it continues to the future and that will be the endeavour of the board. (Watch the full interview)
Shibulal in Q3 earnings call:
The world is exactly what it was, there is no [singular] change in the world. And I am sure you are aware, all are aware of this. The U.S. uncertainties continue. In fact in financial services alone, I was reading reports which said that there is an over-employment of 60,000 people. And we have seen layoffs in multiples organizations. If you look at Europe, the sovereign debt issues are continuing. So our clients’ confidence has really not changed. Even though they have cash, their confidence has really not changed too much, which means that their ability to invest for long term programs, ability to take quick decisions, and their ability to even ramp up on decisions where they have taken -- cases where they have taken decisions, is still low.
So we remain quite cautious at this point. Even if I look at next year, .. we expect the budget to be flat or marginally down. We expect it to be more than marginally down in certain segments, like FSI. And we also expect that even after the budget closes, there will be scrutiny of the budget while it is being spend on a quarter-on-quarter basis. So we have done well in Q3. We remain quite cautiously optimistic.
Rajiv Bansal in Q3 earnings call:
The business environment continues to be challenging. The clients are still not very confident about spending anything in the longer-term investments into the IT. I think a lot of it would depend on how the economic environment of the country is, how the consumer confidence index is and how much confidence it gives to the corporates in this money. So I think the environment remains challenging. The clients we have – though the RSP activities have picked up, the deal volumes have picked up, but the deal closure times are still very long and the decision making cycles are actually much longer and goes multiple levels for approval. So that continues and that is a reason it's very difficult to forecast and predict numbers on an accurate basis at a very short period of a quarter.
In short, their comments are not too different from what they have been saying during the last few quarters. There are bright spots, but the primary concerns haven't changed.
So, what explains the jump?
As far as I can see, there are two reasons. First, Infy's stock got hammered through last year, and in that context, it might be making some recovery.
Second, Infosys set the expectations very low during its meetings with brokerage firms. (Or so the analysts felt.) After talking to Shibulal / Rajiv Bansal as recently as first week of December, analysts from Barclays, Nomura and UBS went back thinking that Infosys might miss its guidance. A day before the results, every newspaper article I read was pessimistic. Our brains are wired for what behavioral scientists called anchoring. With low expectations, even average performance seems good.
In short, the stock market reaction says nothing about Infosys 3.0. But then, quarterly results can reveal only so much about a company's long term future. To get a better sense, we have to watch what Shibulal and his team are doing now.