Why Infosys reduced its revenue forecast for 2016-17

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Bengaluru: Infosys Ltd surprised many in April when it set an aggressive revenue growth target and said it could grow by as much as 13.8% in the year ahead. After all, India’s second largest software services exporter has traditionally been a company that prefers to under-promise and over-deliver.

It emerges that the dollar revenue growth outlook outlined by Infosys in April included business from a proposed merger of drug makers Pfizer Inc. and Allergan Plc., even though the deal had been called off days before Infosys’s management set out the target, according to executives familiar with the matter.

“Yes, the merger was called off before we gave our growth target. But we remained hopeful that since a preliminary work had been done with the client, we could get additional work,” an executive said on condition of anonymity.

The findings raise questions about what really motivated the management to be as aggressive as it was. Was it because there was pressure on the company to perform?

“I don’t know if ‘pressure’ would be the right way to describe the events. I’m not part of the team that prepares the growth target. (But) you had to perform. You all were given a target that had revenue baked-in from this Pfizer deal, based on the visibility we had. And with the events then playing out, this thing would certainly have been on the mind of management, who believed this shortfall in business could have been covered from other areas,” said a second executive, who also asked not to be identified.

A spokesperson for Infosys declined to comment on the issue and on how the company prepares its annual revenue growth target. An email sent to Pfizer seeking comment last week remained unanswered.

Infosys, which in April expected revenue to grow at 11.8-13.8% this year, cut its full-year growth target earlier this month to at-best 12.3% after reporting a poor 2.2% sequential growth in dollar revenue for the April-June period, citing weakness in the consulting space.

An important reason behind this, not revealed by the management, was that it was not getting any expected new business after the implosion of the $160 billion Pfizer-Allergan deal, according to three people aware of the matter, including the two executives cited earlier.

In November, Pfizer, which outsources more than $150 million of work to Infosys every year, announced its decision to merge with Allergan.

A preliminary work of intent made by Infosys’s healthcare and life sciences unit, along with Pfizer executives, and submitted to Infosys’s corporate planning group in February suggested that the IT firm could expect “$70-$80 million new business” in fiscal year 2016-17 from the proposed deal.

That would have translated to up to $20 million of business every quarter this fiscal year.

The importance of this lost business can be gauged from the fact that the Infosys management said it lost about 1% growth, or about $25 million in business, during the April-June period, hurt by weakness in the consulting and package implementation space.

However, Pfizer called off its proposed merger on 6 April, after the US government raised some objections.

Infosys still went ahead and set out the aggressive revenue growth target when it declared its fourth-quarter earnings on 15 April as it believed it could get additional business from elsewhere. Analysts say financial prudence should have made Infosys’s management lower its growth projections when it first shared its revenue outlook for the year, days after news of the merger being called off broke.

The timing was not great.

In the first week of April, only 23.57% of promoter votes were cast in favour of a resolution reappointing Vishal Sikka as the managing director and chief executive, as a few promoters led by co-founder N.R.Narayana Murthy expressed unhappiness with the board’s decision to reward Sikka with a 55% rise in compensation to $11 million.

Sikka was given a two-year extension until 2021, a proposal which was eventually approved unanimously by the shareholders of the company.

A lower revenue translation from some of the large deals won by the company in the last year, coupled with the weakness in the consulting and package implementation space, resulted in the poor sequential growth in dollar revenue for the April-June quarter, eventually making the management cut its revenue growth forecast by as much as $140 million (from 13.8% to 12.3%).

“The situation at Pfizer was a major factor,” said Rod Bourgeois, founder of US-based DeepDive Equity Research. “But there is also more to this story. Infosys’s life sciences business experienced a whopping sequential decline of 16% in constant currency terms in June quarter. Besides the lost growth contribution from Pfizer, Infosys’s revenue also stumbled at other clients.”

Indian IT firms need to be careful in how they set out annual growth targets, he added.

“I underscore that the overall demand environment has changed for Indian IT services firms, requiring them to alter some of the assumptions that go into their forecast-related math,” Bourgeois said.

“In a nutshell, demand for traditional IT services is wrestling with maturation and more heated competition. As a result, when issuing growth guidance, IT services firms today generally need to assume that more can go wrong and that fewer upside surprises are available to offset things that go wrong,” he added.