Infosys founders raise concerns over governance: Should investors be worried

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Intelligence Group: The stock of Infosys came under pressure on Wednesday following news reports of governance issues raised by its founding members. It dropped by 1 per cent while the S&P BSE Information Technology index stayed flat compared with the previous day’s close.

Reports highlighted issues raised by the founders over the executive compensation, which includes the annual salary of the CEO Vishal Sikka, and severance packages given to the previous CFO Rajiv Bansal and former general counsel, David Kennedy. In addition, there was a concern whether the company would be able to meet the steep growth vision set by the CEO in the next few years given the challenging environment.

The stock has been facing selling pressure since its third quarter results declared on January 13. It has lost 4 per cent since then including Wednesday’s fall. Investors worried over the latest governance flag need to note that its severity doesn’t seem to be high enough to overwhelm the current growth challenges for the sector and for Infosys.

Infosys, the country’s second largest software exporter, reported single digit growth in the dollar denominated revenue in the past two consecutive fiscals. Given its performance so far in the first three quarters of FY17 wherein it clocked 8.3 per cent year-on-year growth and seasonal sluggishness in the fourth quarter, the company may report a single digit growth yet again for the full fiscal. This will be much lower than the growth rate of above 14 per cent until a few years ago.

In the past, the company had cited slowing traction in the large, multi-year, discretionary projects. It had also reported delay in project ramp ups. In August 2016, one of its significant clients, Royal Bank of Scotland (RBS), cancelled $300 million worth contract thereby affecting over 3,000 employees.

The current technology landscape is also prompting Indian information technology (IT) exporters to reconsider their traditional business models where the number of employees typically drove revenue growth. To their credit, these companies are gearing up to address the changing client requirements in the form of rising inclination towards new technologies such as automation, mobility, and cloud computing.

The recent rising rhetoric against H-1B visa usage in the US adds to the uncertainty. A related bill presented in the House of Representatives, if passed, will push employers including Indian IT companies such as Infosys to increase local recruitment and raise salaries of H-1B employees by more than double compared with the average pay.

These factors appear to be far more daunting and require immediate attention by the company management and the board in comparison with the governance issues raised by the founders and as reported by news agencies.

During results press conferences in the past few quarters, Sikka has mentioned achieving $ 20 billion revenue milestone by 2020 but more as an ambition or vision rather than as a financial target. The concern of founding members whether this is achievable in the current tough scenario may be apt. But, there seems to be a consideration of only the organic route of growth behind such a concern.

Infosys had over $ 4.5 billion (Rs 30,480 crore) in cash, equivalents, and current investments at the end of December 2016. It can deploy a chunk of this money to grow revenue inorganically that is by acquiring high growth businesses.

The other interesting part of Sikka’s vision is to report $ 80,000 revenue per employee by 2020 compared with $ 50,485 per employee in December 2016.

This reflects the management’s awareness about the diminishing utility of the erstwhile linear relationship between the size of the headcount and revenue growth due to rising importance of automation. In addition, the company does not want to part ways with high profitability while chasing growth. Sikka wants to push the operating margin (EBIT margin) up to 30% by 2020 compared with 24.7% in the nine months to December 2016. This means even if the management scouts for inorganic growth, the future profitability of the business to be acquired will be a critical factor in the decision making.

Investors with a long term horizon therefore may want to stay invested in Infosys given the sound management practices, agility of the business model and deeper penetration in the client accounts.