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Outlook for Infosys: Still "a Marathon not a Sprint"?

Infosys reported Q2 FY15 results today and new CEO Vishal Sikka took the occasion to share his strategic vision for the company. Sikka is quite an orator, for example declaring his aspiration for Infosys to once again be a bellwether of the IT services sector, and to achieving above average topline growth and margin.

Anyone who was looking to learn something more about Sikka’s long term vision for the company beyond what he has already been communicating consistently throughout the 70 days since his appointment might have been disappointed. Innovation features highly, with automation, AI, design thinking, employee training & development, and strategic partnerships as key levers to becoming a “next “generation services company” (see here for some of the key messaging, as shared in an analyst event in Berlin a few weeks ago: http://research.nelson-hall.com/blogs-webcasts/nelsonhall-blog/?avpage-views=blog&type=post&post_id=273). There was a little more flesh on the bone, but not much – to reiterate, we are just 70 days into his tenure.

What did Q2 results reveal?

  • One positive was the 429 y/y bps improvement in operating margin: even though a lot of this appears to come from currency management, operational efficiencies are also having a positive impact
  • And utilization is also picking up, now at 75.2% including trainees, 82.3% excluding (an all-time high for the company)
  • TTM attrition is now over 20%, though management highlighted the attrition rate each month is improving. Infosys has implemented a number of initiatives to retain talent, including promoting ~12,000 employees during the quarter and a 100% quarterly bonus (the first time in 16 quarters). We should expect to see TTM attrition rates start to come down from next quarter
  • Topline growth is less convincing: it was the fifth consecutive quarter of decelerating CC constant currency revenue growth, and the 6.5% reported growth is below the company’s FY15 revenue guidance of 7%-9%.
  • The service line revenue engines continue to be testing and infrastructure services, which together accounted for 43% of the $135m in incremental revenues – with traditional ADM activity accounting for another 33%
  • In contrast, PPS and Software (which are a central plank of Dr Sikka’s vision for thr future Infosys) both saw revenue declines. And after another disappointing quarter, there has been a leadership change of the Finacle business unit
  • By vertical, manufacturing continues to be a major revenue engine, (contributing over a quarter of the growth this quarter) but the growth is now down to ~7%, when it has been delivering double digit growth for years. And the other revenue engine, BFS, also delivered its weakest  y/y topline growth for some time (since Q3 FY 13)
  • New signings included seven large deals with a total contract value of $600m – not a particularly strong quarter. And there is no significant growth coming out of the top 10 clients
  • The Infosys Board has recommended a 1:1 bonus issue of equity shares and 1:1 stock dividend of American Depositary shares to increase liquidity

What now at Infosys?

Clearly, Dr. Sikka intends to leverage his own interest areas and his contacts from the likes of Stanford University (which has been a hotbed of research in AI and DT).

In the short term, expect to see an increased focus on the application of automation and even AI to each service line to improve productivity. In some activities, for example, in application development, he anticipates dramatic improvements in developer productivity. But, of course, this will serve ultimately to depress pricing… the pressure on margins will never go away.

These types of initiative will not in themselves ultimately be a differentiator for Infosys – highly automated processes will become table stakes within a few years. Future differentiation will come from the development of new offerings, and here the application of DT to define future offerings could potentially be a significant factor.

We have to wait until next April (and Infosys’ FY 15 results) before Infosys reveals more about its capital allocation strategy – although Dr. Sikka has indicated several times that inorganic growth will be a key plank of the growth strategy. And Infosys has the cash: cash and cash equivalent were over $5.4bn at end September. The indications are that the investment priorities behind any acquisition will be to bring in technology IP, rather than sector expertise. We would like to see a greater emphasis on sector and on business value coming through in the vision and positioning statements.

Evident already is an increased emphasis on partnerships, with Infosys recently announcing agreements with Microsoft, with Hitachi, with Huawei (see separate blog), and expanded partnerships with Oracle and SAP. And the drive to develop relationships with tech start-ups is a new kind of initiative for Infosys, which has traditionally preferred the home-grown approach.

There is also an ongoing drive to revitalize sales and marketing, in reskilling and also in sales operations management. It is noticeable that Infosys is not seeing growth in its top 10 accounts at the moment. And Infosys has been hiring sales people (around 150), including from U.S. business schools.

Will we see more external hires like that of Michael Reh in an attempt to revitalize weaker performing service lines or verticals?

Several years ago, SD Shibulal referred to” a marathon not a sprint”. We are still being asked to take a long-term view; Dr.Sikka says: “the results will take some time to achieve the meaningful impact … we are going to get there incrementally”.  

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