Date:16/10/2005 URL: http://www.thehindubusinessline.com/bline/iw/2005/10/16/stories/2005101600760900.htm

Back Infosys: Buy

Krishnan Thiagarajan

A ROBUST double-digit revenue and earnings performance for the second quarter has strengthened the fundamentals of Infosys Technologies and set the stage for an improvement of its valuation. Based on the revised per-share earnings guidance for FY 2005-06, Infosys trades at a stiff price-earnings multiple of 29 times, practically in line with the projected earnings growth for the year.

Though the second half of the fiscal is traditionally stronger for software services companies, the scope for substantial revision in earnings is restricted to the fourth quarter as the third quarter has relatively fewer working days . Even in the fourth quarter, the revision in earnings will hinge on the strength of the sequential revenue growth, which is projected at 4.5 per cent.

Unless that jumps to double digits, there may not be a material impact on the per-share earnings guidance for the fiscal. Between Infosys and Tata Consultancy Services, the risk-return equation continues to favour the former, despite the differential in price-earnings multiple. Our preference for Infosys stems from the following positive factors:

Services portfolio and margins: In a buoyant demand environment, the ability of Infosys to penetrate and cross-sell into new service offerings that span engineering services, consulting, BPO and systems integration will be fairly high.

For Infosys, these services (including package implementation and testing) already account for 30-35 per cent of revenues; the growth potential from these services will be stronger. As some of these services also enjoy higher margins, they are expected to provide greater cushion for Infosys to maintain margins and reinvest additional operating profits into newer businesses or markets.

Client composition: The change in the composition of the top five/ten clientele and greater selectivity in client additions are likely to work to the company's advantage in the coming quarters. After two relatively muted quarters for the top five clients, the growth from this segment is expected to power Infosys' performancein the remaining quarters of this year.

In addition, a steady increase in the average revenue per client and movement of clients within the different revenue brackets, starting from $5, 10, 20 and 40 million continues to be encouraging.

Cash chest for disruptive moves: With cash and cash equivalents of nearly Rs 3,800 crore (over $850 million), Infosys is better placed than its frontline peers to react to any mega acquisition moves by any frontline multinational (MNC) or Indian company.

As some of the outsourcing majors, primarily in the US or Europe, such as Atos Origin, Unisys, Bearingpoint or EDS have been slow in building up offshore scale, they may make some aggressive acquisition moves for top or second-rung domestic players.

In this backdrop, Infosys is also slated to face a couple of key challenges:

Headcount build-up: Going by the aggressive hiring patterns by Infosys in the latest quarter, the year-on-year billable employee growth at over 50 per cent has run significantly ahead of the revenue growth at 31 per cent.

While this reflects the expectation of sustained growth momentum, any economic slowdown or unanticipated geopolitical development can leave Infosys vulnerable to a sharp decline in bottomline.

Competitive intensity from MNCs: As MNC players such as IBM, Accenture and even smaller ones such as Sapient or Keane build scale in their Indian operations, the competitive intensity is likely to side for business from new clients and put greater pressure on billing rates than in the past.