Why Infosys has lost its IT bellwether tag

Bengaluru: Foreign institutional investors’ (FII) ownership of Infosys Ltd dropped to 34.87% at the end of 30 June, the lowest since March 2009, marking the souring of overseas investors’ love affair with the company.

Bengaluru-based Infosys has been the bellwether information technology firm in India despite not being the largest in the industry, partly because the country’s second-largest software services company set new standards in corporate governance in India, higher profitability and its scorching growth pace in the noughties and many years before that.

Tata Consultancy Services Ltd (TCS) was the biggest Indian IT firm, while Nasdaq-listed Cognizant Technology Services Corp. clocked the fastest growth for most of the last decade.

Infosys’s current attrition level of 20.6% is the highest in its history while its 23.7% profitability is the lowest, making it a daunting task for non-executive chairman Nandan Nilekani and chief executive officer (CEO) Salil Parekh to return the company to its former glory.

Still, four reasons explain why Infosys was considered a bellwether for the Indian IT industry.

First, Infosys’s higher profitability than peers on account of differentiated solution offerings always helped it earn more money. Second, Infosys was always considered to be an aspirational employer. Third, the management and board’s focus on corporate governance norms made many large foreign investors and analysts take note. Understandably, Infosys came to be the preferred bet among FIIs as they owned between 40% and 50% of the company for much of the past seven years.

However, Infosys has lost some of the sheen on all four counts.

“Behind the headline numbers, there is a bigger challenge faced by Infosys. Two of the most important ones is how can the company retain its differentiated solution offerings and retain talent,” said a Mumbai-based analyst with a foreign brokerage on condition of anonymity. “Once the company gets this sorted, FIIs will surely find merit in investing in the company. For now, it has lost its mojo or so to say the bellwether tag.”

First, management failure to invest enough in newer and more profitable technologies in recent years means Infosys’s digital practice is smaller than some of its rivals, implying the company’s operating margin is less than Mumbai-based TCS. This fiscal, Infosys outlined a profitability of between 22% and 24% even as TCS retained its outlook of 26-28% operating margin.

A year-long feud at Infosys between promoters and the board and management over some decisions has hurt the company.

The fight affected employee morale, making some analysts and proxy advisory question the corporate governance practice followed by the firm, prompting some foreign investors to trim their holding in the company.

Seven months after Infosys named Salil Parekh as CEO in January, the company continues to grapple with retaining talent as attrition in the IT services business shot up to 20.6% at the end of June from 16.9% in the year earlier. Including Infosys’s subsidiaries, the attrition rate is 23%.

Last month, a report by proxy advisory firm Stakeholders Empowerment Services (SES) argued that the turbulent times witnessed by the company over the last year hurt Infosys’s valuation and adversely affected shareholders.

Consequently, FII holdings in Infosys dropped to 34.87% at the end of 30 June from 38.31% at the end of March 2017.

A few analysts are still confident that Infosys will be able to steer through these turbulent times.

“Infosys is, by and large, pretty strong and pulling together where it counts and will benefit from Salil Parekh’s experience in the large deal climate… However, a couple of more disappointing quarters will raise eyebrows and turn off several investors who are skeptical of the market and its potential,” said Phil Fersht, chief executive of US-based HfS Research, an outsourcing-research firm.
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