THE INFOSYS? TURNAROUND : ??HYPE OR REALITY ?

This appeared in The HT MINT dated July 15, 2016 as an Op-Ed article under Home > Opinion> Article Link

The highly disappointing Q1 results of Infosys has put the focus back on this question once again in the popular media. I continue to be amused though at the alacrity with which sell side analysts and excitable TV anchors/commentators rush to conclusions and create demi Gods out of mere mortals when the complexity of a turnaround in an increasingly complex international environment is still to be fully played out. This complex question needs to be analysed under three heads.

Firstly, an understanding of what constitutes a successful turnaround. The three phases are : fixing the structural issues ( revenue, costs and organization), turning around the morale of employees and investors, and finally successfully implementing the new business model thru acquisition of new revenue streams. Vishal Sikka can be credited with achieving the first two. It must be remembered, though, that when one inherits a humongous cash reserve of a few billion dollars, it is relatively easy to throw money at the front and middle line employees, make some acquisitions and talk up the morale thru buzz words like “innovation, Akido ,design thinking”, etc. with some feel good training programs thrown in for good measure. Also, though quick fixes to spur revenue growth so far has been commendable, it has been achieved almost entirely from mining existing customers….which usually is the low hanging fruit after a management failure in any organization of the proportions we witnessed during Shibu Lal’s tenure. However, the strains of pulling up revenue in the last two quarters is now apparent : the true test that the turnaround is sustainable will be based on revenue growth from new services / customers based on definitive business model changes. This is yet to happen and, though Sikka put up a brave front, it is doubtful if the fruits of all his initiatives with respect to this crucial aspect will be evident in the current financial year.

Secondly, the enormity of the challenges facing the IT industry affects Infosys too. These relate to the confluence of four tectonic shifts to our business models and potentially threatening the prime sources of India’s competitive advantage : cloud based services, technological changes, resistance to immigration and global economic uncertainty precipitated by a negative interest rate regime. It is well documented in the annals of management history that the three most significant factors in the inability to navigate periods of disruptive changes are : complacency bordering on arrogance of hugely successful companies with large cash reserves and high margins ; focusing management time away from the pressures of operating the highly lucrative legacy business ; and the misalignment of the CEO’s incentive structure with the need to create a new business model vis a vis continued profitability and EPS growth. Celebrated examples include Kodak, Nokia and Digital Equipment ( where I was directly involved in such a failed transformation ).

Infosys pretty much reflects these realities too. Given all this uncertainty and the enormity of the challenge, I was very surprised that Sikka chose to provide a hugely bullish full year guidance less than 3 months ago. This led to a bull charge on the stock, a rerating by all institutional brokerages and a media frenzy on his “leadership” in “turning around” Infosys. Then, suddenly he “cautioned” the investors 45 days later of some possible volatility ! And dropped the guidance today by 1.5% !! I had written of my skepticism when all this was playing out over the last few months. And this leads me to the third point which is pretty fundamental.

Has the character of Infosys changed from what was painstakingly built by the founders led by legends like Narayan Murthy and Nandan Nilekani , and spawned the dream of an entire generation ? They believed in under promising and over delivering : the key mantra for Infy’s premium valuations and credibility in the bourses. The entire international community used to hang on to every word of the famed Infosys guidance as an indication of the state of play for the IT industry. Not so today. In my opinion, even the reduced guidance of 10.5% to 12% provided today will not be met by the year end as it implies a QOQ growth rate of 3.8 % - 4.7% for rest of the year….an almost impossible target in my view given my assessment of the IT industry and Infosys in particular. Forecasting ability is a key skill which demonstrates that the business is under control of its management. This requires immense coordination and depth of understanding of each customer engagement in totality right down till the grassroots, and a judgement of various macro and micro trends at the CEO/CFO level. It is an ability which was honed to perfection in Infosys due to the untiring, conservative leadership of the NRN, Nandan and Mohan Das Pai combine. With an almost total replacement of the erstwhile top and senior management team ( dangers of a management style I had alluded to in Oct 2015) , coupled with the flamboyance associated with Sikka, I am not surprised that this ability has been the casualty. As someone who has managed this in almost my entire career, I can say with confidence that efficient management teams do not have a better crystal glass : it is solely their ability to be honest, conservative and retain a tight control of the business drivers which helps in the generation of a credible forecast and thus project the confidence of a “tightly run ship” to the investors. And being a key skill impacting credibility, apart from Cognizant, none of the majors provide a full guidance ….Wipro, HCL, TCS included.

 Infosys needs a leadership style honed in the basics to succeed through this difficult period where navigating the rapid rate of change is the main challenge ; it has a distinguished Board but, most being from a non technology background, I guess their reliance on Sikka is total and their focus is on the usual financial metrics and incentivizing type of interventions : Infosys will be well served if the Board uses the expertise of the legendary Ravi Venkatesan,ex Chairman Microsoft India and its only technology member, to the fullest in guiding the management make this strategic shift.

(PRABAL BASU ROY)

Prabal Basu Roy is a Sloan Fellow from the London Business School and a Chartered Accountant: the writer presently manages a PE fund and has formerly been a Director and Group CFO in various companies.

Come and join me on Twitter.com @PrabalBasuRoy

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UPDATE ON JAN 31, 2017 : This is an update after 7 months of writing the above article where I had hinted at a top in Infy at Rs. 1130 ( Mkt cap : $ 40B ) based on my hypothesis as written. Some had commented on the wisdom of the above and I had reiterated that as investors I have no luxury of hindsight to decide....however, as analysts or critics we do have that luxury of hindsight.

Today the price is Rs. 928 ( Mkt cap : $ 31B ).....as I had said in the article, stripped of all the noise, this is the only metric which matters !