Problems Faced by Infosys

Dismal Numbers
Falling numbers Infosys has been delivering disappointing results for some time now. The second quarter earnings for 201213, despite being in line with expectations, failed to enthuse investors. Besides, the company's outlook of 'cautious optimism' for the rest of the year does not paint a good picture. The company has pared down its EPS guidance for 2012-13 to Rs 160.60 from the earlier forecast of Rs 166.46 in the June quarter, due to wage hikes and rupee appreciation. Ankur Rudra, analyst, Ambit Capital, says, "The company continues to lag behind its peers. The cut in EPS guidance is disappointing."

The Game of Thrones

Churn at the top More than the numbers, it's the string of high-profile exits from the company's top management that has been disconcerting for investors. After the departure of Nandan Nilekani and Narayana Murthy, Infosys has witnessed a continued drain of top executives. These exits have exacerbated the company's problems and led to uncertainty regarding its direction and execution. Given the unstable management, Infosys faces a crisis of confidence among investors.

Competition
Strong competition The company has visibly lost its edge over the competitors. Its market leadership position has long been usurped by the current IT bellwether, Tata Consulting Services. Snapping at its heels are smaller, mid-tier players, such as HCL Technologies and Cognizant, which are growing faster than it. At the core of Infosys' problems is a sustained loss of market share in its bread-and-butter application development segment. The loss of market share in the traditional business is a worrying sign for any company.

Adamant Model
Rigid business model Ironically, the business strategy that defined the Infosys success story in the past seems to be playing a part in its undoing. Over the years, Infosys has operated with an unwavering focus on projects that yield high margins. This premium pricing has allowed it to maintain a higher EBITDA margin (around 30%) than any of its peers. However, this rigid pricing policy has been followed at the expense of signing new deals since clients now lay more stress on value proposition in a bid to reduce costs amid a prolonged slowdown. Still, there have been indications that the company is softening its stance on pricing.

High Cash Reserves

Underutilised cash Another gripe with Infosys is its reluctance to part with the overflowing cash reserve for strategic acquisitions. Its conservative approach towards inorganic growth has led to a cash pile of about Rs 22,800 crore. Recently, however, Infosys has shown willingness to make better use of its unproductive cash assets when it acquired Swiss consulting firm Lodestone for Rs 1,932 crore. However, this deal is not significant enough to have much of an impact on the company's earnings. It remains to be seen if Infosys will dip into its cash pool for more overseas acquisitions to retain its premium position.

Low Industry growth rate

Stagnating industry The problems facing Infosys are not entirely of its own making. The IT industry has been going through tough times due to the economic uncertainty in key regions of the US and Europe. This is also responsible for Infosys' troubles since the company derives 80% of its revenue from these two regions. However, it has managed to sign six big deals in the previous quarter, which could point to early signs of demand recovery.

What lies ahead(solutions and recommendations)

Infosys is in the middle of a significant transformational exercise, both in terms of its business model and organisational structure. On the one hand, it is moving towards a non-linear growth model, which is already the norm among its peers. On the other, it has undergone a restructuring exercise, wherein it has consolidated businesses into three service linesconsulting and system integration, products and platforms, and business operationsto aid its transition to a consulting firm. It is difficult to predict whether the company can execute its vision for the future, but experts concur that it will soon show an improvement in performance.

 Dipen Shah, head of PCG research, Kotak Securities, is optimistic about the company's prospects. "Infosys is showing a willingness to change, which is a positive sign. Though the macro scene is strained now, the company should clock better numbers down the road," he says. Adds Abhishek Shindadkar, analyst (IT), ICICI Direct: "The transition period is taking longer due to the tough environment. Over time, the company should revert to historical growth rates."

 While investors may find current growth rates of peers like TCS and HCL Tech more attractive, these stocks have already seen a surge in their valuations. Most of the negatives around Infosys seem to be priced in.