Apr 12, 2013 05:55 PM IST | Source: CNBC-TV18

Infosys caught on wrong foot on margin fixation: Bhasin

Disappointment was shown by many on Infosys' fourth quarter results. It reported 6-10 percent top-line growth guidance for FY14, which was lower than what the street had forecast. Rahul Bhasin, Baring Private Equity Partners said that it will be unrealistic to expect the historical growth.

Infosys shares fell 21 percent to close at Rs 2,295.45, the steepest single day fall in a decade, as a wave of earnings downgrades appear imminent after the tepid 6-10 percent revenue guidance for FY14.

Rahul Bhasin, Baring Private Equity Partners said that it will be unrealistic to expect the historical growth from the IT major going forward. "I think the industry is matured and one cannot see systematic quarter on quarter (Q-o-O) growth in a predictable manner", he added.

According to him companies like Infosys face the challenge of the most favoured nations' clause. However, he adds, Infosys is a solid company, only at this moment they seemed to find themselves in a strategic logjam.

He believes that it is too early to call it either victory or defeat. Over five year period he sees the Indian IT industry in the growing trend.

Below is the verbatim transcript of his interview to CNBC-TV18

Q: Bad day for the market and lead by Infosys. You have been tracking IT space in India for long now. Do you think it is companies specific problem or do you sense that the story is going a bit wrong?

A: We as a system use to extraordinarily have high growth rates because of industry which over the last decade or so has gone through its hyper growth phase. I think the industry is matured and you are not likely to see this systematic quarter on quarter (Q-o-O) growth in a predictable manner.

If one looks at the underlying driver of the software industry and why service is something which keeps growing and why there is demand, it all goes back to Moore’s Law where every 18 months the processing capacity of a chip for the same cost doubles effectively. That doubles the operating layer and on top of it can do with refinement, the ability to handle data goes up proportionately.

One has various applications, which are not possible practical in the past which suddenly becomes practical. So, one has this entire instability engine right at the base of the software industry and that hasn’t changed. This means that the need to go on modifying applications etc in companies and even for entertainment or for social media etc that will keep changing and will keep throwing up opportunities for growth.

I don’t see the fundamental drivers changing. It is just that the size and scale that a lot of the Indian IT companies are at today, it will be unrealistic to expect the kinds of growth that one has seen historically.

Two, if one looks at global growth, it is still a little sclerotic. You are with the debt overhang in most of the developed world. It is something which is going to be a slow growth. Therefore, corporates spend ultimately will reflect gross domestic product (GDP) growth at some point. That will ultimately mute this growth overall.

However, one will still have it. I think over any five year period or sometimes it is a safe bet to assume that the Indian IT industry will keep on growing.

Below is an verbatim transcript of the interview on CNBC-TV18.

Q: We nevertheless heard a lot of positive voices on the business front saying that the industry environment has definitely improved in the developed markets in terms of demand for their businesses. Did they speak too early? Are you getting a sense that the industry itself perhaps is not going to grow as well as it thought?

A: It is too early to call either victory or defeat. The real issue is that most of the Anglo-Saxon world at least is holding up growth largely because of various monetary and fiscal stimuli. When one sees some of that being in some way contracted, one will see this growth coming off. One will see these spurts of growth then slowdown, spurts of growth slowdown, so get used to it.

One is not going to see this predictable linear kind of growth. You are going to see corporate confidence in spending suddenly spurt and then slowdown. So this is going to be a pattern, which is going to repeat itself going forward. Fundamentally, you will have growth, but it is not going to be as exciting as it has been historically.

As far as TCS etc. there is a business strategy issue also. In Infosys’ case they have gotten caught up in trying to retain a certain margin profile historically. That margin profile has given them on a business front a return on capital of over 100 percent.

It was sustainable right through the hyper growth phase, but when the industry is maturing Infosys will need to make trade-offs. Challenge that companies like Infosys have is that typically a lot of these companies have what is called the most favoured nations'clause.

This means that we give a price break to one customer, you will have to give it to all, so they are often reluctant to drop the price. They have got themselves caught up in a bit of a warp there. They will evolve. Infosys is a solid company. I just think that at this moment they seemed to find themselves in a strategic logjam.

Q: In sector you have investments in two listed stocks Manappuram and Muthoot. It would be cheaper to buy it from the market. So this trend does not seem like dropping for the simple reason that gold prices have been falling. How would you look at the business itself for 2013?

A: Indians have as much of their savings in gold as they do in financial instruments. The banking system effectively addresses only a one-third of the population. Two-thirds have never had access to the banking system. The rich hedge themselves against inflation through buying real estates. The poor and the middle class in this country have hedged themselves against inflation by buying gold.

Therefore, the stock of gold gives an idea of where the wealth has been and how people have protected themselves historically and not ascribing a value judgement to that gold. Clearly, if there was instrumentality and access available into the financial market that would be better or the economy.

However, history tells us that has not been the case. In that context if one looks at these companies Muthoot and Manappuram, it has through process innovation, systems, risk management created an incredible franchise. If one looks at the number of transactions, which both these companies do on a daily basis, it is more than what State Bank of India (SBI) does.

If one looks at the collateral, what people do not realize is that the collateral is very liquid. If you were lending against trucks, for example if one repossess a truck it is still very difficult to liquidate and lot of companies will end up with that as stock even if one wants to repossess or mortgage. It is not easy to do it, it’s a lengthy process.

Their underlying security is actually very liquid. Will this loss in this thing make an impact, it will on the margin. One will always have some percentage of people who are unable to repay.

However, that is true in any lending business. It is just that the way that these companies have had their accounting standards prescribed that is evolving and adapting to the market.

Q: At the end of the day the point is that the stock is back to where you made your first investment, down about 40-50 percent. Does it become a buy again at current levels or would you say that maybe the story has changed?

A: We have done our homework and we have already bought more stock.

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