Jul 02, 2013 03:53 PM IST | Source: CNBC-TV18

Earnings reset likely for Infosys: Cowen & Co

Moshe Khatri, Cowen & Co expects the US Immigration Bill to have significant impact on the Indian IT sector.

The Immigration Bill passed by the US senate recently will have a significant impact on the Indian IT sector, says Moshe Khatri of Cowen & Co. Speaking to CNBC-TV18, he says, one of the provisions in the Bill could be consequential and disruptive to the Indian IT sector if it goes through in its current form.

Also Read: H1-B salary rise clause will hit Indian IT cos hard: Nomura

On Monday, Morgan Stanley said that Infosys may lower its revenue guidance for 2013-14 to 4-6 percent, from its forecast in April of 6-10 percent. Khatri, however, does not see any significant margin degradation. "But you could see some revenue and earnings reset in Infosys' at least for the next few quarters given some of the things that are going internally," he said.

Below is the verbatim transcript of Moshe Khatri's interview on CNBC-TV18

Q: What are you hearing first in terms of demand trends and whether it is likely that some of the Indian IT companies may actually talk about a slippage both in guidance and the demand that they expect to see?

A: Assuming the concern emanating from Accenture's results last week, I want to focus couple of minutes on that. The other thing that’s very relevant to what happens to the sector is immigration reform. If you look at the Accenture's numbers last week, they were unusual and also a second quarter in a row that had revenue reset.

The mess seems to be coming predominantly from 5-6 percent of the revenue base and that includes revenues that are generated from Brazil, Japan and southern Europe. I think that’s very relevant because if you look at most of the tier-1 offshore vendors that are based out of India, their exposure to those areas is minimal.

Secondly, Accenture also went through a revenue reset and in their case it seems like some of the smaller consulting like deals are still elusive or are not converting the way they should into revenues.

From a fundamental perspective, if you look at some of the larger verticals that are relevant, North America was very strong for Accenture for the second and third quarter in a row, Continental Europe remains in pretty decent shape. So if you isolate some of the issues that Accenture is going through, at this point, fundamentals are still reasonably okay. What's also very relevant is what's going on with the Immigration reform bill, which went through a final senate recently.

The bill has one of the provisions that could be consequential and disruptive to the sector if it survived the final bill. I am stressing the word 'if' because we don’t know exactly what happens with the house and the bill specifically focusing on what we call outplacement restrictions. This means that if you are a visa dependent company or considered a visa dependent company, you will not be allowed physical access to your client’s permissive. It is very unusual but that’s the proposed law.

Real question here is whether this noise is causing any disruption in terms of new awards for some of the tier-1 offshore vendors. That’s the most important thing to focus on and will impact fundamentals if that actually happens. We are not looking for any significant revenue reset for the group maybe with the exception of some outliers, maybe Infosys, but on the other hand, we have to look at what happened with the noise that this immigration reform bill is creating, because this will be pretty significant and disruptive for the sector.

Q: It did not look like noise but the vote went in with a 68-30 kind of margin so it looks like it had an overwhelming majority. What are the chances that the house actually considers water down version of that bill? Do you think they are going to go with what the majority of the House of Representatives felt which was that the bill was okay in its current form? How soon will we have clarity on this issue?

A: The good news is that some very influential republicans at house are already suggesting that this bill is going to be what they call dead on arrival. In fact a couple of weeks ago, there was another foreign bill that went through with an overwhelming majority by the senate in terms of the bill and then was voted down at the house. If this is the kind of replay of what happened with the foreign bill, we could see that bill either watered down or not even getting the vote.

The senate wanted to get to a majority vote of 70, they felt they got to that 70 level which is making the House of Republicans feeling a bit better and on top of that again it just seems that it is not going to go anywhere at least in the near term at the house. Therefore, that seems to be more positive than negative for the sector but this is politics and a lot of things can change and is very dynamic. So, this is changing very quickly, there could be some ups and downs.

One should focus on what clients are saying and doing. We know some of the large users of this sector in the US are tracking this very closely. They have some contingency planning and it will be interesting to see is if there has been any change to deal award. We haven't heard about this but this is something that we need to track and can go on for the next 6-12 months.

Q: You mention that some companies like Infosys could be under the threat of lower revenues, some of your peers believe that Infosys could scale down its FY14 revenue estimates of 6-10 percent. What is your estimate on that front and more importantly, on margins, how much pressure do you think Infosys could face?

A: Firstly, there could be revenue scale down. Margin pressure, given the fact that the company is clearly changing the way it does business and it seems that they are focusing on revenue growth and potentially on the expanse of margins. You have to look at what happens to the currency in the past few months and maybe that will give you the offset that you need. So maybe you are not going to see any significant margin degradation that people are focused on or worried about and that's going to offset that.

But a lot of people are interested in trying to understand exactly how Infosys is going to change things internally, how it competes for business, how it makes the corporation a bit more agile and a bit more flexible in terms of making decisions and that will help the company down the road. But, you could see some revenue and earnings reset in Infosys' case at least for the next few quarters given some of the things they are doing internally.

Q: Do you expect this divergence in terms of growth trends and earnings performance to continue in this quarter as well where the likes of TCS and HCL Tech will continue to report good numbers while Infosys and Wipro might drag?

A: We have seen that divergence for couple of years now. We have seen Cognizant, TCS on one hand and Infosys on the other hand. I don’t think that changes anytime soon.

Q: Do you expect to see any meaningful change in the business and performance direction for Infosys with return of Narayana Murthy because that saw an initial spike in terms of interest in the stock and some enthusiasm as well?

A: We spoke to a lot of investors and they have very good things to say about him (Narayana Murthy). So there is definitely a lot of excitement on one hand, but on flip side they had to bring him back kind of shows the lack of depth in terms of the senior management that's out there and that will make those changes internally. Therefore, there is definitely an interest on behalf of the investors and a lot of hope that he will drag this company and bring it back to the industry leader level at least.

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