How should investors play the return of Nilekani at Infosys?

BANGALORE, INDIA - SEPTEMBER 1, 2016: Nandan Nilekani, Chairman of the Unique Identification Authority of India, photographed at Better Place office in Bangalore. (Photo by Hemant Mishra/Mint via Getty Images)

Madhuchanda Dey
Moneycontrol Research

Investors of Infosys will breathe a sigh of relief that the spat between the founders and professional managers did not degenerate into a long-drawn battle. With Nandan Nilekani taking over, the baton is decisively in the hands of the founders. The question that has got to be answered is, while this is good news, is it a great outcome? Can they nurture their child to the next level in a dynamic environment that the technology sector is faced with today? How should investors react to the development?

Buyback the only saviour for the small investors

The Infy stock has to be seen in the dual context of a near-term impact of a buyback and the medium- to long- term implication of founders wresting control.

We have delved in detail into the buyback. As per our analysis, thanks to the SEBI stipulation of 15 percent reservation for retail investors, small retail investors (value of holding upto Rs 2 lakhs) definitely derive a positive overall from the buyback exercise.

Will it be “business as usual” for Infosys? The answer is an unequivocal No.
Nandan Nilekani is a capable leader and he has proved it time and again in different capacities. He has deep understanding of the technological space as well. But Nilekani is unlikely to get involved in the day-to-day running of the business for long.

The ship has to be navigated by the captain (the yet-to-be-found Chief Executive officer) under the close supervision of the founders.

As we have highlighted earlier, the hunt for the ‘perfect bride’ is not going to be easy. It is going to be difficult if not an impossible task to find an external candidate who is acceptable to the conservatively minded founders, understands the culture of Infosys well and can navigate through the transformation in the tech landscape.

How quickly will the strategy be in place for “transforming” Infosys?

The biggest challenge that all IT companies are facing today is the tectonic shift in technology landscape that has rendered the low-cost IT offshoring model of Indian IT vendors increasingly irrelevant. This was an area of strength for the Infosys founders and they too will go through a process of unlearning and relearning, which won’t happen overnight.

Dr. Sikka had embarked on a transformation path labelled “new and renew” where the company was focusing on re-engineering the existing business while also devoting resources for new kinds of future businesses, which would mean products, platforms and solutions. Infosys had started seeing early success of this strategy. For a $ 10-bn plus organisation, the faster the new business ramp-up the better it is to offset the pricing decline from traditional services.

If most of the initiatives of the erstwhile management are now scrutinised then it will be an interim period of underperformance/uncertainty till the company defines and executes its new strategy.

Competitors will be quick to capitalise on this transition and Infosys does stand to lose market share in incremental businesses if not in the existing ones.

Investors have got to keep in mind that the public brawl leading to the exit of CEO Vishal Sikka (a Silicon Valley name) may have negative international repercussions for “brand Infosys”. Clients may be watchful till there is clarity on who steers the ship with what technological capability.

In the last three years, Sikka had created his team. So in the coming months expect lots of heads to roll with resultant business disruptions.

Globally protectionism is on the rise and the sector as a whole is moving away from low-skilled jobs. The hiring strategy of Infosys was therefore undergoing a major shift in recent times. The company was stepping up local hiring in client markets. Future events will show how this strategy will unfold under the new management.

So while the truce is welcome, challenges abound and the jury is still out. From a historic valuation perspective, the stock at 14.5X FY17 earnings looks undemanding. However, we do see downside to earnings estimate for FY18.

Retail investors should definitely tender their shares in the buyback. Till clarity emerges on the new management/strategy, investors have got to exercise caution with the IT bellwether.