Is margin fixation costing Infy dear?

IT bellwether Infosys’s dismal performance last quarter throws up many questions, the primary one being whether there was more to it than just weak global macroeconomic conditions.

Many believe the company is sacrificing a bit too much to chase healthy margins. For instance, despite having a 35,000 hiring target for this year, which is much lower than last year’s 45,000, Infy’s reluctance to roll out April hikes has raised many eyebrows.
Many Wall Street brokerages see it as an attempt to correct its utilisation level, which has dipped to low-70s, by driving up attrition. They even warn of the hazards involved in following such a strategy.

“With the utilisation rate at 73%, there seems to be a desire to force higher attrition (by not going for wage hikes), although that can result in adverse selection,” said David Grossman and Nicole Conway, analyst with Stifel Nicolaus.

They say the decision could reflect lack of confidence in the pricing environment and a wage structure that is already elevated relative to the industry.

Jesse Hulsing & Rob Owens, analysts with PacificCrest, shared a similar view in their note to investors on Friday: “Given that Infosys is not planning wage hikes this year, we would expect increased attrition from salespeople, who are not winning major deals anyway, as well as from the development group. With margin overhangs remaining, Infosys finds itself between a rock and a hard place.”

Dipen Shah, head of fundamentals research, Kotak Securities, sees it as a move to emerge stronger on the margins front.

“Correcting bench size, when business is not as good, by recruiting less to improve utilisation is a common thing. Companies use it as a lever to improve margins. Infy’s policy of focusing only on margins and quality growth has eroded its market share. They are trying to sacrifice short-term growth to emerge stronger in the future with high margins — a policy decision that they had taken a few years earlier as well,” he said. 

Worse, Pacific Crest’s Hulsing and Owens suggest Infosys isn’t exactly in a position to safeguard its margins. “Infosys is well-entrenched in many large clients, but has recently faced execution issues both in penetrating current accounts and expanding its global account footprint. To reaccelerate growth, Infosys will likely need to become more competitive both on the sales front and with pricing. This could drive margins down.”

Interestingly, Infosys’ strategy of chasing higher margins has not resulted in the desired outcome as the last quarter saw margins slip further to 29.8% from 31% in the December quarter.

The CEO of a mid-cap IT company, seeking anonymity, said the results and wage hikes announced by rivals will decide whether or not there will be a mass exodus of employees from Infosys.
“The company’s image has definitely taken a beating when they announced no hikes for employees. It needs to prioritise employees over shareholders,” he said, adding, “it surprising that despite having so much cash in hand, the firm shies away from taking risks. With this attitude, local as well as global players will soon take away their share of pie”

However, Jigar Shah, head of research, Kimeng Securities, believes lower hiring and no wage hikes has more to do with growth — since there has been slow growth in the last quarter while US is declining.
“The 8-10% guidance Infy has given will only become effective in the second half of the year. In order to maintain the 50-80 basis points margin, it does not make sense to hire more. It is looking more at profitable growth rather than topline growth, which other companies focus on.”
Shah fears this could backfire if growth returns as it could leave Infy short of skilled people to execute new projects. He expects the second-largest IT firm to revise its revenue growth outlook for the current fiscal in the second half in the event of US customers increasing their discretionary spends or it making a big acquisition.

Many view what is happening at Infosys as a shift in market leadership, which is gradually moving in favour of global players like Accenture, IBM and Cognizant (it is a US-based company). 
“Although our read is that the management does not agree, we believe Infy is losing market share,” said the brokerage arm of US bank Wells Fargo.

Stifel Nicolaus’ Grossman and Conway believe “the balance of power” has already begun tilting in favour legacy players.

“The implications (of Infy result) for legacy players like Accenture and IBM are less significant given their global scale, higher-end service focus and diversified geographic capacity. In fact, we believe the balance of power has shifted back to these players as the importance of domain expertise and higher-end skill sets become the key differentiating characteristics in the marketplace,” the duo noted.