Bellwether tag still some way off for Infosys

In fiscal 2001, around the time the dust of the dotcom explosion had started to settle, Infosys Ltd reported revenues of $414 million. Tata Consultancy Services, which was then still a division of Tata Sons Ltd, had revenues of around $670 million, or about 60% higher than Infosys.

Both have had their share of ups and downs since. In Nandan Nilekani’s five-year term as CEO, Infosys shrank the gap with TCS considerably. By FY09, TCS’s dollar revenues were only 29% higher than Infosys. TCS’s golden years, on the other hand, started in 2009, when N. Chandrasekaran took over as CEO. By FY15, it had widened the gap, and its revenues were 77% higher than those of Infosys.

Infosys’s market share losses vis-a-vis TCS stopped ever since its founders vacated the CEO chair in 2015, and in the past two years, it has even gained market share at the expense of TCS. In fact, by the end of the current fiscal, TCS’s lead over Infosys in terms of dollar revenues is estimated to be around 60%, back to where it was 20 years ago.

With things coming back full circle, and the momentum with Infosys, there is talk of it becoming the bellwether of the industry, a status it enjoyed until the global financial crisis. “Infosys is becoming the bellwether again,” Nandan Nilekani, chairman of Infosys, told Business Standard last week.

But hardly anyone is convinced.

“If being a bellwether means having momentum in terms of growth, then Infosys can claim the tag. However, there is a lot more that goes into being an industry bellwether, and it is premature to ascribe this status, given where various other parameters are,” says an analyst with a domestic institutional brokerage.

These parameters include profitability, cash-flow generation and return ratios, as well as aspects such as range of services in the portfolio and geographical reach.

“A bellwether also defines the agenda for the industry; it identifies trends early and has a dominant voice share in determining how the industry is shaping. These aspects are more relatable with TCS than Infosys,” says the analyst.

To start with, there is the aspect of profitable growth. Here, TCS clearly comes out tops. In FY01, its operating profit was about 40% higher when compared with Infosys. The loss in revenue market share until FY09 was also accompanied by a sharp decline in margins. Despite lower revenues, Infosys ended up with earnings before interest and tax (Ebit) of about $1.4 billion in FY09, almost the same as TCS. But things have changed significantly since.

In FY20, TCS’s operating profit of $5.4 billion was exactly double the profit reported by Infosys. And while the gap is expected to be cut by Infosys this year, the fact remains that TCS’s record in posting profitable growth has been better in the past 20 years.

Besides, with regards to the critical return on invested capital (ROIC) ratio, TCS leads Infosys by a mile. Its ROIC has been steady at 35% in the past two years, while Infosys’s return ratios were far lower at 25%. And while Infosys converted about 15% of revenues into free cash flow in the past two years, in TCS’s case, this ratio stood at over 20%.

While the TCS growth engine has stuttered a bit lately, investors value the above metrics and still see TCS as being more consistent on an overall basis.

Analysts also say that there is much more to being a bellwether than just having better growth or better financial ratios.

“One big reason TCS still has a rightful claim to the IT bellwether tag is that it has a more complete shop. Geographically, it’s far more spread out, and has a formidable presence in a number of service lines,” says another analyst, requesting anonymity. This means TCS has a larger addressable market. Infosys, on the other hand, is seen as a laggard, looking to close the gap in areas such as digital services and internet of things (IoT) engineering services. TCS also has a large products and platforms business, with proven ability to close large deals in this space. “While Infosys has done well lately, it is largely closing the gap with TCS in some key areas, rather than breaking out in new technology areas. That isn’t the mark of a bellwether,” says the analyst.

Also note that even though Infosys shares have outperformed sharply this year, it still trades at a meaningful discount to the sector leader. TCS trades at roughly 30 times estimated FY21 earnings, while Infosys trails with a 25 times price-earnings multiple. Who knows, with another year or two of outperformance, Infosys may command relatively higher valuations; although it will still be a while before it can claim the right to be called the industry bellwether.