The co-founder of India’s technology giant Infosys Ltd ADR (NYSE:INFY), N.R. Narayana Murthy, has returned to the company amid shareholders’ demand for a turnaround following the poor performance of the business.Starting this month, 67-yeas old Murthy becomes the new executive chairman of Infosys for a period of 5 years.
Murthy, who co-founded the software firm in 1981, was the executive chairman between 2002 and 2006 and during that period, Infosys Ltd ADR (NYSE:INFY)’s revenues quadrupled to $2.15 billion. Since 2006, he remained with the company as a non-executive chairman, but retired later in 2011 after the business has struggled due to changing market dynamics. The global economic slowdown and the cost cutting initiatives by some of its biggest clients in the U.S. and Europe were cited by the management as the main reasons behind its problems.
The overall macroeconomic environment for tech-outsourcing firms has been challenging, and very few improvements are expected in the near term. The world’s second-largest technology consulting company, Accenture Plc (NYSE:ACN), and German powerhouse Siemens have also indicated a decline in future IT spending by other firms, particularly in the U.S. and Europe. Infosys Ltd ADR (NYSE:INFY) gets more than 80% of its revenues from North America and Europe so naturally, it has been struggling.
However, despite the challenges, Infosys Ltd ADR (NYSE:INFY) shareholders aren’t convinced. As Infosys has fallen, its rivals have continued to rise. In fact, Infosys’s growth has lagged behind India’s domestic outsourcing industry average growth. Infosys is targeting a growth of 6%-10% while the Indian IT sector is expected to post an average growth rate of 12%-14%.
In last two years, India’s software outsourcing market leader Tata Consulting Services and nearest rival Cognizant Technology Solutions Corp (NASDAQ:CTSH) have easily outperformed Infosys Ltd ADR (NYSE:INFY). In last two years, from India’s IT sector, Infosys’s market share has remained frozen at 6.9%, while TCS now gets 10.7% of the market’s overall revenues, as opposed to 9.3% two years ago.
While Tata Consulting Services, which was already bigger, was getting an even greater share of the market, I believe that a greater symbolic blow came from Cognizant Technology Solutions Corp (NASDAQ:CTSH), which is relatively a newer entrant, when last year, it overtook Infosys Ltd ADR (NYSE:INFY) as the second leading Indian IT firm in terms of revenues.
Cognizant Technology Solutions Corp (NASDAQ:CTSH) is the fastest growing firm in India’s IT sector. According the research firm Gartner, the five biggest Indian IT companies posted growth of 13.3% in 2012, with Cognizant at the top with an enviable growth rate of 20.1%, far above the industry’s average.
In its most recent quarterly results, Infosys Ltd ADR (NYSE:INFY) met the earnings but missed the revenue estimates. The company reported 18.1% year-over-year increase in revenues to $1.84 billion while its net income rose 3.4% to $421 million.
Cognizant Technology Solutions Corp (NASDAQ:CTSH) has also released its quarterly results that topped the estimates. The company’s revenue rose 18% in the quarter, matching Infosys’s growth, to $2.02 billion, below analysts’ expectations of $2.11 billion but its profits rose an impressive 16.6% to $284.2 million. This translates into adjusted earnings of $1.02 per share, above market’s expectations of $0.97. Moreover, the company netted $180 million more in sales than Infosys.
Over the years, the revenue growth of both Infosys Ltd ADR (NYSE:INFY) and Cognizant Technology Solutions Corp (NASDAQ:CTSH) has fallen due to identical reasons, but over the long run Cognizant, as indicated above, has remained ahead of Infosys. Despite the current increase in Infosys’s sales, which were above market’s expectations, I expect Infosys’ growth to trail behind Cognizant’s in coming quarters.
Infosys is significantly more profitable than Cognizant Technology Solutions Corp (NASDAQ:CTSH), as shown in the graph below. But investors should note that Infosys Ltd ADR (NYSE:INFY)’s profitability has wobbled while overall, in the last two years, its quarterly profit margin has fallen by 2.2 percentage points. On the other hand, Cognizant has been far more consistent in its ability to maintain its profit margin at around 14%.
One of the main reasons behind Cognizant’s growth is its effective reinvestment strategy. As indicated above, Cognizant Technology Solutions Corp (NASDAQ:CTSH) is not as profitable as Infosys, but this is because the company has been sacrificing its margin for long-term growth by increasing its sales expenditure. Unlike most of its rivals, Cognizant has made market share its top priority; this is how the company has been operating since its inception. Some of its rise can be attributed to inorganic growth through acquisitions. It is currently planning to acquire six companies from Germany’s C1 Group, one of the largest privately owned system integrators in Germany. Like most of its domestic and international rivals, Cognizant is also making significant strides into the more lucrative consultancy and systems integration business.
The increase in market share eventually translates into improvements in earnings per share. As is shown in the picture below, Cognizant Technology Solutions Corp (NASDAQ:CTSH) has easily outperformed Infosys Ltd ADR (NYSE:INFY), which has reported declining earnings per share in its two previous quarters. In the corresponding period, Cognizant has reported more than 17.5% EPS growth.
Cognizant hasn’t been as profitable as Infosys, but it has been growing at an impressive pace and has delivered much better earnings growth. Due to its lower margins, the business is putting good numbers in those markets where others are struggling, such as Europe. Here, Cognizant Technology Solutions Corp (NASDAQ:CTSH)’s sales in the previous quarter rose 23% from the same quarter last year. When others in the IT outsourcing industry, as indicated by Accenture Plc (NYSE:ACN), are expecting little top-line growth, Cognizant is looking to outperform the market and has reiterated its full year targets. Therefore, I believe that Cognizant is a safer and far more lucrative investment option than Infosys.
Cognizant Technology Solutions Corp (NASDAQ:CTSH)’s shares dropped significantly in April due to a disappointing outlook from Infosys Ltd ADR (NYSE:INFY), but that was (and still is) an opportunity to buy the shares. I believe that Cognizant will continue with its robust growth. In the last week of May, analysts at Janney Montgomery Scott and Deutsche Bank have reiterated their Buy ratings with price targets of $90 and $92 respectively. Clearly, big things are expected from Cognizant, and analysts’ price targets show significant upside from the current price of $66.58.
Although the addition of Murthy is a step in the right direction, unlike some of the other analysts, I am not overly optimistic. It is still too early to start predicting a turnaround. Investors’ hopes are higher than ever, but the conditions won’t be the same for Murthy as they were back in 2006 when Infosys was a smaller player on the global scale. Back in 2006, the company had 53,000 employees and recorded annual sales of $2 billion; now it has a 157,000 strong workforce and sales of nearly $7 billion.
Secondly, executives such as Shibulal and Gopalakrishnan, who have been the center of the shareholders’ criticism, are still at the helm. With Murthi, there will be three executives at the top position, creating even more confusion. I hope Murthi will be the one calling the shots.
Moreover, the company’s original business model of doing back-end work is facing obsolescence, and Infosys Ltd ADR (NYSE:INFY) isn’t moving quickly enough into the higher margin consultancy operation. The time and effort the company spent on acquiring Lodestone last year has highlighted its slow decision-making process. I believe a large part of Infosys’s problems are associated with management’s risk-averse approach. Unfortunately, the leadership has preferred to sit on large cash reserves instead of distributing them among shareholders or investing in acquisitions to force inorganic growth.
Sarfaraz Khan has no position in any stocks mentioned. The Motley Fool recommends Accenture.
The article Cognizant Rises as Infosys Looks for a Messiah originally appeared on Fool.com.
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