infosys: shareholder value

Infosys is currently in news. This time it is up against its founding shareholders. They are questioning corporate governance at the company. 

After October 2014, when the founding shareholders left the company voluntarily, its affairs were handed over to the outsiders. The shareholders showed faith in the new professionals in running the company in a diligent, transparent and professional manner. The expectation was also that the new board and management will increase the shareholder value over time. 

As noted by them, after their departure, the founding shareholders did not interfere in either strategy or direction. 

There was no question of interference from any of the founding shareholders. Then there was this sloppy headline at the economic times:

However, when you click open the headline, this is what you get to read:

However, the headline coolly puts words in Pai's mouth to blame Murthy for the fiasco. It is evident from the article itself that Pai never said anything of that sort. We wonder why not do some clean reporting. In fact, Pai has backed founders in raising corporate governance issues at Infosys. 

Making significant severance payments to departing employees was not called for in the best interests of the company and its shareholders. This was the first crack. Furthermore, remuneration of the CEO not commensurate with the value being created was also questioned; the second. The remuneration committee is primarily responsible for it. 

With responsibility, there comes defense, which is human nature. Yet, not disclosing such a serious matter (excessive severance pay) in the annual financial statements was a serious breach of corporate governance. How could the audit committee overlook such an important matter?

Of course, the board is collectively responsible for this mess. 

And of course, it is a joke to bring in a legal firm to deal with the founders. 

The founding shareholders own over 12% of the business. It is only fair that their queries are addressed in a manner that is transparent and professional. The fact that their opinions are out in the open reflects how they are being treated by the board. 

I am surprised that Oppenheimer Funds, which owns 2.40% of Infosys, is not in line with the other large shareholders. What the founding shareholders have said, and what response Oppenheimer has given is another joke. The fund needs to know the difference between corporate governance and business strategy and plan. They are two different things, although one would expect the managers to have strategy that is not in fight with corporate governance. 

Of course, Infosys is the business of its shareholders. So what it is publicly listed? A 12% shareholder is a significant shareholder, not an apathetic animal in captivity.

Let's come to the management performance. Vishal Sikka took over in June 2014.

Infosys has done reasonably well in the past five years. Both operating profits and earnings have increased on a per share basis. Yet, the market value has not moved much from 2011 high.

Pai is not off-mark when he said:

It looks like the past performance was not satisfactory for the market. Clearly, market expectations are low with respect to its future performance; growth rates have reduced, and both automation and global, especially the US, trends are expected to drive down growth rates further.

Nevertheless, Sikka has grand plans for the business.

For 2016, the revenues were $9.46 b (Rs.624 b), and operating margin was 25.39%. If these targets are achieved, operating profits would be $6 b in 2020; in rupee terms, the value will depend upon the expected exchange rate. At Rs.70, the operating profits would be Rs.420 b as against Rs.158 b in 2016. Infosys was priced at a high of 17.80x EBIT and a low of 13.44x in 2016. If we take the lower value of 13x, Infosys could be priced at Rs.5460 b in 2020, which is only 3 years away. For the investor at the current price of Rs.2224 b, the annual rate of return would be close to 35%; phenomenal, assuming no dilution in equity. Any one interested?

As for the intrinsic value, I am not brave enough to do it as there are too many variables related to the future, which I am not capable of dealing with.