It's Infosys again. I had noted in February and April about how much an investor in Infosys can make. That was based on management's target, which later became an aspiration. I had concluded questioning the possibility of $10 b revenues and 30% operating margins. While I could not answer the question, management did. Well, it has effectively dropped those targets; and it appears to be not even a moonshot aspiration now. After all, 2020 is only three years away; and based on the current situation it was a tall order. When facts change, you change your mind, don't you?
But now what? In earlier posts I had discussed the expected returns of the new buyers of Infosys stock. Now, the founders selling their stake is in the news. Although the former founder chairman has denied the report and the current CEO has taken the damage control mode, an imperative question is whether the founder shareholders are happy with their investment in the company.
Given the size of their investment, how much can they expect to make in future? There are two ways to look at it. One is the emotional aspect; Infosys was built by their sweat, grit and emotions. The company represents them, and they represent the company. It is obviously not easy to let go all of it once for all. It is not a business-only decision for them, which is understandable. Then there is the business rationale. There is a lot of cash that is involved; and the opportunity costs can be huge. If they sold their entire stock, will they buy it back again at current prices?
Infosys is now trading at Rs.948.60, and its equity is worth Rs.2179 b. The founders' stake is worth Rs.277 b at today's prices. Leaving the emotional aspect aside, if the founders are not selling their investment, it would imply that they are expecting a fair return on their investment; and I reckon, that should be upwards of 15% in the long run. They would rather put the cash in the index otherwise.
Revenues increased by over 9% and earnings per share by over 6% in 2017. However, the management guidance for future is lower. I am not going to value the company on intrinsic terms. Let's use pricing mechanics for these discussions as it is more intuitive. In order to get 15% return for the next ten years, the EPS will have to grow at 15% annually when priced at a multiple of 15 at year 10. Even when priced 20 PE, the EPS growth will have to be close to 12%. If we make the managers' job easier and price the stock at a multiple of 25 at year 10, for 15% returns the earnings per share will have to grow over 9% annually.
Historically, earnings per share grew less than 12% in the past five years and at 14% in the past ten years. So which is more probable, per share earnings growth of 15%, 12%, 9% or much less? And then which multiple is more appropriate? The fact is such that when earnings grow at 9%, the stock is more likely to get the multiple of 15 or lower rather than 20. If that is the case, the return over 10-year period would be close to 9%. A growth of 15% and multiple of 25 would take the return to close to 21%. I would rule out any repetition of historical performance. Unfortunately, Infosys has grown past such high growth rates. Hasn't it?
Is it more reasonable to expect earnings growth of 5-8% over the next decade? At the multiple of 15, the annual return will be close to 5% at EPS growth of 5%, and close to 8% at a growth of 8%. In fact at such growth rates, the multiple is likely to be less than 15, which will only lower the rate of return. Obviously that will not be adequate for the founders. May be their estimate is different, and a more optimistic one.
The stock performance during the past two years hasn't been satisfactory.
The opportunity costs for the founders due to returns lower than 15% will be massive. For instance, a return of 8% from Infosys will cost them Rs.523 b over the decade. There must be emotional, rather than business, side to the founders' investment objectives.
The $2 b share buyback might help increase the earnings per share; but the core operations are moving towards the stable business model, and therefore the company may have to be valued as such. Unless of course the company reinvents itself. But how?
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