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Infosys Margin Grows in Second-quarter Slowdown

  • Posted: Tuesday, October 14, 2008
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  • Author: pradhana
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  • Filed under: Business Analysis

By Samad Masood, senior analyst at Ovum

Infosys’s revenue growth fell 18 percentage points to 19% at $1.2 billion in the second quarter of 2008 – its worse sales performance in two years - due to a slump in financial services sector growth. But the firm managed to raise operating margins to a four-year high of 29.5%. While this proves Infosys’s sharp focus on financial performance, questions remain about its inorganic growth strategy.

Financial services holds back the top line

The pinch in financial services is definitely being felt by Infosys, the Indian IT industry’s highest performer in this field. Growth from the financial services sector, which generates a third of revenues, fell to 9% from over 50% in years past. Conversely, manufacturing sector growth increased quarter-on-quarter to 71%, and now accounts for 20% of the total business.

Contrary to robust expectations for the sector in general, telecoms growth slowed for Infosys, and it now represents 19% of revenues. Retail sector growth, accounting for 12% of revenues, was also lower at 16%.

Nonetheless, Infosys has managed to pass this testing quarter with high marks. Not only has it maintained a relatively high level of growth in comparison with Western players, but it has proven the strength of its business model by bringing operating margins to a new peak.

Investors are happy. Infosys’s stock has only fallen 2% on the Bombay Stock Exchange. Shares in Wipro and TCS are down 7% and 4% respectively in expectation of their upcoming results.

However, Infosys has lowered guidance significantly for the rest of the year in anticipation of slower growth in financial services. It needs to start firing up its sales in alternative sectors if it is to perform better on the top line going forward. Diversity across multiple sectors is key to surviving the downturn in financial services IT spending. But with expectations set for full-year growth of just 14%, compared to 35% last year, it seems that the crisis in financial services will continue to take a big bite out of second-half growth.

Axon: a missed opportunity?

This slowdown in financial services is why Infosys’s withdrawal from the bid for SAP specialist Axon is raising questions about its long-term strategy. Strong in manufacturing and other non-financial services sectors, Axon is one of the UK’s ‘best buys’ at this moment. Its acquisition could have buoyed longer-term growth in a broader range of sectors for Infosys. But the company’s conservatism around acquisitions meant that rival HCL won the day.

With all the top five Indian vendors, apart from Infosys, involved in major acquisitions in the past year, the company is increasingly under pressure to prove it is willing to use M&A to stabilise growth in the long term. Spotting another highly profitable onshore IT services company like Axon will not be easy, and Infosys only has so much time before it has fallen behind in the land grab for market share. But it’s hard to complain when a business is delivering market-leading profitability. These results have bought Infosys’s management some time to consider their options. /PR

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