Cognizant's target: A conservative Infosys will be easy to beat

Wipro today, Infosys tomorrow? That goal must undoubtedly be on the mind of Cognizant Solutions Technology Corp., even if the company doesn’t admit it publicly.

Infosys is India’s second-largest software exporter, behind TCS. But with the pace at which Cognizant is growing, Infosys might soon have to relinquish that position.

Earlier, this week, Cognizant reported an eight percent jump in sequential revenues to $1.5 billion for the quarter ended June, overtaking Wipro, which reported about $1.4 billion.

Beating Infosys will be the next milestone for the company that the Wall Street Journal calls the “ dark horse” of India’s outsourcing. At the moment, that might not be such a hard task: Infosys’ performance, in terms of quarterly dollar revenues, has been rather sluggish in recent quarters. Growth has slipped from 10 percent in the September-ended quarter of 2010 to about 4.3 percent in the June-ended quarter this year. The company earned revenues of $1.7 billion in the latest quarter.

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[caption id=“attachment_54243” align=“alignleft” width=“380” caption=“US-based Cognizant is known as a risk-taker compared with Infosys, which has always played it safe. Screen grab from company website”]  [/caption]

Of course, the company is still posting increasing revenues.

“Retail was the star performer with quarter-on-quarter growth of 10.2 percent,” notes a Motilal Oswal results update note on Infosys.

“BFSI (financial services and insurance), excluding products, also witnessed solid growth during the quarter with revenues, rising 5.3 per cent quarter on quarter. However, telecom business continues to reel under the pressure of sub-optimal exposure (more to wireline than wireless) and specific client issues with British Telecom. Telecom revenues declined 7.1 percent from the previous quarter.”

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British Telecom is Infosys’ biggest client. Telecom, which has been a drag for some quarters, accounts for 11 percent of overall revenues and is part of the energy, utilities, communications and services business segment for Infosys.

Cognizant , by contrast, doesn’t have any such problem clients- at the moment. In the most recent quarter, its two biggest revenue drivers were financial services and healthcare.

The company earned about $613 million, or 41 percent of its revenues for the quarter, from the banking and financial services segment. That was better than Infosys’ $592 million in revenues from the financial business in the same period. Financial services account for 35 percent of Infosys’ overall revenues.

In its latest and well-publicised company restructuring initiative labelled ‘Infosys 3.0’ (which included some key management changes), the company reorganised its operations across four key businesses: financial services and insurance; manufacturing; energy, utilities, communications and services; and retail, logistics and services.

According to its latest results, manufacturing accounts for 20 percent of overall revenues, while energy and retail hand in 22 percent each.

Conservative versus risk-taking

While there isn’t much difference in the industries both companies cater to, there are significant differences in their operating cultures: US-based Cognizant is known as a risk-taker compared with Infosys, which has always played it safe.

According to analysts, Infosys has always placed strong emphasis on high operating margins. In the June-ended quarter, the company posted margins of 26 percent. Its margins have soared as high as 35 percent in the past, although they have shown a lower trend in recent years.

Still, that’s much higher than Cognizant, which has always followed a rule of maintaining operating margins at 18-19 percent. The company also invests heavily in the business, especially in sales and marketing. It is also hiring lots of skilled workers currently. The fact that it is headquartered in the US is also pertinent: being close to clients in their markets allows the company to react to client requirements much faster and there is a better ‘cultural fit’ in operations as well.

Moreover, Cognizant is an aggressive bidder for contracts. Infosys, on the other hand, continues to be unyielding on its stance of not accepting lower-margin contracts. “Cognizant has always been a go-getter, while Infosys has always been far more conservative,” pointed out one industry observer who did not wish to be named. “However, it’s very unlikely that Infosys will change because Cognizant seems to have got it right in terms of growth right now.”

That pretty much sums it all up, doesn’t it? Infosys might be feeling the pressure of lower revenue growth, but don’t expect it to suddenly morph into a cheetah from an elephant to address that issue. “It’s a conservative company and is likely to remain conservative,” adds the market observer.

Indeed, its conservative nature is also visible in the fact that despite massive cash reserves, Infosys has never made a large acquisition. The company’s growth has primarily come from self-generated growth and even now, there doesn’t seem to be any change in perception on that issue. Cognizant, meanwhile, has been able to combine self-generated growth with acquisitions. The firm has made about 10acquisitions since 2005.

Take all these facts together, and yes, in the short term, if Infosys continues its sluggish pace of growth, there’s little doubt that Cognizant will take over as India’s No.2 software exporter.

The company has optimistically forecast at least 32 percent growth in revenues in 2011 to $6.06 billion.

Infosys, however, has been much more cautious about its growth outlook.“This is an environment in which you have to be cautious,” said Chief Operating Officer S.D. Shibulal, who will take over as chief executive in August. “We are seeing instability in the environment.”

Still, don’t dismiss Infosys just yet: despite its current setbacks, the company continues to be one of the most profitable top tier IT firms.In the June-ending quarter, Cognizant reported $208 million in profit, while Infosys’ profit was $384 million – almost twice that of Cognizant’s.

As an investor, profitability and earnings per share matter more, so on that count, Infosys still wins.