Ex-Infosys CFOs are right on Rs 11200 cr buyback: Why co must open up its coffers

At least two former chief financial officers (CFOs) of Infosys Technologies, TV Mohandas Pai and V Balakrishnan, and one former Senior Vice-President, DN Prahlad, are said to have asked the company’s board to “immediately” buy back shares worth Rs 11,200 crore. They also want the company to keep doing so at the rate of 40 percent of the previous year’s net profits every year afterwards. They also want the buyback to happen at the highest price achieved by the Infosys share over the last one year, at Rs 3,850.

As at the end of June 2014, Infosys reported cash and cash equivalents of the magnitude of Rs 29,748 crore. So paying this money out won’t dent its bank balance too much.

Giving shareholder cash back to shareholders, especially when you cannot use it profitably in the foreseeable future, is often a good idea, but one wonders if the three gentlemen now demanding it gave the board the same advice when they were working at Infosys.

However, that does not take anything away from making the right demands now, when they are out of the company. Infosys’ new boss Vishal Sikka should hand over more cash to his shareholders. Pronto.

There are very good reasons why companies should not hoard too much cash, unless they have an immediate need for it - to make acquisitions, investing in new fixed assets, or whatever. I had written about Infosys’s growing cash hoard five years ago , and have been repeating it every now and then , and the reason is simple: too much cash means too much safe thinking and risk aversion.

This is exactly what happened with Infosys. It has been too risk-averse, and is consequently paying the price in terms of slower growth than its peers - TCS, HCL Technologies, and Cognizant among them.

This risk-aversion was demonstrated in 2008, when Infosys made a bid for UK-based software company Axon - and withdrew with hurt pride. Rival HCL Technologies made a higher bid , and Infosys retreated as it felt valuations were too high and didn’t want to enter a bidding war. That loss cost Infosys early momentum in the European IT sweepstakes.

While taking on too much risk can be - well - risky, taking too little risk means a company’s returns will start falling over time. Just as you should not invest all you money in stocks, you should not keep all your money in bank fixed deposits either - the former may leave you with nothing, and the latter with too little returns.

Apart from risk-aversion, here’s why Infosys shouldn’t be stuffing its balance-sheet with oodles of cash.

One, a high cash component makes for a lower return on net worth (RONW). Net profits as a percentage of net worth falls when cash increases a company’s net worth. Infosys’s RONW, at 25.8 percent in fiscal 2013-14, is far lower than Tata Consultancy Services’s (43.7 percent), Tech Mahindra’s (41.9 percent), Wipro’s (27.2 percent) and HCL Technologies’s (35.2 percent, for year ended June 2013).

Two, a lower RONW means lower stock market valuations. Since valuations depend on the kind of returns companies generate on shareholder funds (which is net worth, or equity plus reserves), Infosys’ valuations are far lower than they should be. Giving away cash with improve RONW and valuations.

Three, not having cash in the bank does not mean a company’s ability to acquire is reduced. If share valuations improve as a result, it means more of the acquisition price can be paid for in shares rather than cash. Higher valuations merely give the company a different kind of currency - scrip instead of cash.

Four, giving out cash offers shareholders the option to invest the money in higher yielding avenues on their own - if they so want. Instead of the company taking the risk on investment, it can enable shareholders to take the call. The point is this: if the company is going to hold cash in low-risk FDs and bonds, there is no reason why it should do so when the shareholder can do the same.

Clearly, Infy’s ex-CFOs know what they are talking about. Infosys’ new boss, Vishal Sikka, should take their advice and open up the company’s coffers.

Infosys should not play Scrooge anymore.