Spending Rs11,200 crore on buyback will only create a temporary bump in prices which will be used by some for exit. Infosys has to think about shareholders who would stay with the company post buyback.
Infosys is in the news and for a novel reason this time. After experiencing tumultuous times recently, the company has hogged the limelight because of a buyback proposition mooted by some former top level executives. As per reports in the media, former Infosys finance chiefs V Balakrishnan and Mohandas Pai, along with another employee DN Prahlad, had written a letter to the company asking it to consider a share-buyback. In a letter accessed by the Economic Times, Balakrishnan had stated "We are a set of retail shareholders who want to impress upon the board of Infosys to consider our proposal of announcing a large, consistent buyback program for the company. Our discussions with large institutional shareholders of Infosys make us believe that they are supportive of this proposal."
For a company sitting on a cash surplus of around Rs. 30,000 crores, buying back its own shares is the most logical proposition as the general perception is that the company has failed to utilize this cash, which continues to balloon. Cash and cash equivalents constitute more than 40% of the total size of Infosys' balance sheet. With limited opportunities for organic growth and stiff competition from competitors, Infosys has failed to add value for its shareholders in the recent past. Infosys has also lost the pride of place it used to enjoy, and which set the tone for the entire stock market. In this context, the idea of a buyback of shares looks justified. But will the buyback serve the purpose of value creation or will it just be an exit route for those who want to liquidate their position at a good price, or will it just provide some more money in the pockets of those employees who wish to utilize their ESOPs.
Let us look at some basic drivers that make buybacks successful. “Share buy-backs should only be used if the stock is trading below its economic value and the repurchase represents the best use of cash available. You cannot create value by buying back overvalued shares.” (Source: Research by Mr. Smith). Accorsing to this approach, buying back an overvalued share is not a great idea. So is Infosys overvalued? The answer is yes. This over-valuation is not related to the intrinsic value of the company. The company seems to have lost its way and that is what makes it overvalued. Some of the key indicators reflect this. For instance, gross profit/revenue has come down for the company, selling and marketing, general and administrative expenses are on the rise and the Return on Capital Employed (ROCE) has fallen over the last five years. The last two years have been particularly bad for the company. ROCE which was over 40% in 2011-12 came down to 35.83% in 2013-14. Rivals such as TCS did see similar falls. Attrition has been very high and some senior resources have also left the company, ending up in some bad press too.
The financial performance of the company has not been exemplary, something which was a hallmark of the company for years, and IT as a sector is also not offering great opportunities for shareholders. But a buyback is not an alternative as well. The company has to perform to sustain the value created by buyback. The share price of Rs. 3850 will not be tenable if the company does not improve its financials. Even after spending Rs. 11,200 crores as proposed, there may be just a temporary creation of value for shareholders which will be used by some for exit and buyback the shares again in future once the prices fall. Infosys has to think about those shareholders as well who would stay with the company post buyback. Are these shareholders going to fund an exit option for other shareholders?
Infosys has the option of buying another IT company which has a higher or equivalent ROCE as the company. It is apparent that the company has not used this option for a long time now. To bolster share price, the company can consider a bonus issue and by sustaining high level of dividend in future can add value for shareholders. But the most important thing that Infosys needs to be focused on, is improving organic growth.
Employee retention, new business acquisition and high level of corporate governance can take Infosys out of the current challenging time the company is facing. Also, reaching a share price of Rs. 3850 is not that challenging for Infosys if it decides to set the house in order.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)