Infy’s falling shares attractive for PE play?

Low Promoter Stake, Poor Valuation Make IT Co Candidate For Outside Intervention Mumbai/Bangalore: Infosys shares have fallen cheaper than that of iGate Corp and Tech Mahindra on valuation metrics, making India's second largest technology services company attractive to new shareholders who would look to "influence" the management.      Top bankers have explored whether large investors — private equity groups or hedge funds — could be goaded into building up a significant stake in Infosys after the stock was hammered following a string of under performing quarters. Infosys, with a traditionally low promoter holding, is in the toughest phase of its life since going public almost two decades ago.      "Large funds are comfortable with the long-term growth of Indian IT services. They like mature, growing businesses where they could be influencers. Infosys is already attractive at current valuations for investors wanting to buy-in. But are there large blocks of shares available? It's also not certain what level of influence they would wield even after building a large stake," said Nikhil Rajpal, Partner, Ernst & Young.      Bankers averred that Infosys won't be a classic acquisition target, with founders who hold about 16% not being the sellers. "Long-term investors may want to influence a change of direction in a company that's grappling with transformation in difficult times," said a banker who did not wish to be named. Big investors influencing the boards of underperforming companies isn't new globally, with one such playing out at consumer goods giant Proctor & Gamble (P&G).      "Infosys is a world-class business with high standards of corporate governance, and private equity firms would naturally be drawn to it. But it won't be a simplistic decision based on current P/E multiples relative to historic (values). In my opinion, it would be depend on a set of factors such as the evolving structure of IT services industry and preferred client engagement models, global economic revival and other triggers, which could erode profit margins and operating leverage going forward," said Rahul Bhasin, Managing Partner, Baring Private Equity Partners India with more than $1 billion in assets.      Infosys promoters have consistently said that they are not worried about their low stake in the company and have termed it a deliberate strategy. From 100% just before the company went public in 1993 their stake has fallen to the current level because the promoters, as a matter of principle, did not subscribe to any rights issues, preferential allotments or ESOPs. Today, 13% of the shares are with retail investors while institutional investors hold a 56% stake, with the biggest chunk being held by foreign institutional investors (38%).      Infosys's valuations based on price earnings (P/ E) ratio and EBITDA multiples dropped sharply in recent quarters. It's not only behind peers Tata Consultancy Services (TCS), Wipro and Cognizant Technology Services, but even smaller rivals such as iGate. HCL Technologies and Tech Mahindra, too, had higher EBITDA multiples compared to Infosys, according to a fortnightly report of Chesapeake, a New York-based technology investment bank, based on June 30 stock quotes. Infosys's mcap was then pegged at $25.7 billion, days before the latest quarterly numbers routed the stock further.      Infosys's P/E ratio at 15x trailed that of Wipro (17.5), iGate (22.5), Cognizant (19.8) and TCS (24). On EBITDA multiples, Infosys fared worse at 9.8x, falling behind most IT services companies (except Mphasis) with revenue in excess of $500 million. Analysts combing P/E ratios on forward earnings, which some argue are more relevant, also suggest the falling lustre of the technology services bellwether.      "The valuation multiples of Infosys are now closer to the mid-caps. The company's P/E ratio at 13x (based on FY13) is comparable to HCL Technologies, which used to trade at significant discount historically. There have been worries over growth and earnings stability. Infosys has talked about a transformational story, ramping up revenue from products platform and consulting over the next 5-7 years. We do not see an immediate re-rating of the stock, but possibly over the next 18 to 24 months," said Priya Sunder, research analyst at Avendus Securities, who put a 'add' on the stock citing valuation comfort.      Bankers have always had an eye on Infosys, given its historical low promoter holding. Even 10 years ago, it was below 30%. Buzz in Bangalore is that it was once hawked to Azim Premji, who then held a 80% plus stake in Wipro. A block deal and a share swap would have given him Infosys while retaining majority control over Wipro. Premji is said to have summarily dismissed the proposal. More recently, a big European bank approached Infosys to explore a consolidation story, which, again, was rejected in the first sitting.      Earlier proposals stayed at that level mainly on two accounts: Infosys's vaunted management and valuation. The argument against buying Infosys being that value in the company rests with its management and an acquisition would see them head to the exit and an Infosys without Murthy & Co would be just another company. But the company's current management lacks the lustre of Murthy and Nilekani reign.      Second deterrent was its until recent very high valuation, with P/E comfortably in the higher 20s. That made Infosys a very expensive acquisition. The price was a put off earlier but no longer, maybe. Financial investors would find $4 billion cash sitting on the company books a tough to factor in, said one banker, who added that the cash pile might be a deterrent inadvertently.      "It's still not a terribly cheap buy for anyone unless they have a meaningful influence on the management," said one of the bankers mentioned earlier. Private equity firm ChrysCapital made a small play (building up under 2% stake) in Infosys in the past, purely as a stock market investment. It exited with handsome returns almost two years back before the company entered the bearish phase. Interestingly, investors haven't been vocal in airing angst against the management despite the company's under-performance in recent quarters. "There aren't large shareholders wanting to press exit yet. Some of them believe in the transformation story with Shibulal doing a good job in keeping the management intact till now," said a research head at a foreign brokerage who isn't authorized to talk to the media.