[Kotak] Infosys (Rs2,231, ADD) Will the Results of Reorganization Be Different This Time

8/9/2019 [Kotak] Infosys (Rs2,231, ADD) Will the Results of Reorganization Be Different This Time

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For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THEEND OF THIS MATERIAL.

Kotak Institutional Equities Research [email protected]: +91-22-4336-0000

New structure empowers delivery; moves away completely from a verticalized structure

Infosys has reduced the number of industry verticals to five from six: (a) financial services,(b) retail, CPG and logistics, (c) manufacturing, (d) energy, utilities, communications andservices, (e) and life sciences, healthcare and insurance.

Service lines have been moved out of a verticalized structure into independent practices.Infosys has created seven service lines — digital integration services, ADM, engineeringservices, cloud and infrastructure services, independent validation and testing, enterprisepackage application services and management consulting services.

Growth markets such as India, Australia, China, Japan, Germany and France will besubsumed under the respective verticals and service lines.

All service line heads will report to Ravi Kumar who will head delivery and in turn report to

COO, UB Pravin Rao. The sales team will report to CEO, Vishal Sikka.

New parameters to assess performance of different groups

Vertical heads will be evaluated on revenue growth and pricing, not on unit-level profitability.However, part of variable compensation is still linked to the company’s performance.

Service line heads will be evaluated on productivity measures and gross margins. To put itdifferently, delivery will be responsible for controlling something directly under control i.e.cost of delivery. This can be achieved by controlling role ratios, managing the effort mix,improving utilization rates and driving automation.

One of the interesting aspects of the change is attributing P&L responsibility in a differentmanner —verticals managing pricing and revenues and service lines ’ cost of delivery. Both theseaggregated together equates to P&L. Instead of holding a vertical head responsible for theentire P&L, the new structure establishes accountability at functional levels.

Infosys (INFO) Technology

Will the results of reorganization be different this time? Infosys is undertakinganother reorganization that involves moving away from a verticalized structure withsingle-point P&L responsibility to (1) separation of service lines from verticals into sevenindependent practices and (2) new parameters to assess the performance of verticalheads. Our initial assessment is (a) the reorganization aims to empower delivery andplaces special emphasis on renewing service lines; and (b) a trade off in the newstructure is loss of single-point accountability. More details will emerge on thereorganization. The emphasis on renewing delivery is evident from the new structure;the company will have to manage the transition to ensure there is no seniormanagement attrition or loss of business momentum. We retain ADD.

DD

FEBRUARY 09, 2015

UPDATE

Coverage view: Attractive

Price ( ` ): 2,231

Target price ( ` ): 2,350

BSE-30: 28,718

Kawaljeet [email protected]: +91-22-4336-0860

Jaykumar Doshi [email protected]: +91-22-4336-0863

InfosysStock data Forecasts/Valuations 2015 2016E 2017E

52-week range (Rs) (high,low) EPS (Rs) 108.4 123.1 146.0Market Cap. (Rs bn) EPS growth (%) 14.0 13.6 18.5

Shareholding pattern (%) P/E (X) 20.6 18.1 15.3Promoters 13.1 Sales (Rs bn) 537.6 612.0 716.2FIIs 41.6 Net profits (Rs bn) 123.9 140.7 166.8MFs 5.4 EBITDA (Rs bn) 151.5 175.7 208.3

Price performance (%) 1M 3M 12M EV/EBITDA (X) 14.8 12.5 10.2Absolute 14.1 8.2 25.2 ROE (%) 25.7 25.0 25.3Rel. to BSE-30 7.3 5.1 (11.5) Div. Yield (%) 1.6 1.8 2.1

Company data and valuation summary

2,248-1,4402,561.7


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Technology Infosys

2 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Intent of reorganization and a few positives from it

Infosys’ intent of renewing service lines would not have worked under the currentverticalized delivery structure — the delivery team was simply providing demandfulfillment with little incentive for innovation. The new structure places greater emphasison the role of delivery and provides greater visibility to it in the organization. Under thenew structure, gross margin targets would compel the delivery team to implement newways of delivering services —focus on innovation and productivity.

The new structure provides scale and incorporation of best practices across service lines, apositive. Utilization can improve with centralized resource management

Reorganization unlikely to be disruptive even though there is a trade-off

Change to the structure will lead to changes in reporting lines and invariably lead toattrition though not material.

Elimination of single point responsibility, which was with the vertical head earlier, willdemand additional bandwidth of management to resolve disputes. The new structuremay give rise to disputes between verticals and service heads. Infosys requires a strongconflict resolution system in place, in our view. Inevitably this will consume more CXOlevel bandwidth.

Infosys has also changed the roles of some of the leaders. The new structure will also leadto change in reporting for many. The company has to ensure seamless transition toensure minimal disruption to the business.

Bottomline. Emphasis on renewing delivery is evident from the new structure; the companywill have to manage the transition to ensure there is no senior management attrition andloss of business momentum.

Key changes

Ravi Kumar who was head of insurance, healthcare, cards and payment has been madedelivery head. The heads of seven service lines (digital integration services, ADM,engineering services, cloud and infrastructure services, independent validation and testing,enterprise package application services and management consulting services) wouldreport to him. Mr Kumar will report to Pravin Rao, COO.

Mohit Joshi, who heads the financial services vertical, will also handle cards and payments(now a part of financial services). Insurance and healthcare will be clubbed with lifesciences. Manish Tandon will continue to head this vertical.

Michael Reh, who joined from SAP and has been entrusted with turnaround of Finacle,will now head the products and platform subsidiary, EdgeVerve (Sanjay Purohit’ s portfolio)as well. The company intends to appoint a CEO EdgeVerve who would report to MrPurohit.

Mr Purohit will head Management Consulting Services. Lodestone CEO Ronald Hafnerand Eric Rich (unit head of management consulting services) will report to him.

Srikantan Moorthy who heads HR will move back to delivery as head of independentvalidation and testing.

Vishnu Bhat — head of cloud and infrastructure services quit recently. EdgeVerve COOSamson David has replaced him.

Infosys has appointed VG Dheeshjith, SVP and head of the growth market unit as theChief Information Officer (new position created).


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Infosys Technology

KOTAK INSTITUTIONAL EQUITIES RESEARCH 3

Previous reorganizations

Reorganization under NRN (June 2013 – May 2014)

Infosys made several changes to its organizational structure under Narayana Murthy ’sleadership. Some of the changes were:

Appointment of two presidents, BG Srinivas and UB Pravin Rao, reporting to CEO. TheExecutive Council (EC) was dissolved.

BFSI, manufacturing, energy & communications, public services, Lodestone, StrategicGlobal Sourcing (large deals group), marketing and alliances reported to BG Srinivas.

Retail & CPG, logistics, life sciences, resources & utilities, growth markets, cloud andmobility, quality and productivity and Infosys Leadership Institute reported to UB PravinRao.

In addition, BG Srinivas was to focus on global markets while UB Pravin Rao would

focus on global delivery and service innovation.

Six countries (four in APAC, two in Europe) with high growth potential were carved outof the verticalized structure to have separate P&Ls. This was done to give more freedomto growth markets.

CS Kakal was given the responsibility to handle consulting & SI (33% of revenues) inaddition to BITS (62% of revenues). Effectively the entire delivery organization reported tohim.

Product, Platforms and Solutions (PPS) business was carved out into a separate subsidiary,EdgeVerve. Sanjay Purohit was appointed as its head.

Infosys 3.0 reorganization (March 2011)

Industry verticals were consolidated in four and service offerings were grouped into three.P&L responsibilities were taken away from service lines and the company P&L wasaddition of four vertical P&Ls.

Consolidation into four verticals — (a) financial services and insurance headed by AshokVemuri, (b) manufacturing headed by BG Srinivas, (c) energy, utilities, communication andservices headed by Prasad Thrikutam and (d) retail, CPG, transport and life sciencesheaded by UB Pravin Rao. In addition, there was one more vertical Infosys public servicessubsidiary for handling the US government’s public service work.

Services were re-grouped into three offerings (a) Business transformation (Consulting, SI,ES and select Application development work), (b) Business operation (ADM, Independentvalidation, IMS and BPO), and (c) Business innovation (products, platform, solutions andaccelerators).

Rest of the world geography was verticalized. The company retained special focus units incertain investment countries such as France, Germany, China, Japan and India.


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Technology Infosys

4 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Exhibit 1: Condensed consolidated financials for Infosys, March fiscal year-ends 2013-17E ( ` mn)

2013 2014 2015E 2016E 2017EProfit modelRevenues 403,520 501,330 537,630 611,997 716,247

EBITDA 115,600 136,340 151,530 175,693 208,274 Depreciation (11,310) (13,740) (11,006) (14,209) (17,406) Other income 23,590 26,690 32,964 32,627 37,628 Pretax profits 127,881 149,291 173,490 194,112 228,497 Tax (33,670) (40,620) (49,567) (53,380) (61,694) Profit after tax 94,211 108,671 123,924 140,731 166,803 Diluted earnings per share (Rs) 82.4 93.2 108.4 123.1 146.0 Balance sheetTotal equity 379,940 445,300 520,628 607,438 712,331 Deferred taxation liability (4,690) (6,290) (6,290) (6,290) (6,290) Total borrowings — — — — —

Minority interest — — — — —

Current liabilities 83,370 124,360 125,745 129,620 135,053 Total liabilities and equity 458,620 563,370 640,083 730,768 841,094 Cash 218,320 259,500 314,526 364,380 434,245

Other current assets 140,120 180,240 192,253 214,395 247,410 Goodwill — — — — —

Tangible fixed assets 82,790 93,390 103,064 121,754 129,200 Investments 17,390 30,240 30,240 30,240 30,240 Total assets 458,620 563,370 640,083 730,768 841,094 Free cash flowOperating cash flow, excl. working capital 81,390 93,920 101,964 122,313 146,580 Working capital changes (11,820) (2,810) (10,628) (18,267) (27,583) Capital expenditure (32,460) (27,450) (20,680) (32,899) (24,852) Free cash flow 37,110 63,660 70,656 71,147 94,145 Key ratios and assumptionsRevenue growth (US$ terms) (%) 5.8 11.5 6. 5 10.6 13.4 Re/US$ rate 54.5 60.8 61.2 63.0 65.0 EBITDA margin (%) 28.6 27.2 28.2 28.7 29.1

EBIT margin (%) 25.8 24.5 26.1 26.4 26.6 Debt/equity — — — — —

Net debt/equity (0.6) (0.7) (0.7) (0.6) (0.7) RoAE 27.2 26.3 25.7 25.0 25.3 RoIC 52.1 49.9 51.6 52.4 53.8

Source: Company, Kotak Institutional Equities estimates


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KOTAK INSTITUTIONAL EQUITIES RESEARCH 5

Disclosures

"I, Kawaljeet Saluja, hereby certify that all of the views expressed in this report accurately reflect my personal views aboutthe subject company or companies and its or their securities. I also certify that no part of my compensation was, is or will be,directly or indirectly, related to the specific recommendations or views expressed in this report."

Ratings and other definitions/identifiers

Definitions of rating

BUY. We expect this stock to deliver more than 15% returns over the next 12 months.

ADD. We expect this stock to deliver 5-15% returns over the next 12 months.

REDUCE. We expect this stock to deliver -5-+5% returns over the next 12 months.

SELL. We expect this stock to deliver


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[Kotak] Infosys (Rs2,231, ADD) Will the Results of Reorganization Be Different This Time

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