Infy saga. One possible (though unlikely) path ahead. Cognizant + Infosys = CogniSys
Infy made a serious strategic design mistake right at inception when IT outsourcing was born
In the early days Global players IBM, ACN, EDS made 4-8% margin on sales as most of their cost was onshore
TCS and Infy reinvented the business by picking work onshore and sending it to India to be done cheaper
The price they charged for Indian work gave them fat margins (North of 50-60%) which cross subsidized discounted work onshore
And SGA spends. They still returned over 30-35% to shareholders
That was a mistake. All was well in Gung ho years as more corporates built an India tech strategy and sent work out
The Indian services got commoditized and margins of over 35% were obviously not going to last both from demand and supply sides
With benefit of hindsight it seems @cognizant got its strategy right
They promised and delivered 18-20% margins to shareholders while following the TCS Infy playbook
Excess margin reinvested to grow the business. This worked as they overtook everyone other than TCS from Indian competition
When cloud hit demand side of equation and commoditization hit pricing, margins suffered for the IT services industry
Companies like TCS and Infy had to dip from Investors surplus which obviously markets don't like. Reduced sales growth + reduced margins = bad news for stocks
Cognizant (under pressure from activist shareholder), traveled the other direction. It cut internal discretionary investment and increased margin guidance
Slower growth + better margins in an industry with declining margins = good news for stock price
So we are now here with CTSH near 52 week highs and Infy near 52 week lows about $40bn and $30 bn mcap respectively.
The board room drama is playing out in this back drop and the poor actors are hardly to blame for where they find themselves now. It's a reflection of the bigger story unfolding in the background.
So where does Infy go from here? I believe it is in a tough spot.
They are unlikely to find quality leadership for a company their size in current company context
They will thus make a compromise with a not top notch leader. That will be a slow-death option, a continuation of the bad last few years
The only salvation is for Nandan to return and steer the Titanic to safer waters. His credibility is beyond doubt and abilities even more so
Other leadership options internal and external are likely to be sub optimal
An industry with demand side problems and margin side problem is ripe for consolidation
In this scenario, an interesting experiment would be to seek an amalgamation /merger
I suggest that a merger of equals between Cognizant and Infosys would be beneficial to both set of shareholders
Infy's leadership problems require a person like Nandan to solve them.
In his absence that of someone like Frank who will obviously not leave cognizant to take up Infosys
However the two are top notch, highly respected, proven companies enjoying considerable client and investor respect.
Cognizant could make an offer to buy Infosys using its shares. Both are solid companies with amazing complementary skillsets in consulting, front end and back end
Their combined size would permit a load of duplicate cost take outs and service line enhancements leading to topline synergies.
The two would combine to a topline of about $25 bn and margins of about $6 bn with net cash of over $5 bn and an annual cash generating capability of over $6 bn and mcap north of sum of parts $70 bn
Infys declining and Cognizants increasing margin trajectory could potentially settle around a healthy 21-24% region for a combined entity.
The two also have a long list of common shareholders who believe in the industry story as also individual company stories
They can compete aggressively with TCS IBM ACN Cap Gemini and set agenda for the entire industry
Obviously the integration risks of such a large transaction are high but both companies have leadership depth and common culture to pull it off
It needs ambition/ risk taking at Cognizant and pragmatism at Infosys to see the merits of a potential combination
I believe it would be worth while for the two companies to sit down and study this in some detail.
Infy made a serious strategic design mistake right at inception when IT outsourcing was born
In the early days Global players IBM, ACN, EDS made 4-8% margin on sales as most of their cost was onshore
TCS and Infy reinvented the business by picking work onshore and sending it to India to be done cheaper
The price they charged for Indian work gave them fat margins (North of 50-60%) which cross subsidized discounted work onshore
And SGA spends. They still returned over 30-35% to shareholders
That was a mistake. All was well in Gung ho years as more corporates built an India tech strategy and sent work out
The Indian services got commoditized and margins of over 35% were obviously not going to last both from demand and supply sides
With benefit of hindsight it seems @cognizant got its strategy right
They promised and delivered 18-20% margins to shareholders while following the TCS Infy playbook
Excess margin reinvested to grow the business. This worked as they overtook everyone other than TCS from Indian competition
When cloud hit demand side of equation and commoditization hit pricing, margins suffered for the IT services industry
Companies like TCS and Infy had to dip from Investors surplus which obviously markets don't like. Reduced sales growth + reduced margins = bad news for stocks
Cognizant (under pressure from activist shareholder), traveled the other direction. It cut internal discretionary investment and increased margin guidance
Slower growth + better margins in an industry with declining margins = good news for stock price
So we are now here with CTSH near 52 week highs and Infy near 52 week lows about $40bn and $30 bn mcap respectively.
The board room drama is playing out in this back drop and the poor actors are hardly to blame for where they find themselves now. It's a reflection of the bigger story unfolding in the background.
So where does Infy go from here? I believe it is in a tough spot.
They are unlikely to find quality leadership for a company their size in current company context
They will thus make a compromise with a not top notch leader. That will be a slow-death option, a continuation of the bad last few years
The only salvation is for Nandan to return and steer the Titanic to safer waters. His credibility is beyond doubt and abilities even more so
Other leadership options internal and external are likely to be sub optimal
An industry with demand side problems and margin side problem is ripe for consolidation
In this scenario, an interesting experiment would be to seek an amalgamation /merger
I suggest that a merger of equals between Cognizant and Infosys would be beneficial to both set of shareholders
Infy's leadership problems require a person like Nandan to solve them.
In his absence that of someone like Frank who will obviously not leave cognizant to take up Infosys
However the two are top notch, highly respected, proven companies enjoying considerable client and investor respect.
Cognizant could make an offer to buy Infosys using its shares. Both are solid companies with amazing complementary skillsets in consulting, front end and back end
Their combined size would permit a load of duplicate cost take outs and service line enhancements leading to topline synergies.
The two would combine to a topline of about $25 bn and margins of about $6 bn with net cash of over $5 bn and an annual cash generating capability of over $6 bn and mcap north of sum of parts $70 bn
Infys declining and Cognizants increasing margin trajectory could potentially settle around a healthy 21-24% region for a combined entity.
The two also have a long list of common shareholders who believe in the industry story as also individual company stories
They can compete aggressively with TCS IBM ACN Cap Gemini and set agenda for the entire industry
Obviously the integration risks of such a large transaction are high but both companies have leadership depth and common culture to pull it off
It needs ambition/ risk taking at Cognizant and pragmatism at Infosys to see the merits of a potential combination
I believe it would be worth while for the two companies to sit down and study this in some detail.
