India Technologies InfosysEquity Research | IT

Result Update

INFOSYS TECHNOLOGIES
Demonstrating the power of the business model, no negatives

INR 1,976

BUY

Infosys Q2FY08 results have been robust. While top-line performance (11% growth in USD Q-o-Q and 8.8% in INR) at INR 41,060 mn was largely in line, margin performance exceeded our expectations. But the rapid build-up in the stock-price prior to the results (over a relatively compressed-time frame) seems to have given way to profit-booking, which in our view, seems unwarranted. We see several positives from the results, which we believe, overshadow the negatives. We lay out the positives and negatives in this analysis, following our primary conclusion below:
Q1 FY08 Actual R evenues (INR mn) EBITDA (INR mn) 37,73 0 10,84 0 Guida nce 39,520-39,93 0 Q2 FY0 8 Consensus 40,982 12,393 Edelweiss 40 ,564 12 ,262 Actual 41,060 12,840
Viju George +91-22-2286 4295 viju.george@edelcap.com Kunal Sangoi +91-22-2286 4309 kunal.sangoi@edelcap.com October 11, 2007

EBITDA margin (%)

EBIT (INR mn)

28.7
9,40 0

30.2
11,031

30.2
10 ,778

31.3
11,400

EBIT margin (%)

Net profit (INR mn)

24.9
10,79 0

26.9
10,831

26.6
11 ,030

27.8
11,000

Net margin (% )
EPS (INR )
Source: Edelweiss research

28.6
18.9 18.9

26.4
19.0

27.2
19.3

26.8
19.3

Reuters

: :

INFY.BO INFO IN

Conclusion: Infosys EBITDA in Q2FY08, at 31.3%, was only ~80bps lower than what it was one-year back in Q2FY07, even as the INR appreciated fairly significantly Y-o-Y by 13.6% (from 46.5 to 40.2). Our analysis suggests that if this were not so, Infosys would have grown 40% Yo-Y in net profits instead of the actual 18.4%. We note that our FY08E EPS stands revised by less than 10% from what it was when Infosys guided for FY08 during its Q4FY07 results discussion, even as the INR appreciated above 10% (against the USD) since then. This is a testimony to the companys ability to manage external shocks. We believe that the investor should not discount Infosys ability to deliver decent earnings growth in the future, provided the INR appreciation is not drastic and remains within the reasonable limits. Infosys can deliver ~20% earnings growth in FY09E on our assumption of INR-USD of 38. We believe that weakness in the stock price, following the results, presents the investors a buying opportunity with a 15-20% upside over 9-12 months.

Bloomberg

Market Data 52-week range (INR) Share in issue (mn) M cap (INR bn/USD mn) Avg. Daily Vol. BSE (000) : 2,439 / 1,745 : 571.2

: 1,129 / 28,699 : 1,743.5

Share Holding Pattern (%) Promoters MFs, FIs & Banks FIIs Others : : : : 16.5 6.6 32.8 44.1

Financials Year to March Revenue (INR mn) Gross profit (INR mn) EBITDA (INR mn) Net profit (INR mn) EPS basic (INR) P/E (x) EV/EBITDA (x) Mkt. cap / Revenue (x)
1

Q2FY08 Q1FY08 Growth % 41,060 18,750 12,840 11,000 19.3 37,730 16,040 10,840 10,790 18.9

Q2FY07 Growth % 34,510 16,180 11,090 9,290 16.7

FY08E 167,312 75,292 51,958 46,308 80.9 24.4 20.0 6.7

FY09E 211,991 98,364 67,837 55,817 96.5 20.5 14.7 5.3

8.8 16.9 18.5 1.9 1.9

19.0 15.9 15.8 18.4 15.0

Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.

Infosys Technologies

Positives 1. Magnitude of revenue growth guidance upgrade has been decent. Infosys has raised its USD growth to 34.5-35% from the earlier 29-31%. We can build in out-performance on this, and hence, expect the company to end the year at ~40% USD growth (we factor in about 36%). FY08 EPS (INR) guidance at INR 79.49-79.88 has been modest at 2%, but we expect out-performance on this score as well. 2. Margin maintenance has outperformed expectations. Infosys has delivered 260bps sequential improvement in EBITDA margins, notably above our expectation of 160bps improvement. This is 18.3% growth Q-o-Q and by any account is a strong operational performance. We note that the company has achieved this performance, despite an increase in sales and marketing expenditure (38% growth sequentially, 6.9% of revenues versus 5.4% in Q1FY08) towards one-off commissions and earn-outs for the senior consulting staff. Why is this significant? It tells us that Infosys has latitude to absorb the impact of undertaking such discretionary expenditure and still deliver margin improvement sequentially. 3. Highest sequential improvement in realisations. This quarter saw the highest-ever improvement in sequential realisations (2.9% onsite and 2.6% offshore). This is the fourth straight quarter when Infosys has posted realised improvements exceeding 1.5%. On a Yo-Y basis, onsite pricing improvement is 8.3%, while offshore pricing has moved up 7%, which is significant (see chart 1). We are impressed not just by the companys consistency in realising pricing increases, but also the quantum of such increases. We note that zero pricing improvement, hereon, is assumed in issuing its guidance for the rest of FY08. On this count, we expect 2-3% out-performance in revenue and EPS growth. 4. Increasing contribution of solutions and frameworks and high-value services. Infosys indicated that contribution from the componentisation of services is continually increasing. We believe that this is currently about 10% of revenues. Revenues from such delivery innovations afford materially higher EBITDA margins than the company average. We believe that the companys focus on high-value services such as package implementation (11.9% growth Q-o-Q and 18.7% of revenues) and consulting (12.4% growth Q-o-Q and 5% of revenues) is raising its value profile, driving downstream business on a large scale. Together, these two profitable practices have grown 58% Y-o-Y (in USD). 5. Addition of 48 clients highest in recent times. The company has indicated that all its clients have the potential of scaling to upward of USD 1 mn in 12 months. The average client addition would have been about 37-38 new clients in a quarter. 6. Uptick tentatively seen in CY08 BFSI budgets. Despite difficulties in the US, the BFSI vertical has grown 9% sequentially, and is witnessing increasing traction in terms of helping clients in risk and compliance, standardising their trading and processing platforms, and meeting regulatory requirements. Areas across the BFSI spectrum, including capital markets, signal positive trends in CY08, the recent write-offs of global investment banking banks notwithstanding. 7. All-round vertical strength. Except telecom, all verticals led by retail, grew healthy sequentially (chart 2). The telecom verticals growth slowed down to 3% Q-o-Q, as Infosys top-client (a British telecom major) could not scale up this quarter. However, on a Y-o-Y basis, this vertical still grew ~50% (USD). 8. Increased contribution of fixed price. In this quarter, Infosys generated ~30% of its revenues from fixed price as against ~28% in Q1FY08. This shift in favour of fixed price is helping Infosys maintain margins. Notably, by way of comparison, TCS has got the ability to deliver on a fixed price basis down to a fine art (over 40% of revenues come from fixed price projects). Infosys has to cover ground in this respect and it is doing so.
2

Infosys Technologies

9.

Infosys BPO business posts impressive performance despite INR appreciation. Infosys BPO business, at USD 53 mn, in revenues posted net profits of about USD 10 mn in this quarter, holding margins commendably. Notably, the average deal size in the BPO segment is also getting larger with the company gunning for several deals of the order of USD 50-75 mn (as against USD 25 mn currently).

10. Hedged position of USD 1.4 bn (as at June 30, 2007, the hedged position was USD 0.9 bn) takes care of any adverse INR-USD movement (strengthening of the INR) over the next four quarters. What are the negatives? 1. Infosys net employee addition for the quarter stood at 4,530 (gross addition 8,543 versus indicated addition of 11,000). The company attributed this to the delays in construction of the Mysore facility, because of which, it had to defer the joining dates of about 2,500 employees by one month. 2. Volume growth at 7.7% is traditionally low for Q2, given that Q2 is Infosys strongest quarter. However, we must recognise the significant growth in the comparative base itself, hence volume growth cannot always keep pace with that of previous years. Also, we believe that Infosys FY07 was exceptional, marked by unexpected ramp-ups from 3-4 big clients (including BT). Hence, volume growth (at 36%) in FY07 over FY06 is unlikely to repeat in the future. We expect volume growth to be at 30% in FY08. Valuation conclusion: A Weakness post result presents a buying opportunity Infosys, at CMP of 1,976, trades at 24.4x FY08E and 20.5x FY09E. The negatives (INR-USD exchange rate, margin pressures due to wages, higher tax rates in FY10E, and now concerns in the US) seem to far outweigh the positives at this stage (reasonable valuations and decent business momentum) and could keep the stock under pressure over the near-term The run-up to the stock ahead of the results (20% over 10 trading days) has seen investors book quick profits. We believe that this weakness presents a buying opportunity with a 15-20% upside over 9-12 months. Chart 1: Sequential improvement in realisation sustains and has been the highest this quarter
3.5 Onsite rate q-o-q movement Offshore rate q-o-q movement Blended rate q-o-q movement 3.0 2.5 2.0 1.5 1.0 0.5 Q1 FY07 Q2FY07 Q3FY07 Q4 FY07 Q1 FY08 Q2 FY08 (%)
Source: Company, Edelweiss research

Infosys Technologies

Chart 2: All verticals, except telecom, have shown healthy sequential growth (Q-o-Q)
27.5 21.1 19.1 12.6 30.0 25.0 20.0 15.0 10.0 5.0 Telecom Services Manufacturing Transportation Banking & Finance Energy & Utilities Insurance Retail (%)
55,817 96.5 6.2 8.3 32.0 26.3 26.3 16.4

9.0 3.1

10.1

11.6

Source: Company, Edelweiss research

Financials snapshot Year to March Total revenues Software dev expenses Gross profit Selling & marketing exp General & admin exp Overhead expenditure EBITDA Depreciation EBIT Other expense Other income PBT Tax Adjusted net profit Minority Interest Reported net profit EPS basic (INR) as % of net revenues Gross profit Selling & marketing exp Admin exp EBITDA Adjusted net profit Reported net profit Tax rate Q2FY08 41,060 22,310 18,750 2,830 3,080 5,910 12,840 1,440 11,400 1,540 12,940 1,940 11,000 11,000 19.3 Q1FY08 37,730 21,690 16,040 2,050 3,150 5,200 10,840 1,440 9,400 2,530 11,930 1,140 10,790 10,790 18.9

(INR mn)

Growth % 8.8 2.9 16.9 38.0 (2.2) 13.7 18.5 0.0 21.3 (39.1) 8.5 70.2 1.9
-

Q2FY07 34,510 18,330 16,180 2,210 2,880 5,090 11,090 1,220 9,870 660 10,530 1,230 9,300 (10) 9,290 16.7

Growth % 19.0 21.7 15.9 28.1 6.9 16.1 15.8 18.0 15.5 133.3 22.9 57.7 18.3 18.4 15.0

FY07 138,930 74,580 64,350 9,290 11,150 20,440 43,910 5,140 38,770 20 3,720 42,470 3,860 38,610 (110) 38,500 69.2

FY08E 167,312 92,021 75,292 10,155 13,179 23,334 51,958 6,040 45,918 7,460 53,378 7,071 46,308 46,308 80.9

FY09E 211,991 113,627 98,364 13,037 17,489 30,527 67,837 7,632 60,205 6,600 66,805 10,988 55,817

1.9 1.9

45.7 6.9 7.5 31.3 26.8 26.8 15.0

42.5 5.4 8.3 28.7 28.6 28.6 9.6

46.9 6.4 8.3 32.1 26.9 26.9 11.7

46.3 6.7 8.0 31.6 27.8 27.7 9.1

45.0 6.1 7.9 31.1 27.7 27.7 13.2

46.4

Infosys Technologies

Company Description
Infosys is the second-largest IT services company in India providing consulting and IT services to clients globally. It is also among the fastest growing IT services organization in the world and a leader in the offshore services space with a pioneer in Global delivery model. Infosys provides business consulting, application development and maintenance and engineering services to over 509 active clients spread across Banking, Financial Services, Insurance, Retail, Manufacturing, and Utilities verticals and 29 countries. The company has also its own proprietary core banking software - Finacle used by some of the leading banks in India, Middle East, Africa and Europe. Infosys also has a BPO arm, Infosys BPO which employs almost 13,000 people. Infosys IT services employee force stands at 80,501 and the companys revenues for the last twelve months (TTM) stood at INR 153.0 bn (USD 3.6 bn).

Investment Theme
Infosys is known for its excellent project execution skills, which makes it the most preferred tier 1 vendor. With rapidly increasing numbers of service lines and domain capabilities, Infosys has readied itself for multiple possible points of initiating and growing client engagements. The company has also demonstrated its ability to engage with larger client organizations and winning increasing proportion of their wallet share. Infosys growth over the last three to four years reflect its abilities to benefit from the improving macro environment, as reflected in its above-peer group growth in its offshore revenues, key verticals and service lines.

Key Risks
Key risks to our investment theme include Slowdown in US, Significant increase in the salary hikes and attrition rate creating cost pressures Reduction in the number of H1B visas granted by US will have an adverse impact and Further appreciation of rupee against US dollar, Euro and GBP.

Infosys Technologies

Financial Statements
Income statement Year to March Revenues Software development charges Gross profit Selling & Marketing expenses General and admi. exp Operating expenditure EBITDA Depreciation EBIT Total other income Provision for investments Profit before tax Tax Profit after tax Extraordinary income(loss) Minority int. and others Reported PAT Adjusted EPS basic (INR) CEPS (INR) Dividend (%) Dividend pay out (%) Common size metrics - as % of revenues Year to March Software development charges Gross profit Selling & Marketing expenses General and admin. exp EBITDA margin EBIT margin PAT margin Growth metrics (%) Year to March Revenues EBITDA EBIT Net income EPS (INR mn) FY09E 211,991 113,627 98,364 13,037 17,489 30,527 67,837 7,632 60,205 6,600 66,805 10,988 55,817 55,817 96.5 109.7 600 35

FY05 71,297 37,647 33,650 4,610 5,690 10,300 23,350 2,869 20,481 1,239 (1) 21,721 3,256 18,465 452 (0) 18,917 35.2 40.6 115 19

FY06 95,216 50,654 44,562 6,005 7,639 13,643 30,918 4,371 26,547 1,396 11 27,932 3,132 24,801 (202) 24,599 45.1 53.1 900 57

FY07 138,930 74,580 64,350 9,290 11,150 20,440 43,910 5,140 38,770 3,720 20 42,470 3,860 38,610 (50) 38,560 69.2 78.5 232 19

FY08E 167,312 92,021 75,292 10,155 13,179 23,334 51,958 6,040 45,918 7,460 53,378 7,071 46,308 46,308 80.9 91.5 500 35

FY05 52.8 47.2 6.5 8.0 32.8 28.7 26.5

FY06 53.2 46.8 6.3 8.0 32.5 27.9 25.8

FY07 53.7 46.3 6.7 8.0 31.6 27.9 27.8

FY08E 55.0 45.0 6.1 7.9 31.1 27.4 27.7

FY09E 53.6 46.4 6.2 8.3 32.0 28.4 26.3

FY05 46.9 46.5 50.9 52.1 50.4

FY06 33.5 32.4 29.6 30.0 27.9

FY07 45.9 42.0 46.0 56.8 53.7

FY08E 20.4 18.3 18.4 20.1 16.9

FY09E 26.7 30.6 31.1 20.5 19.2

Infosys Technologies

Balance sheet Year to March Equity share capital Share premium account Reserves Total shareholders funds Preference shares issued by subsidiary Minority Interest Sources of fund Gross fixed assets Depreciation Net fixed assets Capital WIP Investments Deferred tax asset Cash & Bank Balances Debtors Loans & advances Total current assets Sundry Creditors Provisions Total current liabilities Working capital Application of funds Book value per share (BV) (INR)

(INR mn) FY05 1,353 8,999 41,900 52,251 935 1 53,188 22,873 10,308 12,565 3,177 12,108 444 15,756 13,220 10,244 39,220 6,560 7,765 14,326 24,895 53,188 95 FY06 1,380 15,430 52,850 69,660 680 70,340 29,830 13,280 16,550 5,710 7,550 650 34,290 16,080 12,970 63,340 9,340 14,120 23,460 39,880 70,340 122 FY07 2,860 27,680 82,010 112,550 40 112,590 46,420 18,360 28,060 9,650 250 920 58,710 24,360 12,140 95,210 14,690 6,810 21,500 73,710 112,590 202 FY08E 2,860 33,080 112,228 148,168 40 148,208 56,420 24,400 32,020 10,230 400 384 89,676 26,259 15,175 131,110 17,628 8,308 25,936 105,174 148,208 259 FY09E 2,880 43,080 148,391 194,352 40 194,392 68,920 32,031 36,889 9,280 640 384 127,958 31,562 18,969 178,489 21,154 10,136 31,290 147,199 194,392 337

Cash flow statement Year to March Cash flow from operations Cash for working capital Net operating cashflow(A) Net purchase of fixed assets Net purchase of investments Others Cash flow from investments(B) Dividends Proceeds from issue of equity Cash flow from financing (C) Exchange Rate Differences (D) Change in cash(A+B+C) + (D)

(INR mn) FY05 21,459 (7,745) 13,713 (8,298) (2,200) 1,141 (9,357) (10,206) 4,408 (5,798) 40 (1,401) FY06 27,201 (3,820) 23,381 (10,890) 4,550 2,110 (4,230) (4,030) 6,460 2,430 90 21,671 FY07 45,280 (10,180) 35,100 (14,960) 7,460 3,150 (10,950) (15,320) 12,160 (3,160) (70) 20,920 FY08E 50,719 (4,934) 45,785 (10,580) (150) 6,600 (4,130) (16,089) 5,400 (10,689) 30,966 FY09E 68,591 (9,097) 59,494 (11,550) (240) (11,790) (19,442) 10,020 (9,422) 38,282

Infosys Technologies

Ratios Year to March ROE (%) ROCE (%) Debtor Days Fixed asset T/0 Valuation parameters Year to March Adjusted EPS (INR)

FY05 43.7 43.7 67.7 7.1

FY06 40.0 39.8 61.6 6.7

FY07 42.3 42.2 64.0 7.3

FY08E 35.5 35.5 57.3 6.9

FY09E 32.6 32.6 54.3 7.4

FY05 35.2

FY06 45.1

FY07 69.2

FY08E 80.9

FY09E 96.5

Y-o-Y growth (%)

BVPS (INR) PER (x) Pr/CF (x) P/BV (x) EV/EBITDA (x) EV/Revenues (x) Market cap/Revenues (x)

50.4
94.8 56.1 51.8 21.6 47.2 15.5 15.8

27.9
122.0 43.9 39.0 16.2 35.2 11.4 11.9

53.7
202.1 28.5 25.8 10.0 24.4 7.7 8.1

16.9
259.0 24.4 21.6 7.6 20.0 6.2 6.7

19.2
337.4 20.5 17.8 5.8 14.7 4.7 5.3

Infosys Technologies

Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai 400 021, Board: (91-22) 2286 4400, Email: research@edelcap.com
Naresh Kothari Vikas Khemani Shriram Iyer Co-Head Institutional Equities Co-Head Institutional Equities Head Research naresh.kothari@edelcap.com vikas.khemani@edelcap.com shriram.iyer@edelcap.com +91 22 2286 4246 +91 22 2286 4206 +91 22 2286 4256

Coverage group(s) of stocks by primary analyst(s): Information Technology:

Geometric, HCL Tech, Hexaware, i-flex, i-Gate, Infosys, Infotech, Mastek, Mphasis, Patni, Rolta, Sasken, Satyam, TCS, and Wipro

Infosys Technologies
2,400 2,260 (INR) 2,120 Buy 1,980 1,840 1,700 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 May-07 Sep-07 Jun-07 Mar-07 Aug-07 Oct-07 Apr-07 Jul-07 Buy Buy Buy Buy Buy Buy

Recent Research
Date
10-Oct-07

Company
iGATE Global Solutions

Title
Profits improve significantly, owing to cost management;

Price (INR) Recos

340 Buy

Result Update
09-Oct-07 08-Oct-07 Infosys Is a great company now Technologies an unexciting investor bet? 2,048 Buy

Event update
IT Seeking catalysts in a strong quarter Result Preview; 10 relevant questions posed; 285 answers reinforce confidence; Buy

26-Sep-07

Mphasis

Event Update

Distribution of Ratings / Market Cap

Edelweiss Research Coverage Universe Buy
Rating Distribution* 100

Rating Interpretation
Rating Expected to
appreciate more than 20% over a 12-month period appreciate up to 20% over a 12-month period depreciate up to 10% over a 12-month period depreciate more than 10% over a 12-month period

Accumulate
46

Reduce
23

Sell
6

Total
183

Buy Accumulate

* 6 stocks under review / 2 rating withheld

> 50bn
Market Cap (INR) 83

Between 10bn and 50 bn

66

< 10bn
34

Reduce Sell

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