It was not that investors were unaware of SARS, the Iraq war and the slowdown in tech spending haunting the company at that point of time, but the extent of the caution in the guidance took analysts and punters alike by surprise.

The ensuing melee at the bourses saw the stock losing substantially and consequently taking the whole market down with it. But what the bellwether went on to do in the ensuing four quarters is the stuff that fightbacks are made of.

If one looks at Infosys' guidances in the past and compares them with actuals, one wonders if its outperformance has to do with the management's preference to be conservative or its inability to assess the environment.

Some fund managers feel that company managements, however talented they may be in their business pursuits, often fail to take an accurate call on the prospects, especially over the medium-term.

This is because managements do not tend to take a dispassionate view of the business environment and their own operations.

What ever the case may be, Infosys's bullish guidance has made analysts revise their otherwise bearish tone just a couple of months ago.

Analysts for once were not convinced of the Infosys growth story.

Barely a month ago, foreign brokerage CSFB (Credit Suisse First Boston) came out with an 'underperform' recommendation on the stock. It cited scale-up issues to be a challenge. Its argument was that if revenue growth continued at the current level of over 35 per cent, Infosys would need to hire more than 10,000 employees in FY03/05 (on a base of 20,000 employees).

It also said that margins were not expected to improve as large customers resist any hike in billing rates and that contributions from low-margin BPO and infrastructure outsourcing should increase.

Similarly, Sandeep Shenoy, head of equities, Pioneer Intermediaries, cited base effect, squeezing of costs by large customers and humongous overheads costs as major problems.

"The heady days when IT bellwether stocks could enjoy premium valuations are over and big players may be in for a derating," he said in an interview.

The comeback

Cut to the present scenario and take a look around. Billing rates have stabilised, the economy is on a mend and tech spending has picked up in the US.

This is well reflected in the results the company has reported - sequential revenue growth of 6.1 per cent, 4.9 per cent and 8.9 per cent in the three quarters of the FY04 fiscal respectively.

The company revised its earnings projections in December to 29 per cent growth over FY03 earnings. This was much above the 12 per cent growth that the company had projected in April 2003.

Not without reason, Infosys ended the year with a bang, delivering an earnings growth of 30 per cent for the full year.

This time around, the company has, in a manner of speaking, thrown caution out of the window - it has announced an aggressive 3:1 bonus and a Rs 100 special dividend.

More importantly, according to its guidance for FY05, revenues will grow over 24 per cent in rupee terms and earnings by 20 per cent. This is despite the fact that the backlash against outsourcing in the US is expected to continue at least till the US elections are over.

Thanks to the upbeat guidance by the company, analysts are also slowly humming a bullish tune now. Is this exuberance for real? To be sure, we analyse the various elements of the resurgence.

Moving up the value chain
	Mar-04	Mar-03
Active clients	393	345
Clients billing more than $50 mn	3	-
Clients billing more than $20 mn	12	9
Clients billing more than $10 mn	25	16

Exuding confidence

Analysts are unanimous that the company exudes confidence and has come off its overly cautious stance which had been the main characteristic of its management in the past.

Firstly, analysts reckon that the bonus shares offered by the company are an indicator of the management's confidence level in the company's earnings sustainability.

Secondly, in its guidance for FY05, the company expects revenues to grow over 30 per cent in dollar terms. Revenue growth in rupee terms is expected to be much lower at 24 per cent because of the currency scenario.

The company expects earnings growth to come in lower at 20 per cent. The four-percentage-point difference between revenue and earnings growth is primarily because of investments the company plans to make in its new business such as consulting.

10,000 more hands

In its results, the company addressed the first issue head on by announcing that it expects to add 10,000 employees in FY05. Growth in revenues for a software company is dependent either on higher volumes of work (for which the company needs to continuously invest in manpower and supporting infrastructure) or on a rise in billing rates.

Now, due to increasing competition and oversupply situation, billing rates are likely to be stagnant, or improve marginally only for high-value services.

Thus, it leaves software companies with only a couple of ways of growing larger in revenue terms – adding to their employee base and moving up the software value chain.

However, even offerings that are higher up the value chain tend to get commoditised as more and more companies develop competencies in a wider gamut of domains. This leaves companies like Infosys with only one way of growing larger in size – by going aggressively after higher work volumes, adding to its employee base.

And this is exactly what the company is doing at present.

As regards sustainability, analysts feel that the company has what it takes to do it. Reaffirms R Ravi, IT analyst at IDBI Capital, "Revenue growth is a function of price versus people. In a scenario when price increases do not look very likely, growth in employee strength is very much required to take care of the burgeoning volumes."

Ravi says people expressed reservations when the company increased its headcount to 10,000 from 5,000 and to 20,000 from 10,000.

He is confident that Infosys has its process management and project management plans in place, making it capable of churning out a large number of billable employees.

Besides, there has been a noticeable easing of margin pressure. This, along with the fact that the BPO invasion from international players has petered out due to the superior competencies that are the domain of the established players, makes it easier for Infosys to meet its revenue growth target.

To add 10,000 more
Employee stats	Mar-04	Mar-03
Total employees	23,377	15,358
Billable S/W professionals	19,205	12,747

Consulting - a key driver

The company's client traction was impressive - revenues from top clients increased 25 per cent on a sequential basis while those from the top five and 10 increased 8.29 per cent and 8.9 per cent respectively.

Analysts feel that volume visibility in FY06 looks very good. Infosys also recently announced the setting up of a subsidiary in the US. The arm will be called Infosys Consulting Inc and will have on its rolls some leading consulting professionals who Infosys has hired from top global consulting firms like Deloitte and EDS.

Consulting currently forms around 3.6 per cent of Infosys' total revenues and analysts feel that the company would do better to increase this contribution, as it would then add to the profitability.

This is because consulting, being a high-end work, commands relatively higher billing rates than other services like software development and maintenance.

"The fact that Infosys is moving up the value chain augurs well for the company," says an analyst from a leading brokerage.

Analysts feel that the company's unique positioning is that apart from having reputed names from the top consultants in the world, the consultancy's rates would be at a discount to top players as they would find it very difficult to match the offshoring expertise and rates of Infosys Consulting.

"Consulting would be the key," says a prominent IT analyst. "In fact, the magnitude of the impact of consultancy on billing rates would be fully seen two years down the line," he adds.

Currency woes

Operating margins may have declined but that is not a phenomenon that is restricted to Infosys. The impact of the rupee on profitability will, to a large extent, be negated by hedging. But, as the company found out in the March quarter, that may not be sufficient.

Last quarter, the sharp appreciation in the rupee led to a negative impact of Rs 26.83 crore on the company's bottomline, compared to a positive impact of Rs 19.52 crore in the December quarter. One of the reasons for this is that regulatory constraints force the company to hedge only to the extent of around 25 per cent of its revenues.

Also consider the fact that the covers to the rupee appreciation are valid for only six months and one cannot blame the company for any complacency in this regard, say analysts. The company reduced the share of fixed price projects in the quarter by 3.7 per cent to lessen the impact of currency fluctuations.

Meanwhile, analysts expect billing rates to slowly edge up in the coming quarters. The company has effected a 17 per cent hike in the fixed component of offshore salaries, but this is not expected to impact margins because a similar amount was paid as a one-time bonus in FY04. The impact on the net margin is expected to be 50-100 basis points.

Financials Standalone figures
(Rs in crore)	Q404	Q304	% Chg
Sales	1,309	1,235	5.96
Other income	2.39	45.19	-94.71
Operating profit	446.74	410.18	8.91
OPM (%)	34.13	33.21	-
Net profit	337.05	328.14	2.72
Net margin	25.75	26.56	-
EPS	50.63	49.49	-
Trailing 12-month EPS	187.38	-	-
Price-earnings ratio	28.7	-	-

The verdict

Analysts view rupee appreciation as a phenomenon which is beyond the company's control. This increase in costs could be absorbed by cost efficiencies, primarily in SG&A (selling, general and administration).

In any case, Infosys plans to make good any loss owing to an appreciating rupee by cutting SG&A expenses by 220 basis points. Analysts expect a 4-6 per cent increase in IT services budgets of Infy's customers.

However, offshore operations should grow as a proportion of IT services spending which, coupled with high end work like consulting, should be the growth driver for the future. At Rs 5380 Infosys presently trades at around 22.8 times estimated FY05 earnings. Analysts are upbeat about the company's volume visibility in FY05 and entry into the consulting arena.

"The stabilisation of billing rates in the last three quarters bodes well for the company and the strong recruitment projections are just an indication of the confidence that the company exudes. 

In all probability, the company looks to be on course to match, if not better its FY05 guidance," says an analyst from a leading brokerage.

Analysts peg an EPS target between 235-240 for FY05. The scrip seems to be fairly price at current levels but it will be prudent not to expect anything more than what the management has guided for.