A Bullish Call on Infosys

from US markets, By JMP Securities ($42.10, Dec. 20, 2007)

WE ARE INITIATING COVERAGE OF Infosys with a Market Outperform rating and a $51 price target, representing 19% upside from current levels.

Infosys is an India-based provider of information technology and business processing outsourcing (BPO) services to Global 2000 companies. Infosys obtains approximately 50% of its revenue from offshore delivery in India and 50% from on-site services to clients predominantly in the U.S. and Europe.

Infosys generates 91% of its revenues from IT services, which include: 1) application maintenance (28%); 2) custom development (20%); 3) package implementation (19%); and 4) testing (8%). Additionally, Infosys generates approximately 5% of its revenue from BPO, which is currently growing at 50%-plus annually.

We believe Infosys' American depositary shares have overreacted to concerns around rupee appreciation, and a potential slowdown in IT budgets, particularly in financial services. Although Infosys does have significant exposure to financial services, we believe Infosys is well positioned to weather a modest decline (2%-5%) in IT budgets.

In regards to rupee appreciation, Infosys has a number of levers to offset margin pressure caused by currency appreciation, as it demonstrated earlier in the first quarter of 2007, when the rupee appreciated 7% in one quarter. Infosys' ADS are currently trading at an out-year (fiscal 2009) multiple of 17.3 times, an all-time low. On a calendar-year basis, Infosys trades at a calendar 2008 price/earnings multiple of 18.5 times, below the peer group median of 20.9 times. Our $51 price target implies a calendar 2008 P/E of 22.4 times, a slight premium that we believe is justified by Infosys' high operating margins, strong revenue growth, and Tier-1 position.

Our estimates call for FY'09 GAAP EPS of $2.43, above the consensus estimate of $2.39. Our revenue estimate for FY'09 is $5.34 billion, compared with consensus of $5.31 billion.

Key positives for Infosys include: First, Infosys is well positioned to weather a slight decline in IT budgets, in our view. Second, Infosys has a number of levers to offset margin pressure due to the appreciating rupee and wage pressure. Third, offshore IT services and BPO services are large, fast-growing, and unsaturated markets. Last, Infosys has introduced a number of new service offerings, which should allow it to sustain strong growth rates in range of high 20% to low 30% for the next three to five years.

Key risks that could prevent Infosys from achieving our price target include margin pressure due to appreciating rupee and wage inflation, increased competition from domestic players (Accenture, IBM), and reduced profitability due to expiration of tax holidays.