Why a buyback makes sense

Updated: Aug 11 2014, 16:34pm hrs
The argument made in the Financial Express editorial published August 7 Buyback is no solutionthat nothing other than good performance counts for stock priceis correct. This is true of every company every day of the year, not just Infosys of today. This is a given and given that there is confidence in management of Infosys, we are addressing the issues of prudential capital management. Hence, this out-of-the-hand dismissal of this idea is thus not in keeping with either modern notions of good capital management (management is a custodian of shareholders funds) or the belief that Infosys wants to manage its capital better.

There are several compelling reasonsboth financial and non-financialthat demand some sort of buyback and proper use of cash reserves. First of all, we would discount the argument that ex-CFOs have proposed an idea that they did not accept when they were in Infosys. The context of that era was different from the current one. It is our belief that these issues were consistently debated internally. Decisions like one-time dividends are a result of such healthy debates.

Infosys always worked on the following principle: In god we trust while rest of us bring data to the table. Thus, any idea is to be evaluated purely based on merit, regardless of source of the idea, timing of the idea and we would even add motivation behind the idea. Questioning these as some of the reports have done is to throw the baby out with bathwater.

Let us take the financial points first. The key points are there is $5 billion of cash today, earning 5.5% post tax. The quality of earnings is also deteriorating with close to 20% of the net profits coming from non-operating income. Infosys is in a maturing industry and has gross cash flows of approximately $2 billion per year. It has a declining ROI. Cash to revenue ratios are closer to 60% rather than 35-40% which used to be the case when the company was growing at higher growth rates. The company has also started investing part of the surplus in long-term bonds to enhance returns, compromising its ability to use it for strategic intent. Documents attached to the letter to the board contain details of this compelling argument.

Accenture, a company in the same business, has single-digit growth rates and has doubled its market cap using buybacks. Tragedy forced a change of leadership at Apple. The incoming CEO was reminded of cash reserves by shareholders and they started a buyback and dividend programme which has met with shareholder approval. Nothing bad has happened to Apple either except becoming the most valued company. Hence, this is a call for prudent capital management from a company known for its prudence.

Let us take a look at the non-financial parameters. Big acquisitions are very risky at best. (HP and Autonomy is a good recent example). Assuming that Infosys will not bet all of its cash pile on the big ones, there is adequate money for small ones and hence this hoarding for an acquisition is a flawed argument. Besides, one can always use stock instead of cash.

Given the fast paced change in management, we believe that Infosys is at an inflection point, similar to what Apple was when its new management team took over. New management team at Infosys may not have the same emotional and financial stake in the company as the old founding team. Hence, all the more reason for this proposal to be taken seriously.

Lastly, there is an argument that if we do not like the Infosys stock, we can vote with our feet. This is absolutely correct and we would have done so but for a small factor. We are emotionally attached to Infosys. It is indeed painful to see Infosys lose it position of eminence and play catch up.

V Balakrishnan, DN Prahlad & TV Mohandas Pai

The authors are former Infosys top executives