Buybacks Could Prompt Fresh Trends in IT sector

Mon, 20 Feb Pre-Open

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Indian outsourcing companies are plagued with rising demands from investors for a buyback of shares, even as they grapple with slowing growth and the threat of rising protectionism in the United States.

The outsourcing industry has seen a steady dip in growth in recent times. The National Association of Software and Services Companies has cut the industry's growth target for fiscal 2017 to 8-10% from 10-12% for the same year.

Tata Consultancy Services Ltd (TCS) has said it is considering a buyback of shares. Reports suggest Infosys Ltd may follow suit. This comes close on the heels of Cognizant Technology Solutions Corp.'s decision to drastically increase payouts to shareholders, after being prodded to do so by activist investor Elliott Management Corp.

The Indian mentality is to hold on to cash as most of the Indian businesses are promoter-owned and they like the idea that there is a lot of cash with the company. Buybacks happen when the industry has matured or going through a slow growth period.

This comes at a time when the return ratios of these companies have been unduly low. According to an article in The Livemint, at end of March 2016, 33.5% of TCS's and 45.9% of Infosys's total assets were held in the form of cash and cash equivalents. Return on equity (RoE) at the two companies stood at 33% and 22%, respectively, for fiscal year 2016.

In comparison, Accenture Plc, which has been aggressively buying back shares for years, boasted a RoE of over 60% in the year till August 2016. The company's earnings per share rose at a compound annual growth rate of 15.3% between 2003 and 2016, meaningfully higher than the rate (11.6%) at which net profits have grown.

Also, the argument that buyback would act only as a temporary pain killer and depleted cash could have been used to acquire companies or fuel future growth doesn't hold true. Despite its generous payout ratios, Accenture has also managed a large number of acquisitions, and its growth in terms of incremental revenues has been far ahead of Indian peers lately.

The question now is, does Infosys need to adopt a similar strategy, where the company buys back its shares regularly and buy back is not a mere one time exercise? The shift in strategy is essential as many believe the company is not seen as a growth company anymore, and is instead seen more as a value company. Shareholders can be rewarded either by distributing cash i.e. dividends or via buyback.

The other side of the argument remains that Infosys can utilize the excess cash to buy new technology, which is not cheap, thereby empowering itself to grow at a higher rate.

A share buyback does not change the ground reality that the sector is going through a bad phase. A buyback may signal that a company is deprived of ideas for growth since it is unable to utilize its cash.

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