Founders’ Keepers? A $5 Billion Question
Due diligence and governance may be serious issues at Infosys, but is it for Murthy & Co to play watchdog after exiting the management? Infosys needs to figure the best way to utilise the cash it is stitting on
They’re calling it Founder’s Remorse. NR Narayana Murthy founded Infosys in 1981, retired three decades later, came back as executive chairman in June 2013 and stepped down in a year after handing over charge to a professional management led by CEO Vishal Sikka. In the process, he also left the board, which today comprises a non-executive chairman (R Seshasayee), seven independent directors and two executive members (Sikka and COO Pravin Rao).
Last week, in a candid interview with ET, Murthy spoke of a “concerning drop in corporate governance” at Infosys. Subsequent reports in ET also suggest the IT bellwether may have fallen short of the standards it’s been known for on the due diligence and disclosures fronts.
Murthy’s criticism led to the board appointing legal firm Amarchand Mangaldas to act as an official communication vehicle among its members, the company’s founders and key stakeholders. It will also guide the board on matters such as the appropriate form of engagement and sharing of information, while adhering to regulatory norms.
Infosys is a company whose global delivery model was envisioned and nurtured by the founder (along with six cofounders), which ensures Murthy’s largerthan-life aura still pervades the headquarters in Bengaluru’s Electronic City. Murthy may have goaded the board into action, but increasingly, the question being asked is, should the founder who stepped away from the board and management be playing watchdog? “Founders who step out should stay out,” declares M Damodaran, a former chairman of market regulator Sebi. “If they have concerns as shareholders, they should write to the company’s management. If their response does not appear convincing, the matter must be raised at the annual general meeting.” Damodaran, now chair person of Excellence Enablers, a corporate governance advisory firm, reckons that airing concerns in the media in a confrontational manner, especially if coming from persons closely identified in the public mind with the company, can be “destabilising.” “While it seems odd for major shareholders to engage with the board and the management through the media, it is equally odd for the board and management to engage with shareholders through a law firm,” he adds. “Such engagement is what the stakeholders relationship committee is specifically tasked with. In all of this, the problem of asymmetry of information should not be lost sight of.”
Infosys is no fami ly-r un business, but since the founders collectively own 12.75% of shares, their position is not too different from a business in which the promoters step back to leave day-to-day operations to a team of professional managers.
Take the Burmans of Dabur India. Vicechairman Amit Burman speaks about the role of the family in business. “They should be available to give broad directions or for any help required, but should stay away from day-to-day management. We believe the family has a trusteeship role to follow and, from time to time, give suggestions to the professional team, but the final decision on whether to implement that suggestion or not rests with the professional management. The founder family, regardless of the percentage they own, is equal to all other shareholders.”
To be sure, founders’ shareholding does give them a right to make their voice heard. R Gopalakrishnan, a former Tata Sons director, says founders who have handed over to a successor may have ei-
The general feeling is that founders should give directions, suggestions or help but stay away from day-to-day management at the co
ther control or influence through their shareholding. “In case the founder is a minority shareholder, they certainly have the right to comment and influence, preferably through the board. The golden rule to remember is that communication, persuasion and influence are hugely valuable in the governance triangle among shareholder, board and CEO.” Shriram Subramanian, MD of corporate governance firm InGovern, said founders are shareholders who have the right to raise issues (and offer solutions) but cannot have preferential access to confidential information. “Infosys has been less transparent on the exits of (former chief financial officer Rajiv) Bansal and (former chief compliance officer David) Kennedy and this shows that values and principles were not right.”
Just when local IT services companies are already on the edge with rising protectionism and tightening visa norms in their biggest market, the US, India’s second-largest player is bogged down by governance challenges.
Although Infosys CEO Vishal Sikka described issues raised in the media as a distraction, investors awaiting a denouement are concerned about the effect of this corporate governance wrangle. Shareholders are anxious about what Infosys plans to do with its stack of $ 5.25 billion in cash. In addition, they want to know how quickly Sikka will shift to the digital model he’s driving, from the worker arbitrage system dominant when the founders ran the show. The CEO’s am- bitious goals include $20 billion in sales, 30% operating margin and revenue per employee of $ 80,000 by March 2021.
“The market is getting impatient about what Infosys will do with the cash,” said a top manager at a securities firm, who asked not to be identified. “As they raise governance issues, can the Infosys board, management and founders afford to take eyes off the competitive environment? IBM and Accenture are getting stronger in digital businesses.” The consensus among investors appears to be that Infosys must use its cash pile to either reward shareholders or acquire assets. “First choice will be to look at business expansion and strategic acquisition,” said the manager quoted earlier. “If there is no acquisition, Infosys should reward shareholders. Either way, Infosys has to spell out the alternatives.”
“Sitting on cash is dragging return on equity,” said Sarabjit K Nangra, vicepresident, research, IT, Angel Broking. “The only way to lift it is to increase the payout ratio (as TCS and Wipro have indicated) or acquire assets.” According to another Mumbai-based analyst who wished to remain anonymous, a buyback is an option to increase shareholder value. “Not doing anything is not a great situation. It’s an opportunity they are missing,” said the analyst.
“They should use the cash to buy technology product and solution companies in the US and spin off low-margin businesses like infrastructure management services,” said Pari Natarajan, cofounder, management consulting firm Zinnov. The other dilemma before Infosys is whether to get on to the digital-first strategy or to continue with the workerarbitrage strategy, which allowed it to send software engineers from India to client sites abroad at a lower cost than hiring them overseas.
Under the arbitrage model, “Infosys will build on its reputation for premium services to protect its industry-leading margins and offset impact on share price by returning cash to shareholders,” said Peter Bendor-Samuel, CEO, Everest Group. However, under the digital-first vision, Infosys will accelerate investments in automation, analytics, cloud and cognitive technologies. While Infosys does not give revenue share for its digital business – Sikka said last year that the company’s “business is 100% digital as we write code” – rivals are taking to the new model. IBM and Accenture have built strong digital consultancy arms. Local rival Wipro bought Danish agency DesignIT in 2015 to launch its digital division and has spent $1.13 billion in acquiring global firms including HealthPlan and Appirio to boost its digital offering. TCS claimed a 30% growth in digital business and Cognizant said 23% of revenue came from digital businesses in 2016. That includes automation, machine learning, AI and data analytics, as opposed to traditional bu s i ne s s s o f t wa r e maintenance services.
Analysts believe digital business for top companies is less than 10% at present. While the management should focus on business, the boardfounders governance tussle threatens to distract executives and dent the brand image of Infosys, which is grappling with shifts to a digital strategy, slowing growth and moves on H-1B visas, which could impact margins significantly.
Nangra of Angel Broking believes more onsite hiring and doubling the minimum wage for H-1B visas could result in a 30% hit on net profit for top players.
Infosys has to act fast to strengthen its governance, show how it’s making the transition to digital and decide on what to do with its cash. Month/Year, Target, Cost ($ million)
NoahConsulting, Kallidus Inc, Panaya*,
R GOPALAKRISHNAN FORMER TATA SONS DIRECTOR
US *This is Infosys’ second-largest acquisition; largest was Zurich-based Lodestone for $350 m in 2012