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Why do great Indian companies like Infosys self-destruct?

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Infosys founder N R Narayana Murthy came back from retirement earlier this month to take charge of India's second biggest outsourcer, which has lagged behind over the last few quarters, pressuring its stock price and dampening investor confidence.

Not so long ago, Infosys was the market favourite, reporting ahead of its own conservative estimates and beating the most optimistic of Street forecast. But over the last five years Infosys has lagged HCL Tech and TCS the same way as TVS Motor has lagged Bajaj Auto, domestic investment bank Ambit says in a report titled "Why do great Indian companies self-destruct?"

Over the past five years, Infosys' net operating profit after tax (NOPAT) declined from 25.1 per cent (in FY09) to 19 per cent (in FY13). During the same period, HCL Tech's NOPAT margins remained relatively flat at 15 per cent in FY13 against 15.5 per cent in FY09.

"Unsurprisingly, therefore over this period, Infosys has underperformed the Nifty by 20 percentage points whilst HCL Tech has outperformed the Nifty by 540 percentage points," Ambit said. (Track stock)

Infosys is not an isolated example of a "great" company running out of steam. Hero MotoCorp, Tata Motors, Ranbaxy and Bharti Airtel, too, have slipped to mediocrity in a span of five years, Ambit's  Saurabh Mukherjea and Gaurav Mehta said.

These companies, once sector leaders - Hero over 2004-09, Tata Motors over 2006-11, Ranbaxy over 2005-10 and Bharti over 2007-12, have turned into laggards and are out of favour of investors, the brokerage says. Tata Steel, Indian Hotels and Bharat Forge have also lost their mojo over the last few years.

In contrast, outsourcing major TCS, ratings agency Crisil, engineering and construction giant L&T and FMCG major Dabur seem to have sustained their leaderships, Ambit says.

"We find that the average probability of a sector leader remaining a sector leader five years later is only 15 per cent, implying that 85 per cent of BSE500 companies slide towards mediocrity. In fact, the average probability of a 'great' company becoming a sector laggard five years later is 25 per cent," Ambit said.

Poor strategic decision-making, fuelled by 'hubris and arrogance', results in poor capital allocation which destroys RoCE (return on capital employed) and creates financial stress," the brokerage adds.

Ambit says the transformation from a "great" company to a laggard takes place through the following phases.

1) Hubris and arrogance: When a company is on top of its game, the management becomes intoxicated by success and adulation. Arrogance sets in and the company loses sight of the factors which made it successful in the first place.

2) Unbridled expansion: In search of more growth and more adulation, the management begins expanding into new geographies and product lines where it has no real experience or expertise.

3) Stuck in a rut: As cost discipline and product excellence erodes, the leader becomes increasingly autocratic and announces plans that aren't based on accumulated experience.

4) Grasping for solutions: The company thrashes around and looks for a solution even as profits and financial strength continue to slide. Senior management jobs are on the line.

5) Capitulation or recovery: The firm is sold or fades into insignificance or turns the corner and begins the long, slow climb to recovery.

Often, promoters cite exogenous factors such as business cycle, government interference, rising competitive intensity or the macro environment for their underperformance, but other firms in the same sector do better than them, Ambit concludes.

 

(Read complete report here)

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