Investing in India: should you buy Infosys?

India's software sector has been one of the most high-profile success stories of globalisation. And Infosys Technologies is among the best-known of the companies in the sector.

Infosys is a global technology services company headquartered in Bengaluru (Bangalore), India. It is India's second-largest information technology (IT) company, and is ranked 28th globally. It has a presence in over 33 countries through its offices and development centres in the US, India, Australia, the UK, Canada, Brazil and Japan.

It's a hugely admired company, having won a slew of awards over the years. Better yet, it has also created enormous wealth for its investors. According to Boston Consulting Group (BCG), Infosys ranks among the top ten global technology companies in terms of total shareholder return for the five years from 2005 to 2009.

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The UK represents a huge market for the Indian IT industry, which derives nearly 18% of its total business from the country. Several UK government departments have already started sending IT jobs overseas to cut costs and cope with a shortage of skills locally. For instance, HM Revenue & Customs is beginning an offshore outsourcing pilot scheme in India with technology vendor Capgemini.

While rivals TCS and Wipro have established subsidiaries and won several government outsourcing deals, Infosys's management is taking a more conservative approach, so as to avoid getting into contracts and obligations which may turn out to be detrimental for the company. Given the various pitfalls inherent in working with governments from project delays, to politically motivated last-minute changes this is probably wise.

The outlook for India's IT industry

Like any other industry, the 2008 credit crisis hit the Indian technology sector, with companies around the world reining in their spending. But the fact that offshore outsourcing still offers good value to hard-pressed companies helped the industry bounce back in 2010. The latest results from the major Indian IT companies point to a revival in global IT spending, and their head honchos seem more upbeat about prospects for the future.

Global IT spending is expected to grow by 5.6% this year, compared to 5.4% last year, says research group Gartner. This bodes well for the Indian IT industry in general: it may take a while to get back to pre-downturn growth rates, but there is a strong chance that growth will hit an average of more than 20% a year over the next 5-10 years. Deals are being done at a healthy rate across most markets and most sectors, including banking & financial services, retail and healthcare. This means visibility of deal pipelines and future revenues is reasonable. Infosys should be in a good position to capitalise on this continuously improving environment.

Of course, there are challenges. The IT sector faces serious competition from other outsourcing destinations such as the Philippines and Vietnam, which are catching up. Costs are also rising, which has been made worse by the strength of the rupee and emerging market currencies in general against their Western peers. High employee turnover which also adds to costs - has also become a cause of concern. Infosys has not been immune its profit margins are better than average for the sector, but rising staff costs are squeezing profitability.

It is also important to note that clients are awarding mostly short-term projects, rather than long-term ones. A major reason for this could be the uncertainty at the client level: the global economy might be recovering, but there is still plenty of uncertainty out there. That means there could also be delays in spending decisions which would affect the company adversely.

Infosys has lagged behind its peers in terms of growth due to its conservative nature, in any case. And unlike its peers, the company has not looked to spend its huge cash reserve of US$3.7bn on new acquisitions, so it hasn't benefited from inorganic growth as some of its rivals have. But with new management in place, this is expected to change.

Overall, Infosys Technologies Ltd (NYSE: INFY) has a strong service portfolio and a cost structure that helps it earn above average margins. Of course this industry will be tied to the fortunes of the global economy, but Infosys is one of the best players in the sector. That means it all comes down to the price you pay. For now, Infosys does look cheap. Long-term investors should take the opportunity to buy on dips.

By Equitymaster India's leading 'independent' equity research initiative. Trusted by over a million members all over the world, Equitymaster, with its well-researched, unbiased and honestopinions is the preferred destination for investors interested in the Indian share market.