IT majors’ share buyback: Shouldn't they fuel innovation and support startups instead or are they done?

Instead of investing in the future, IT companies feel that it is the best time to reward shareholders. The top seven IT companies, which are flush with more than Rs 1,95,948 crore in reserves, should use this money to buy out startups and create an ecosystem of innovation. But that is not happening. Here is why?

Every shareholder is happy when a share buyback is announced. Some even pressure companies to repurchase shares because they see no value in remaining shareholders of the company. And sometimes it is the management that wants to be free of shareholders. But to what end?

By freeing themselves from shareholders they signal two things; first, the companies' inability to innovate and their desire to let shareholders cash out today. Second, it's likely that by freeing themselves from shareholders they can actually go after innovation and be free from quarterly reporting. However, the jury today is in favour of the former and only time will tell if IT services companies are heading for a slowdown or will go on to become new-age platforms companies.

To become platforms companies they need to have lean teams and automate services, which is happening at a very slow pace. Thanks largely to their legacy assets and politics — of job creation - they are not able to focus on a new direction.

Anyway, share buybacks are happening this year and here's why YourStory feels they should not do it. Let us not look beyond Hewlett-Packard, which between 1999 and 2011 bought back $67 billion in stock and HP is still looking to find a spark. Shouldn't Indian companies have something to learn from global experiences?

TCS recently announced a share buyback from investors worth Rs 16,000 crore at Rs 2,850 per share. We also saw a few shareholders of Infosys, like Mohandas Pai and Kris Balakrishnan, demanding a share buyback. Blackstone, the private equity company, offered a buyback to investors in MphasiS after it acquired a majority stake in the company last year. It too offered a buyback of Rs 1,103 crore recently. "Clearly, management wants to take control of things, and it also means that they want to reward shareholders," says Ganesh Prasad, Partner at Khaitan and Company.

So, while the media revels in such announcements from IT companies, are there underpinnings that the reader forgets to notice?

The top seven Indian IT companies have a combined cash hoard of Rs 1,95,948 crore. More than half of this is held by Infosys and TCS. The question is: Shouldn't this money be used for innovation?

Faltering returns

As Ganesh points out, rewarding shareholders isn’t the only reason for a buyback. What must be remembered is that the IT services industry has not been offering the greatest of returns, and the managements want to take control of the running of their companies. There are reasons for such a move. The industry has seen net margins fall to 17-19 percent from the 24-26 percent they were seeing a decade ago. The services industry is getting all the flak for being top-heavy and heavily dependent on people-oriented processes. That's where Infosys is trying a different narrative.

Vishal Sikka, CEO of Infosys, is trying to turn the tide in favour of services companies by building a narrative of doing more with less and of more value. Clearly, IT services is now focused on platforms rather than low-cost testing and application development services. The difficulty, however, is in moving away from services that have won these companies multi-million dollar deals in the past. Today, the platforms or the digital narrative makes up less than 10 percent of any IT company's revenues.

"The IT industry is focused on digital transformation, and its leadership teams are working with their clients to create new business models," says Sanchit Vir Gogia, CEO of Greyhound Research.

Now, the larger question arises: will IT companies buy back shares because they do not know what do with their cash reserves and surplus? This could be one of the possibilities, say analysts, who point to how innovation has been stifled on account of preoccupation with shareholders’ return.

"This is the problem all IT services companies face today. They are stuck between innovation and shareholder return. The next few years will see platform-based services grow in revenues, but what is left to be seen is the clear emergence of a business model," says D.D. Mishra, Research Director at Gartner.

So, buying back shares gives management the comfort of not being asked questions by shareholders. They can run the company to suit their revenue targets or drive consolidation in the industry. But before all this can happen, the shareholders have to agree on a price for a share buyback. For now, the right price is what management is working on. But make no mistake, the IT industry itself is an self-evaluation mode.