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Infosys Turns to Outsider to Shake Things Up and Spur New Growth

Stocks in this article: INFY SAP IBM ACN

NEW YORK (TheStreet) -- In a move that came as no surprise to anyone who follows this company, Infosys (INFY), India's second-largest enterprise consulting company, is replacing co-founder S.D. Shibulal as CEO.

What is a surprise is Infosys went outside of the company in its choice for Shibulal's successor, picking Dr. Vishal Sikka, former chief financial officer at German software company SAP (SAP). He becomes CEO as of Aug. 1.

The move demonstrates the extent of the board's desperation to turn Infosys' fortunes around. The CEO post has only been held by its co-founders since the company's inception in 1981. But persistent stock declines has forced the board's hand to usher an entirely new era.

Infosys shares, currently around $54, are down nearly 5% year to date and 30% over the past three years. Investors want to know how much value Sikka, who will be inducted into Infosys' board this weekend, can harvest out of an underperforming stock.

The IT consulting industry, in which Infosys competes against IBM (IBM) and Accenture (ACN), is still ways away from returning to its once-robust levels. So Sikka has his work cut out for him.

I don't think Sikka will be any worse than Shibulal. In fact, he'll be an upgrade to Infosys' two other co-founders Kris Gopalakrishnan and Narayana Murthy. The latter returned last June as executive chairman. He will step down effective June 14 but retain his role as chairman emeritus.

With shares down 30% over the past three years, Infosys stock should begin to trend higher towards $60 in the next six to 12 months. Assuming Infosys can maintain 8% to 10% long-term revenue growth rate, the stock should regain its three-year high of $75. But the new CEO will need time to harvest that value. Investors must realize it's not going to happen overnight.

While these moves may have come as a necessary measure, there's also the risk Infosys may lose the trust of its customers. Execution during this transition becomes even more crucial. The more pressing question is, what will be different?

Investors should want to see the extent to which Infosys is able to strengthen its market position. To do this, Sikka has to turn around Infosys' persistent reactionary strategies and become more proactive. Sikka needs to figure out ways to get Infosys to respond quickly to changing markets. These are the strengths that IBM and Accenture have demonstrated.

To the extent that Sikka can unhinge the company from the discretionary spending environment, which is always in flux, Infosys will be well on its way to turning things around. Plus, there are plenty of growth opportunities in emerging markets like China and Russia where Infosys' proximity gives it a strong advantage.

But for the shares to work in the long term, Sikka must address the company's persistent lack of profitability. Although Infosys has done an above-average job in growing revenue, (8% year over year vs. 1% for Accenture and -4% for IBM), the rate of growth in free cash flow hasn't been impressive. These shares should do well to the extent management can find ways to boost margins.

To that end, management's job now is to convince investors Infosys is well-positioned to capitalize on service outsourcing if/when that market returns to robust levels. I love the stock at this level, and I don't see any additional risks to this story that has not already been priced into the stock.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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