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Troubled Infosys risks losing clients in already weak market

Allegations of accounting malpractice shake India's second-largest tech company

Whistleblowers say Infosys CEO Salil Parekh was "bypassing reviews and approvals" on large deals, and withholding information from auditors and the board of directors. (Nikkei Montage/ Reuters)

MUMBAI -- A fresh whistleblower complaint against India's second-largest IT services company Infosys over alleged fraudulent accounting practices to inflate its revenue and profit margin is threatening to further derail a sector that is already facing a slowdown, as demand for its services from financial institutions shrinks.

Infosys, once a bellwether for the industry, is facing allegations of financial malpractice for the second time in just three years. In 2017, then-CEO Vishal Sikka was blamed for misgovernance and was forced to leave after a spat with one of the company founders.

Analysts said the new controversy could push clients to other IT companies.

"The corporate governance issue raises concerns over the company's integrity," KR Choksey Institutional Research said in a note. "We feel that reviewing the whistleblower's complaints might take a few months and the stock will hover upon the ongoing uncertainty. Overall, the development is a huge negative for the company."

On Tuesday, the first trading day after the complaint was made public, investors pulled money out of Infosys causing the stock to tank 16%. The company's market capitalization plunge as much as 534 billion rupees ($7.53 billion).

The whistleblowers filed a complaint letter dated Sept. 30 to the board of directors and the U.S. Securities and Exchange Commission, in which they claimed Infosys CEO Salil Parekh bypassed reviews and approvals on large deals and withheld information from auditors as well as the board.

The employees allege that senior management pressed for the reversal of $50 million worth of upfront contractual payments to be left out of the latest quarterly results, as it would have dented the company's profit.

"Critical information is hidden from the auditors and board. In large contracts like Verizon, Intel and JVs [joint ventures] in Japan, ABN Amro acquisition, revenue recognition matters are forced which are not as per accounting standards," the letter said.

A view of the Bombay Stock Exchange in Mumbai: After the complaint against Infosys was filed to the board of directors and the U.S. Securities and Exchange Commission, the company's stock plunged.   © Reuters

The letter which was also sent to local media on Sunday pushed the Bombay Stock Exchange to seek a response from the company regarding its failure to make disclosures. Indian market regulator Securities and Exchange Board of India and U.S. SEC have begun investigations.

Separately, U.S. law firms, including the Rosen Law Firm, have filed a class-action suit "to recover losses suffered by Infosys investors."

On Tuesday, Infosys Chairman Nandan Nilekani informed the stock exchanges the complaints were being looked into by the company's audit committee and an independent investigation is being carried out. "These complaints are being dealt with in an objective manner," he said in the statement.

The alleged malpractices could deal a heavy blow to the company that faces a sector-wide slowdown. India's top four IT companies -- Infosys, Tata Consultancy Services, HCL Technologies and Wipro -- together made a profit of 173.24 billion rupees, up 5.4% on the year in the last quarter, on revenue of 942.58 billion rupees, up 8.5%. That was the slowest growth in about a year.

In the quarter ended September, Infosys' net profit fell 2.2% to 40.19 billion rupees, although its revenue increased 9.8% to 226.29 billion rupees. It revised upward the lower band of the yearly revenue guidance to 9%-10% from 8.5%-10% projected earlier.

HCL, which announced its earnings on Wednesday, reported net profit of 27.11 billion rupees, up 7% year-on-year on revenue of 175.27 billion rupees. The market leader Tata Consultancy Services' net profit stood at 80.42 billion rupees, merely 1.8% over the previous year, while revenue was higher by 5.8% at 389.77 billion rupees. Its margins are at a nine-quarter low.

Indian IT companies, in the last five years, have moved into providing new digital services from the earlier practice of software maintenance. The investments in new technologies, such as the internet of things, cloud computing, artificial intelligence, worked for both top line and bottom line in recent quarters, although the sector is losing momentum.

Infosys, Wipro, and Tata Consultancy have warned of a softer second half ending March 2020, in large part due to challenges in Europe and the U.S.

In a call with analysts, Wipro's CEO Abidali Neemuchwala pointed out the weakness in the banking and financial services sector. "While we have robust new accounts being added over there [in Europe], some of the drops [are] coming from there and resulting in a negative growth."

DD Mishra, senior director and analyst at global research company Gartner said: "The dream run is over and it is not going to be easy for IT companies to drive and maintain the growth which they used to have. The overall situation will depend on how IT companies are internally transforming to address the new buyer demand in changing market." 

According to local brokerage Nirmal Bang Equities, the peaking of capital expenditure in both the U.S. and Europe and the difficulty in hiring overseas talents in the U.S. because of a tighter visa regime will also hit the industry.

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