Tata Consultancy Services: Big and Beautiful

The battle for leadership between Wipro, Infosys and TCS just got fiercer
with TCS now strongly in the public gaze after its public issue. Since it is
significantly larger than the other two, and also due to its Tata Group legacy,
TCS is thought of as less aggressive and nimble. Consequently, in the stock
markets too, it is valued slightly lower than both Wipro and Infosys. We believe
that the greater public scrutiny and interest that its listed status entails
would keep the management on its toes and help TCS maintain its leadership
position in the software firmament.

TCS is part of the Tata Group, which has a heritage of over 135 years as one
of India's leading corporate groups. The Tata Group has interests in a diverse
range of industries, and had a group turnover of Rs 542 billion in fiscal
2002-03.

Established in 1968 in Mumbai, Tata Consultancy Services (TCS) is a leading
global IT services provider and a pioneer of significant developments in the
Indian IT services industry, including the offshore delivery model for IT
services. It is the largest Indian IT services organization in terms of revenues
as well as profits and was the first billion-dollar Indian IT services
organization in terms of annual revenues.

The company provides software services and products in the areas of
e-business, application development and maintenance, architecture, technology,
quality, infrastructure development and managament consulting, engineering
services and, e-security. TCS also performs BPO operations for its IT Services
clients within its various divisions.

TCS offers a comprehensive range of IT services to its clients in industries
such as BFSI, manufacturing, energy and utilities, telecom, retail, healthcare
and transportation. TCS has offices in 32 countries with development centers in
11 countries and a corporate training center located at Thiruvananthapuram. The
CEO of the company is S Ramadorai. The promoter, Tata Group, through Tata Sons
and various other Tata group companies, holds a stake of 85.2% stake, while 1.5%
is held by others, and 13.3% by the public.

TCS entered the capital market in July 2004 with a public issue of 55,452,600
equity shares of Re 1 each comprising fresh issue of 22,775,000 equity shares
and an offer of sale of 32,677,600 equity shares by Tata Sons Limited and
certain other shareholders of TCS. The company issued a bid price range of Rs
775 - Rs 900 and the bids were closed at Rs 850 per share. TCS was earlier a
software division of Tata Sons, and the business was transfered to TCS Ltd for a
total consideration of Rs 2,300 crore. The proceedings of the public issue were
paid back to TCS as transfer amount of the software division. Consequently,
TCS currently has no cash on its balance sheet.

Consolidated revenues for the financial year ended March 2004 amounted to Rs
7,122.7 crores, registering a 29% growth as compared to Rs 5,517.9 crores in the
last fiscal. The consultancy services provided during the year earned revenues
amounting to Rs 6,576.5 crores, up 29% over the last year, contributing a huge
chunk of 92% to the total revenues. This was followed by revenues from sale of
equipment and software licenses, which contributed 7% amounting to Rs 486.9
crores, witnessing a 32% increase over the previous year, whereas the remaining
1% was from other revenues amounting to Rs 59.3 crores, up 13%. TCS has shown
excellent industry average growth despite its growing size. Over the past three
years, revenues have grown at a CAGR of 32% and net profit at 27%. 

TCS is renowned for executing large sized multi-million dollar projects. It
is one of the earliest companies to successfully execute large and complex
projects offshore. Over the past couple of decades, TCS has built up strong
offshore delivery model, which is unlikely to be replicated by MNCs in a short
time. TCS has successfully executed large multi-million dollar contracts
for British Telecom, Canadian Depository, GE Medical Systems, National
Securities Depository and National Stock Exchange. Moreover, TCS is serving
six of its top 10 clients for more than five years, which indicate the ability
to maintain long-term contracts.

With more than 28,000 employees and revenues of Rs 7,122.7 crore, TCS is 1.5
times bigger than its closest listed peer Infosys Technologies. TCS' client
profile is impressive and it services more than 548 clients with GE being its
major client contributing to 20% of total revenues. TCS is also a leading
player in the domestic market after it acquired CMC couple of years back.
Domestic business constitutes 10% of TCS' annual revenues.

Over the past few years, TCS has been aggressive in growing inorganically.
Its major acquisition was that of the Indian government-owned CMC a couple of
years ago. TCS also provides BPO services and it has been consolidating its BPO
operations over the last 15 months. It acquired Swissair's stake in Airline
Financial Support Services Private and plans to acquire a majority stake in WTI,
a firm focused on BPO services in the geospatial segment. TCS also acquired
Phoenix Global Solutions, a provider of IT and BPO services in the insurance
segment. The BPO services are provided through its various divisions. To focus
independently on the BPO services, TCS sold its 50% stake in the BPO JV with
HDFC, Intelenet Global Services for around Rs 161 crore before the IPO.

On the flip side, however, TCS dependence on one client, GE, for 20% of its
revenues is a cause for concern. Revenues from GE stood at around Rs 1,350 crore
out of the Rs 7,500 crore revenues clocked by TCS in FY 2003-04. TCS dependence
on GE could impact its operating margins going forward as GE is known for
squeezing billing rates. Notably, Infosys and Wipro have in the past refused
business from GE due to low realization whereas Satyam and Patni have been
focusing on reducing their dependence on GE.

TCS announced consolidated revenues of Rs 2,133.5 crore and a net profit of
Rs 501.2 crore for the first quarter ended June 2004. While the corresponding
figures for the previous quarter are not available, we believe that the company's
performance is slated to improve following improvement in the performance of
recently acquired CMC. However, the profitability in fiscal 2004-05 could be
impacted by a one time outgo of a special bonus of Rs 100 crore to its key
employees. We believe that with increasing competition, TCS is likely to align
its salary structure in line with its peers', which could increase salary
costs going into the next fiscal as well. For our estimates, we have not taken
into account the extraordinary income arising out of sale of the 50% stake in
the BPO joint venture Intelnet.

TCS currently discounts in March 2005 EPS by 22 times and March 2006 EPS by
17 times. This implies a 10% discount to Infosys' March 2005 PE and 8%
discount to Infosys' March 2006 PE. We believe that this discount will reduce
when TCS announces its next quarterly results, increases cash on its balance
sheet, and when there information about the company's operations becomes more
available to investors. The final verdict, however, is Buy.

Sushanto Mitra The
author is the founder of Technology Capital Partners The views reflected here
are of the author and not of this publication. No liability is accepted for
losses based on the information presented here