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Software: Tata’s colossal presence - Views on News from Equitymaster
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  • May 11, 2001

    Software: Tata’s colossal presence

    Dr. Nirmal Jain the managing director of Tata Infotech, has admitted to the possibility of a merger between Tata Infotech and the software giant of the Tata group, Tata Consultancy Services (TCS). With estimated revenues of Rs 29 bn in FY01 TCS is the largest software company in the country. The merger with Tata Infotech will add Rs 3 bn to its topline thus, creating a software behemoth.

    While Tata Infotech has a diversified business model (it is into software education and hardware), TCS is purely into the software business. It is due to this fact that TCS would have operating margins higher than Tata Infotech. TCS is into value added areas like high-end consulting and end-to-end solutions.

    Tata Infotech % contribution
    to revenues
    TCS % contribution
    to revenues
    Software (International) 50% High end consulting 8%
    Software (Domestic) 20% End to end solutions 40%
    Hardware and Education 30% Development and short
    term assignments
        Time and material
    related contracts

    In FY00 TCS had a net profit was Rs 6,400 m and revenues of Rs 21,150 m, which brings the net profit margins to 30%. Assuming 6% of revenues as interest and depreciation expenses the company’s operating margins comes to around 36%. Considering a 40% growth over FY00 numbers and net profit margin remaining constant the net profit figure for FY01 is expected to be about Rs 8,972 m.

    FY01E TCS Tata Infotech Combined
    Revenues (Rs m) 29,610 5,020 34,630
    Operating Margin (%) 36.0% 7.0% 31.8%
    Net Profit Margin (%) 30.3% 3.7% 26.4%
    Net Profit (Rs m) 8,972 186 9,158
    No of shares (m) 0.4 18.4 -
    Face Value 1000 10 -
    Equity capital 404 184 -
    EPS 22,199 10 -

    TCS plans to become one of the world’s largest IT consulting companies by 2010. The IT consulting space is at the highest end of the software value chain as skill set requirements not only include IT experience but also relevant industry experience. According to IDC (International Data Corp) spending on E-consulting is expected to grow at CAGR of 58% year over the next four years. The market for E-consulting will be US$ 78 bn market by 2003, up 10 times as compared to US$ 7.8 bn in 1998. The other Indian company eyeing this segment is Infosys. With the merger TCS can concentrate on areas like consulting and Tata Infotech already has experience in areas like software development and maintenance.

    TCS also is looking at creating intellectual property and has entered into the products business. The company already has products in the area of accounting, banking, insurance, securities trading and manufacturing segments. Products business has traditionally had higher operating margins. However, the element of risk is also high. The company had planned to earn 30% of its revenues from products by FY01. However, TCS is expected to earn only 5% from products for FY01.

    However, the concern with TCS is that the company has not been agile like its peers (Infosys and Wipro). It had not been able to capitalize on new opportunities like e-commerce and telecommunications software.

    Another concern with the company has been attrition. Traditionally TCS’s pay scales have been lower than the industry leaders. The company being unlisted, its employee stock option schemes seemed unattractive to employees. However, in lieu of that TCS made cash payments of approximately Rs 400 m as performance incentives. The company is also looking at redesigning the compensation packages for its employees.

    But the very fact that the company is planning to be a listed entity is a clue to how radically it is looking at doing away with all the concerns regarding it. No doubt it will continue to be a formidable force in the Indian software industry.

    The question is what valuations the markets will accord to TCS? There seems no ground for it to get anything less than the best in the industry, however a smaller topline growth compared to its peers might bring in an element of discount.



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