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TCS Vs BearingPoint: Battle of the goliaths! - Views on News from Equitymaster
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TCS Vs BearingPoint: Battle of the goliaths!
May 18, 2005

India’s software industry is among the most widely tracked sectors of the economy today. And surely, this is not for nothing! The industry has showcased India’s technical and managerial potential to the world in no small measure. It has produced leaders of repute, such as NR Narayanamurthy and Azim Premji, visionaries who have been at the forefront of the IT revolution in the country. Apart from that, software services is a highly people-intensive business and as a result, it has a tremendous job-creating potential – the industry already employs 1.1 m people and is expected to reach 2.0 m people by the year 2008 (as per NASSCOM). This is a big enabler to economic growth. TCS is the largest software services company in the country, offering end-to-end services from plain vanilla application development and maintenance (ADM) to higher-end services such as systems integration and IT/business consulting. However, given that the industry is global in nature, where geographical barriers are irrelevant, it is necessary to have a global vision to become the best in the business. Therefore, just being the largest company from a country is not enough. Comparisons with global peers become necessary if one wants to benchmark oneself against the very best globally.

BearingPoint (formerly KPMG Consulting) is one such global corporation. The company provides systems integration and consulting services to Global 2000 corporations worldwide, serving the government, financial services, consumer, industrial and communication sectors worldwide. We attempt to do a comparison between these two behemoths and see who comes out on top.

Financial comparison: Blow by blow
In terms of revenues, BearingPoint is noticeably larger than the Indian software behemoth. In FY03 (the latest year for which information is available), BearingPoint’s revenues crossed the US$ 3 bn mark, growing by as much as 33% compared to the previous year (the company’s financial year ends in June). This is an impressive performance and to grow at a rate in excess of 30% on a base of a couple of billion dollars is definitely no mean achievement. The company was boosted by some acquisitions it made in Europe and the awarding of a contract to provide services to the Government of Afghanistan.

Revenues: Catching up, slowly but surely!
(US$ m) FY01 FY02 FY03 CAGR
TCS 666 915 1,141 30.9%
BearingPoint 2,856 2,368 3,139 4.8%
Note: BearingPoint’s financial year ends in June.

It must be noted here that since 1999, the company has been executing a strategy to develop a global business platform primarily through acquisitions. This has been the major driver of growth over the years. In fact, in FY01, BearingPoint acquired as many as 17 consulting businesses around the world. Since the global disintegration of Arthur Andersen, BearingPoint acquired Andersen Business Consulting Practices in about 15 countries in FY02. Even in FY03, the company acquired consulting resources in around eight countries. BearingPoint divides its revenues into four segments – communications and media, financial services, consumer, industrial and technology, and public services. Its public services division crossed US$ 1 bn in revenues during FY03.

As far as growth over a period of time is concerned, revenues grew at a meager CAGR of 4.8% between FY01 to FY03. However, from FY97 to FY01, revenues grew at an impressive CAGR of 31.7%.

TCS, on the other hand, earned revenues of around US$ 1.1 bn during FY03 (conversion rate taken as 1 US$ = Rs 48.35). This was, in fact, the first year when it managed to cross the US$ 1 bn mark, the first Indian software company to do so. This was compared to US$ 914.9 m in revenues during FY02, a growth of 20% in dollar terms. However, as far as growth over a period of time is concerned, TCS has grown its revenues and profits at an impressive CAGR of 33.6% and 27.4% respectively from FY01 to FY05. Even if we take the period FY01 to FY03, the company’s revenues and profits have grown at a strong CAGR of 34.4% and 18.5% respectively.

A point to be considered is that BearingPoint’s revenues actually declined by 17% during FY02. The company, in its annual report for FY02, attributed this decline to an economic downturn, as a result of which IT spending of most of its clients was slashed. As a result, the CAGR from FY01 to FY03 has been affected and is in single digits. On the other hand, TCS’ consolidated revenues rose by as much as 43% during FY02, belying any suggestions of a slowdown. Thus, the so-called ‘cyber-coolie’ grew revenues at an exceptionally strong pace when compared with its competitor, which is located higher up the value chain!

One possible explanation for this is that BearingPoint derived as much as 92% of its revenues from North America. Given that the company serves hundreds of Global 2000 clients and that most of these clients are located in North America, the economic slowdown in North America would have mainly affected the IT budgets of these clients. Therefore, this would have had an adverse effect on the company’s revenues. TCS, on the other hand, had a wider geographical spread, earning around 61% of its revenues from the American markets in FY02. Also, the high skills-low cost advantages, coupled with global delivery capabilities and a unique geographical location has helped TCS and most other top tier Indian IT firms to grow their revenues at a strong pace over the past few years.

The Profitability angle: It’s a knockout!
As regards these companies’ efficiencies on the margins and profitability front, TCS wins hands down. At the operating level, in FY03, BearingPoint earned operating margins of a mere 3.6%. The figure for TCS was 24.4%. During FY01 to FY03, the company earned operating margins that hovered between 3.6% and 8%. TCS on the other hand, earned operating margins between 25% and 31%, thus, clearly showing that it is miles ahead of BearingPoint in this regard.

Operating margins: Only one winner!
  FY01 FY02 FY03
TCS 31.2% 30.5% 24.4%
BearingPoint 7.8% 5.6% 3.6%

At the net level, there is virtually no comparison. TCS is a profitable company that has enjoyed strong net profit margins over the years. During the period under comparison, the margins hovered between 20% and 25%. BearingPoint, on the other hand, incurred losses in FY01 and FY02, owing to a combination of an extremely high effective tax rate and one-time items such as the conversion of its preference shares to equity shares at a discount, apart from charges related to rightsizing its employee base. Due to the various acquisitions that the company has made as a part of its growth initiatives, it has incurred charges related to severance pay and other acquisition-related charges. In FY03, the year in which it managed to record a profit, its net margin was a meager 1.3%. TCS’ margins were 19.8% in that year. TCS has benefited from a relatively lower tax rate of 19% during the period under comparison, as well as the strong business growth it has witnessed.

Conclusion
Going forward, it does seem that BearingPoint has recovered from the difficult FY02 that it faced and with better geographical diversification (71% of revenues from North America in FY03 compared to 92% in FY02) and continued focus on inorganic growth, future prospects appear bright. However, given robust business expected to come the way of the Indian software industry, due to factors such as a highly skilled workforce, strong project management skills, cost optimization, global delivery capabilities, fast-improving infrastructure and good management skills, we expect TCS to be a major beneficiary of this growth over the next few years. As the company increasingly moves up the value chain, it will have to compete with global majors such as BearingPoint, IBM Business Consulting and Accenture. Thus, it will not be an easy task. Therefore, it is imperative that the management takes the necessary steps to build greater competencies in high-end services like consulting, or faces the risk of commoditisation of low-end services like plain-vanilla application development and maintenance.

At the current market price of Rs 1,140, TCS’ stock trades at a price to earnings multiple of 21.3 times our current FY06 earnings estimates. We had recommended a ‘Hold’ on the stock in October 2004 at the price of Rs 1,127 with a target price of Rs 1,600. We maintain our recommendation. We will update our research report on TCS shortly after a meeting with the management.

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