Infosys vs. TCS: Round 4 - Views on News from Equitymaster

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Infosys vs. TCS: Round 4

Jul 8, 2010

We had earlier compared the two IT biggies Infosys and TCS as per various metrics including the P/E ratio, operating margins and employees. In this final article of the series, we will discuss which company has been a more stable performer in the past. We will specifically look at their performance on the revenue growth and operating margins fronts.

Revenues growth comparison: Over the past few years, the Indian IT sector has grown at a rapid pace. High double digit growth rates were the norm. But, in FY10 due to the global economic crisis the software companies witnessed the slowest growth in over a decade. The sunshine days for the industry surely seem to be over.

Source: Annual Reports, Equitymaster Research
Note: Sector average is based on the average growth rates of the top 5 Indian IT companies
2007 sector growth rate is higher due to Tech Mahindra signing a US$ 1 bn deal with British Telecom
Since HCL Tech's fiscal is June ended - FY10 is an estimate

Over the coverage period, both TCS and Infosys have shown similar movement to how the sector has performed in the period. Infosys however outperformed TCS in revenue growth. It even reported better growth rates than the sector average in FY09, but dipped slightly in FY10. But we believe that Infosys will remain the gold standard of the Indian IT industry with strong growth going forward. However, TCS is close on its heels with new deal wins and new service offerings. New services, launched only in the past few years contributed over 25% of total revenues for TCS.

Operating margins comparison: Infosys clearly has the edge in terms of operating profit margins. It is well ahead of its peers. This is mainly due to its efficient operations and offshore leverage. We had earlier mentioned that TCS is catching up quickly since it has increased its offshore presence. Nonetheless, we believe Infosys will maintain its leadership position going forward on this front as well.

Source: Annual Reports, Equitymaster Research
Note: Sector average is based on the average margins of the top 5 Indian IT companies
Since HCL Tech's fiscal is June ended - FY10 margins are an estimate

Exposure to Europe and future outlook: The Euro-zone crisis has captured headlines over the past few months. While Indian IT companies' clients in North America have been increasing the amount of work they outsource to India, European clients are still tentative. Even with the huge bailout announced for the Euro nations, clients there are still unsure about the future outlook. Gartner has also lowered its forecast on the IT industry. It lowered its estimate on growth of IT spending from 5.3% to 3.9% currently. The main reason for this downgrade was the devaluation of the euro versus the dollar since the beginning of the year.

Infosys has around 23% of its revenues coming from Europe, including UK. However, in terms of currency exposure, only 7% of its revenues are exposed to the Euro and around 8% exposed to the British Pound. Although the region contributes 23% of its revenues, only around 15% of its revenues will be affected due to adverse currency swings.

TCS on the other hand has almost 27% exposure to Europe. Of this a little over 10% is from Europe with the rest coming from UK. Thus, we believe that TCS will be more affected due to adverse currency swings as compared to Infosys. This will have some affect on its rupee revenues, as well as its margins in the short term.

According to Forrester Research, the drop in the Euro is expected to result in at least 12-15% loss in income for Indian software vendors in Europe. It however suggests that service providers could look at increasing billing rates by 10% or more and modify contracts in order to protect themselves against any further drop in Euro's value. Thus clients will be asked to bear the brunt of forex risks.

But, since private clients and governments in Europe are still struggling from the slowdown, they will push for lower billing rates and may even reduce offshoring contracts. All these factors may lead to a drop in revenues from the region, which contributes almost 1/4th of the total revenues of these firms


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