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Tata Infotech merger with TCS: Our view - Views on News from Equitymaster
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Tata Infotech merger with TCS: Our view
Jul 18, 2005

TCS, Asia’s largest software services company, announced its 1QFY06 results on Friday, July 15, 2005. The company also announced that Tata Infotech Limited (TIL) will be merged with it, effective April 1, 2005, subject to necessary approvals. In this write-up, we analyse the impact of this merger and the potential benefits for TCS and the shareholders. What is the company’s business?
TCS is the largest software company in Asia and has become the first Indian software company to cross the coveted US$ 2 bn revenue mark. It has a wide range of offerings and caters to industries like BFSI, manufacturing, telecom, and retail. The company was one of the pioneers of the much-acclaimed global delivery model and has the largest employee base in the Indian software sector. TCS has grown revenues and profits from FY01 to FY05 at a CAGR of 33.6% and 25.8% respectively.

Tata Infotech Limited (TIL)
TIL is a leading IT company, operating in the areas of software services, BPO, hardware contract manufacturing and education and training. The company has strengths in systems integration, IT infrastructure management, hardware design, contract manufacturing, telecom and education and training. Consolidated revenues and profits stood at Rs 9,599 m and Rs 798 m respectively in FY05. The company divides its revenues into three segments: systems integration services, manufacturing services and education services. Of these, the systems integration segment contributed over 80% to standalone revenues and nearly 70% to standalone EBIT during FY05. EBIT margins in the manufacturing services segment, however, are the highest (around 23%).

The deal…

Tata Infotech: The numbers
Revenues (Rs m) 9,599
% of TCS 9.9%
EBIDTA (Rs m) 1,045
% of TCS 3.7%
PAT (Rs m) 798
% of TCS 3.9%
Employees 3,600
% of TCS 7.4%
Each shareholder of Tata Infotech will receive 1 share of TCS (Face value: Re 1) for every 2 shares of TIL (Face value: Rs 10) held. The market capitalisation of TIL at the current market price is Rs 11,653 m. Thus, the market cap to sales ratio comes to 1.2 times. This appears to be reasonable for a company like Tata Infotech, which, while operating in areas synergistic to those of TCS and complementing its portfolio, has margins which are not nearly as high as those enjoyed by TCS and could be a drag on margins in the short term.

Benefits for TCS
TCS will benefit from the merger. TIL’s strength in high-end systems integration will help TCS’ move up the value chain. The company also operates in the education and training segment. Thus, this acquisition will enable TCS to become a complete end-to-end services provider, operating in the upstream education and training business as well as downstream activities, such as application development and maintenance (ADM). The merger will add 3,600 professionals to TCS’ employee base of nearly 50,000. TCS will also get access to the numerous Fortune 500 clients that TIL serves.

However, it should also be noted that this acquisition could prove to be a drag on margins in the short term. TIL earns operating margins of around 11%, compared to over 27% for TCS. Also, the education business of TIL needs to be revamped to gain market share.

Our view
At the current market price of Rs 1,315, TCS trades at a price to earnings multiple of around 18.3 times our estimated FY07 earnings. The merger with TIL will add around Rs 1.6 to TCS’ earnings. We had recommended a ‘BUY’ on TCS in June 2005. Given the strong prospects of the industry, we expect TCS to be one of the major beneficiaries of the outsourcing story, going forward. Thus, we re-iterate our view on the stock.

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Feb 21, 2018 03:23 PM