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Software: Who's the best?

Aug 30, 2004

As TCS, the largest software services exporter from the country, has been listed on the stock exchanges, the fight to capture the top spot on the investor's radar is likely to become even tougher for the other two software majors - Infosys and Wipro. In order to find who is the top pick among these behemoths, we conducted a poll on Equitymaster. And the result, not quite surprising, can be summarised in the graph below.

While the largest percentage (57%) of those who voted opted for TCS, Infosys and Wipro stood second and third with share of 32% and 11% respectively. However, while the response might be skewed in favour of TCS on account of the euphoric response to its very recent IPO, we believe investors need to take note of the respective performances of these three companies and their growth prospects before making any investment decision.

Comparative parameters (FY04)
(FY04) TCS Infosys Wipro*
Sales growth (CAGR, FY01-FY04, %) 32.6 36.7 35.1
Profits growth (CAGR, FY01-FY04, %) 27.5 25.5 NA
Operating margins (%) 27.3 32.9 22.0
North America's share (% of sales) 62.2 71.2 66.0
Onsite presence (% of sales) 63.8 55.1 58.1
Revenue per client (Rs m) 130.0 123.5 128.5
No. of clients (Nos.) 548 393 339
Revenue per employee (Rs m) 2.4 1.9 2.1
Profit per employee (Rs m) 0.5 0.5 NA
No. of employees (Nos.) 30,121 25,634 20,768
Attrition (%) 6.1 10.5 17.0
Promoter's shareholding (%) 82.7 22.0 83.7
* Only for Global IT services

As seen from the table above, while TCS scores on profit growth, revenues per employee and attrition rate parameters, Infosys has an upper hand on factors like sales growth and operating margins. Also, while Wipro leads in none of the above parameters, it trails both the above companies on operating margins and attrition rate parameters. Wipro's low operating margins can be attributed to large acquisition related expenses that the company had to bear in FY04. And as far as attrition rate is concerned, Wipro trails on account of a large number of its employees working in the BPO division (Wipro Spectramind) that usually has such high employee turnover rates.

Infosys has the highest operating margins of the three mainly on account of a large proportion (45%) of its revenues coming from services rendered offshore, which have higher margins relative to onsite services. On the other hand, TCS and Wipro earn around 36% and 42% of revenues from offshore services, affecting their margins vis--vis Infosys. While billing rates are high for onsite services, costs are also higher thus resulting into lower margins.

Now as far as risks to investment are concerned, Infosys seems less risky a proposition than TCS and Wipro. This is on account of a lower promoter shareholding in Infosys that provides the ordinary shareholders greater liquidity in the markets. For Wipro, while promoters' shareholding stands at around 84%, it is 83% for TCS. Wipro also assumes great risk on account of a large proportion of its revenues coming from the highly volatile R&D outsourcing space. This is because, in times of downturn, expenditure on R&D is the first to get hit. This was evident from the slowdown in technology spending in 2001 and 2002.

Valuation comparison...
(FY04) TCS Infosys Wipro
Current price 963 1,565 569
EPS 34 47 15
P/E 28.6 33.5 38.4
P/S 6.2 8.6 6.7

Now, if one were to gauge the respective valuations of these companies, Wipro, is the most expensive and the major reasons for this are, as mentioned above, low liquidity and high proportion of revenues from R&D services. On the other hand, Infosys commands higher valuations to TCS mainly because the company has a higher margin profile and in our view, is poised to outperform peers going forward.

Through the above discussion, Infosys and TCS come out leaders over Wipro, at least on the basis of past performances and their business models. However, to judge the better player amongst these two would be the difficult part. While Infosys scores on key aspects like project execution, delivery and management excellence fronts, TCS has the advantage of scale (US$ 1.5 bn in revenues and over 30,000 employees) and long-term relationships with key large clients. As such, rather than ranking these companies on the basis of past performance (as there is not much difference), investors need to gauge on the basis of risks involved. And, on that account, our ranks are - Infosys, TCS, Wipro - in that order.

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