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TCS: Eyeing long term payoff
Oct 7, 2009

Comparing the management at Coca-Cola to a winning team, Warren Buffett had said - "If you have the 1927 Yankees, all you wish for is their immortality." This can rightly be said about good management teams. But immortality is a fantasy and so is the concept of leaders who 'lead' happily ever after. Leaders come, lead to excellence and then retire giving way to more leaders. It is perpetual and natural.

India's and Asia's largest IT services company, TCS witnessed the phenomenon most recently. Mr. S. Ramadorai retired from the position of CEO of the company and gave way to Mr. N. Chandrasekaran, who previously served as Chief operating officer (COO) and executive director.

Mr. Ramadorai, as is widely known, has propelled TCS through the thick and the thin for the past 13 years to its current illustrious position. He now believes that Mr. Chandrasekaran, who started his career with TCS back in 1972, is well equipped to take on from him.

As we always believe that management is the first and the foremost criteria for judging a company, we thought it is important to analyse the change of guard at TCS.

Strategy: Yesterday, today and tomorrow
Under Mr. Ramadorai's leadership, TCS became a US$ 6 bn company, world's eighth largest IT service provider (by revenues), having a rich clientele of over 800 customers. Apart from the focus on key markets in the US and Europe, the company ventured into new markets in Latin America, China and Eastern Europe.

Source: Company Annual Reports

Given that there has been a change of guard at TCS headquarters, what change in strategies one can expect? Nothing drastic, we believe. The company has followed five core strategies - customer focus, integrated full-service portfolio (IT services, BPO, and infrastructure management), focus on emerging markets, expansion of global delivery footprints with more onsite presence, and keen focus on service quality. This has been TCS' recipe for success over years and is unlikely to be disturbed. Yes, the numbers say it all.

We believe that these have been the major factors that have helped TCS clock in a compounded annual growth of 32% in topline and 27% in bottomline since 2000. The numbers look all the more impressive when one considers the role that the company's management has played in placing the Indian IT industry on the global radar.

As a major change in game-plan, the new leadership is looking to increase the focus on building IT products and frameworks which can ensure more non-linear growth. Such IP creation helps companies in earning higher revenues without adding more to their headcount. It will be a welcome change for TCS, as the company has a higher employee base and lower operating margins as compared to its nearest competitor, Infosys.

Products business, which contributes less than 3% to the company's topline, indeed requires a closer focus. The company plans to set up more global delivery centers and hire more local teams in the US, France, Germany and Japan. The cash-rich IT major will be able to fund capital expenditure from the surplus cash sitting on its books. The company's cash-war chest is expected to be used for strategic acquisitions of capabilities which will expand its portfolio in the IT and IT-enabled service (ITES) domains.

Over the last few years, TCS has made some successful acquisitions like CMC in India, FNS (a banking product company in Australia) and Comicrom (BPO in Chile). However, the company remained cautious about inorganic growth during the current downturn. The deal like Xerox-ACS and Dell-Perot Systems show that consolidation is happening in the global IT environment. As such, the Indian IT majors will have to relook at their strategies for future expansion.

What to expect?
We believe that TCS has shown great resilience while weathering the downturn, re-iterating its leadership position in the global and Indian IT-services arena. It registered decent results in the first quarter of FY10 and has won significant deals in the domestic and global markets. As the company focuses on product development, onsite hiring, employee empowerment and capital expenditure, its operating margins might get constrained in the short-term. But these strategic moves look very appropriate and will bear fruits in the long run.

At the current price of 592, the stock is trading at a multiple of 15.7 times our estimated FY12 earnings. While the stock has run up a lot since our last recommendation, we maintain our positive view on the same.

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