Superb financials but with a plethora of inconsequential siblings
Need for more clarity in financial statements
Companies operating in the public hemisphere have evolved a way of managing the environment, and that includes Tata Consultancy Services (TCS) no less. That is to say concentrate on the image management perspective by focussing on the positives, while quietly sweeping the negatives under the carpet.
The directors' report of TCS to its shareholders bears this out in full view in one glaring respect. The report highlights the increase in gross revenues and net profit of the consolidated entity as compared to that of the preceding year. Fair enough. Similarly, it also highlights the improved performance of the standalone company over that of the preceding year. This too is bang on target. What is left unsaid here is that while the consolidated entity recorded revenues of Rs 489 bn against revenues of Rs 389 bn for the standalone company, the net profit of the consolidated entity is lower than that of the standalone entity during the year. The consolidated entity reported a net profit of Rs 104 bn while the standalone entity posted a net profit of Rs 110 bn. (On the flip side though, the net profit of the consolidated entity in the preceding year was appreciably higher than that of the standalone entity).
Margins under strain in the consolidated entity
The reason for these bizarre set of figures is the tax provision that it has made on the consolidated entity's profits vis-a-vis that of the standalone entity. The consolidated entity reported a marginally higher pre-tax profit of Rs 139 bn as compared to that of the figure of Rs 134 bn for the standalone entity. But the tax provision that the consolidated entity has provided is much larger at Rs 34 bn against Rs 24 bn provided by the standalone entity. This provision in turn led to a lower net post tax profit of the consolidated entity. Still it also goes to show that though the company is at the top of the heap in India, it is a lot more difficult to stay alive given its pidgin size when operating as a legal entity in foreign shores.
There are other pointers too that the consolidated entity may be on a difficult wicket as compared to the standalone entity. This conclusion follows the analysis of the data of one of the key trends of the consolidated entity for the past eight years. In the financial year 2004-05 the consolidated entity earned an average net profit per employee of Rs 4.3 lakhs. In the financial year 2007-08 the profit per employee was Rs 4.5 lakhs. In 2009-10 the profit per employee was Rs 4.36 lakhs. In 2011-12 the profit per employee was Rs 4.36 lakhs. At the end of 2011-12 the consolidated entity has an employee strength of 2,38,583 numbers as against a mere employee strength of 45,714 numbers in financial year end 2005. As one can clearly see there appears to be a catch somewhere. It appears that the per employee contribution in the profit generation is facing a stone wall or some such. The human resources also constitute the bulwark of any IT company, and their compensation package is the single biggest item of revenue expenditure. In the consolidated grouping, employee handouts at Rs 186 bn accounted for 38% of revenues - excluding other income. In the standalone statement, employee handouts at Rs 141 bn accounted for 36% of revenues in a similar manner. The consolidated grouping includes the working results of 21 directly owned subsidiaries and 37 indirectly held subsidiaries. But one will shed more light on this confusion later on in this show.
Employees hold the key
Judging from the looks of it though, there will be let up in employee accretions in the immediate future. In 2011-12 there was a consolidated gross addition of 70,400 employees and a net addition of 39,969 employees. The trend is likely to continue in the current year. This also begs the question of what slowdown that market men are talking about in the IT sector. The other interesting statistic that the company has furnished is that the average employee age is a mere 28 years. This is a revelation alright. For it shows that IT companies are largely run on the motivation and drive of younger blood, and this in itself becomes a fathomable enough reason for IT companies to go on a recruitment spree each year. Not only are the companies dependent on human resources for their succour it costs the employers a pretty package too. The average employee payout for the consolidated entity in 2011-12 was Rs 7.8 lakhs against a much lower 7 lakhs in the preceding year. That is a 12% hike over the previous year.
The standalone entity generated revenues of Rs 388.5 bn - 33% higher than previously. (The parent also boasts of inter-se revenue accruals of Rs 242 bn during the year). But, other income rose substantially to Rs 31 bn from Rs 5.5 bn previously - excluding, that is, forex losses which has lumped with other income. (It also took quite a whack on the solar plexus with a forex loss of Rs 4.3 bn by ending up on the wrong end of the forex call). Consequently, other income accounted for a significant 23% of pre-tax profits against a much lower 6% previously. Thanks partly to this bonanza, the pre-tax profit rose by 53.6% to Rs 134 bn. Curiously enough the jump in other income is almost fully accounted for by a rise in dividends. Dividend income rocketed to Rs 24.2 bn from Rs 390 m previously. (The vast bulk of the company's investments of Rs 57 bn are locked into the equity and debt capital of its siblings). Ironically enough the dividend inflows accelerated precisely at a time when the consolidated entity is collectively generating less money on its siblings! The company also bought and sold collectively, debt instruments and other investments of the value of a phenomenal Rs 270 bn, but it does not appear to have made more than a few dimes on this fruitless exercise.
Higher pre-tax profits
With the tax man getting only a slightly larger bite of 18% of the pre-tax profit against 13% previously the shareholders were rewarded with a much larger post tax income of Rs 110 bn against Rs 75.7 bn previously. The management was generous to a fault in sharing these good tidings with its shareholders. The dividend payout including on preference shares and the dividend tax together at Rs 57.1 bn accounted for 52% of the post tax profit against Rs 32 bn or 42% previously. But the point to also note is that the Tatas are the biggest beneficiaries of this bonanza. Tata Sons and some other group companies control close to 74% of the equity capital of Rs 2 bn while it owns the entire preference capital of Rs 1 bn. So it made eminent sense to dish out a bonanza, so to speak, especially since Tata Sons also has to service the capital requirements of other group companies with its dividend accretions.
The company has a rock solid balance sheet though, and with a most admirable cash flow statement to boot. It generated a net cash inflow of Rs 31.7 bn from operations, though this was much lower than the Rs 57.2 bn that it generated in the preceding year. The taxes paid of Rs 33 bn against 14.8 bn previously partly led to the drop in net cash flow. But this cash generation was more than adequate to take care of its capital expenditure requirements and then some more. Inspite of the gargantuan dividend payout there was still enough loot to put down on fixed deposits.
The company's financial figures at the end of the day are only a tad different from what Infosys conjures up. It boasted cash and bank balances and/or deposits of Rs 58 bn, trade receivables consisting of 85 days sales, a miniscule capital base of Rs 3 bn and backed up by humungous reserves and surplus of Rs 246 bn, and almost size-zero borrowings. As stated earlier, the bulk of the investments of Rs 57 bn are bottled down in tied investments. And, a further sizeable sum of Rs 43 bn is dispersed under a masala mix head called Loans and Advances. The vast bulk of these advances appears to constitute statutory deposits and hence represents working capital funds under government siege. Loans to related parties constitute a mere Rs 5.4 bn out of this largesse. The finances in toto are about as good as it gets.
The gross tangible and intangible assets of Rs 73 bn at year end generated revenues 5.3 times its size in 2011-12. The biggest constituent of the tangible fixed assets schedule is computer equipment of Rs 23.2 bn accounting for 32% of the tangible gross block, while freehold buildings at Rs 19.3 bn came in a close second accounting for 27% of the gross block. Computer equipment is very rapidly depreciated in the books, and the net block at year end was a mere Rs 7.4 bn. This capital item will be a constant drain seen especially in the context of addition to manpower each year and the never-ending need to spruce up the quality of its assets.
The siblings and some more
The bulk of the company's investments in its siblings are concentrated in a few worthies. At the top of the heap is TCS e-Serve with an outlay of Rs 24.2 bn. The shares of the face value of Rs 10 each were acquired for a handsome price of Rs 2,032 per share. This company alone accounts for 47% of the total amount held in tied investments. The other companies with fairly significant investments are Tata America International Corporation with Rs 4.5 bn, Diligenta with Rs 4.3 bn, Tata Consultancy Services Netherlands with Rs 4 bn and CMC ltd with Rs 3.8 bn. There are also some large investments routed through preference shares and debentures too. Interestingly enough the large debenture investment of Rs 3.3 bn is in its own holding company, Tata Sons. So it is also a game of you scratch my back, and I in turn will scratch your back too. Besides, some of these acquisitions were affected at incredulous prices relative to the face value. The shares of Tata America International were acquired for Rs 2,26,500 per share against a face value of US$ 10 per share. Similarly, Diligenta was acquired at a price of Rs 4,290 against a face value of 1 pound sterling.
The company has furnished the financials of 58 direct and or indirect siblings. At the top of the heap and by a mile at that is Tata America International Corporation. This is truly a standout performer. For, on a capital base of a piffling Rs 10 m (that's right Rs 10 m) it generated stupendous revenues of Rs 240 bn and posted a post tax profit of Rs 6.6 bn. That makes this company almost two thirds the size of the standalone company in revenue terms. It also boasted total assets of Rs 56 bn. What in heaven's name does this Charlie do to earn its place under the sun? And that too on an almost non-existent capital base at that! It appears that the IT revenues generated by the parent for the North American markets are offloaded on to this sibling, which is also allowed to make some profit on this exercise. There is no other explanation for this cockide state of affairs. Way down the list at second spot is TCS e-Serve which on a capital base of Rs 124 m generated revenues of Rs 17.3 bn and a post tax of Rs 5.2 bn. Third in the sweep stakes is CMC Ltd (formerly Computer Maintenance Corporation and a spinoff of the old IBM India) with revenues of Rs 10 bn and a post tax profit of Rs 1.4 bn. Next is Tata Consultancy Services, Netherlands which on large capital base of Rs 4.5 bn (the largest among the siblings) generated revenues of Rs 9.3 bn and a post tax profit of Rs 1 bn. The other sibling of some significance is Tata Consultancy Services Switzerland with revenues of Rs 7.6 bn and a post tax profit of Rs 320 m.
An enigma of sorts
Of the list that it has furnished some 14 companies have declared a dividend. The largest dividend was paid out by you guessed Tata America International with a payout of Rs 20.5 bn. The smallest was by Tata Consultancy Services Africa with Rs 9 m. Tata America International is an enigma of sorts - there are no two questions about that. The company posted a post tax profit of Rs 6.6 bn but managed the feat of paying out a dividend far in excess of the net profit that it earned during the year. The only deduction is that it was arm twisted into doing so to shore up the bottom-line of the parent, for reasons better known to the management. Three other companies in the list were also forced to do likewise-the Netherlands sibling, the German sibling, and the Belgian offspring. This would not seem to be exactly the best way to go about doing business, but this is the reality of the matter. But at the same time it is nice to note that the siblings by and large are all reporting a profit at the end of the day.
It will help immensely if the directors can also give a detailed account of the working of the siblings even though the shareholders of the parent are only indirect shareholders of the siblings. There are far too many questions that remain unanswered and it is necessary to come clean on all aspects of its operations.
Disclosure: I hold 416 shares in TCS
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.
Tata Consultancy Services (TCS) has declared results for the quarter ended December 2016. The company has reported a 1.5% QoQ increase in consolidated sales while the consolidated net profit was up 0.9% QoQ.