What to watch for in TCS’s June quarter results

Apart from the problem of revving up growth, TCS also needs to address the pace at which it is making itself future-ready


Analysts now expect TCS to post 3.4% sequential dollar growth in the April-June period. Photo: Mint
Analysts now expect TCS to post 3.4% sequential dollar growth in the April-June period. Photo: Mint

Bengaluru: Has Tata Consultancy Services Ltd (TCS) turned the corner? A few equity analysts, like TCS boss N. Chandrasekaran, certainly believe so. TCS, India’s largest software exporter, reported a 1.5% sequential dollar revenue growth in the January-March period to end with $16.54 billion in revenue in 2015-16.

Analysts now expect TCS to post 3.4% sequential dollar growth in the April-June period. Is this enough? TCS’s closest challenger, Cognizant Technology Solutions Corp.’s growth engine is sputtering, as the Nasdaq-listed company lowered its growth target in May to at-best 13% from 14% in calendar year 2016. This saves the TCS management from keeping an eye on the rear-view mirror in fear of being overtaken by US-based Cognizant (unless Cognizant makes a buyout, the company is likely to end this year with at-best $14 billion in revenue).

Still, the April-June period will be the fifth successive time that TCS’s quarterly dollar growth will be lower than Infosys Ltd’s.

Agreed, compared to TCS, Infosys is small (Infosys’s $9.5 billion versus TCS’s $16.54 billion in revenue). To expect a 353,843-strong TCS to grow at the same pace as Infosys is unfair. But repeated good show by Infosys under boss Vishal Sikka means that for the first time since 2007-08, TCS risks adding less incremental revenue than Infosys in this year.

Last year, TCS’s dollar revenue growth of 7.1% ($1.09 billion in incremental revenue) lagged Infosys’s 9.1% ($790 million in new business). TCS does not give any quarterly or yearly guidance but it needs a growth of at least 7.8% this year or face the humiliation of adding less incremental revenue than Infosys’s projected $1.31 billion.

An even bigger concern for TCS is that in each of the two last quarters, the company’s year-over-year (y-o-y) growth has fallen behind Accenture Plc’s. Accenture, which is twice the size of TCS, recorded an 8.5% y-o-y dollar revenue growth in the March-May quarter and a 6% y-o-y growth in the January-March period (Accenture follows 1 September-31 August as the financial year). TCS managed a 7.9% growth in the January-March period and 5.5% growth in the October-December period.

Revving up growth is only part of the problem; a bigger challenge that needs to be addressed by TCS is the pace at which the company is making itself future-ready.

Accenture’s higher growth is primarily because of a strong consultancy practice and the management’s aggressive streak in buying small firms for technologies such as design consultancies and automation platform providers. In the May quarter alone, Accenture invested about $835 million across 11 acquisitions, making its “new strategic initiatives” like cloud and security account for about 40% of the revenue, according to Keith Bachman, analyst at BMO Capital Markets.

Oddly, TCS’s Chandrasekaran has shied away from making a single buyout of any automation or design consultancy. TCS believes it can always build these technologies, including automation and artificial intelligence platforms like Ignio, on its own.

It’s time now that the TCS board, including Tata Group chairman Cyrus Mistry, nudges Chandrasekaran to start buying or investing in smaller firms focused on these technologies. It is not to suggest to TCS to spend billions in headline-grabbing acquisitions; rather it should buy smaller niche-focused firms for technology and talent.

TCS, despite its efforts to concede that newer technologies are fundamentally changing the outsourcing industry model, continues to look away from investing outside the company. The company needs to give a facelift to its existing nine-year-old program of Co-Innovation Network (COIN) to better tap into the start-up ecosystem. Unless there is a change in mindset, TCS’s aspiration to be a worthy competitor to Accenture will remain merely a pipe-dream.

Finally, re-skilling a third of an organisation’s workforce (like TCS) to write software codes on cloud platforms is just one piece; taking technologies of smaller start-ups to TCS’s clients is what completes the jigsaw. Sikka, until now, has followed this two-pronged strategy: Making half of Infosys’s employees go through a day-long class on user-centric approach of Design Thinking offers a helping hand; Infosys in the last 15 months has also spent over $400 million to buy three firms and invest in eight start-ups.

An update on US-based Epic Systems lawsuit against TCS will be helpful but the management may not disclose much. With this as a backdrop, Mint puts the spotlight on five things to watch in TCS’s first quarter earnings on 14 July:

1. Revenue growth

Brokerage BNP Paribas expects TCS’s revenue to rise 3.4% to $4.35 billion in the April-June period on a sequential basis. Although this will be less than 3.5% sequential growth reported in the first quarter of last year, it will be a decent start to the year. Management commentary on demand levels from its customers in Europe, especially in the wake of uncertainty thrown by Britain’s vote to leave European Union, will be crucial.

2. Rain check of weak sectors and geographies

At the end of the fourth quarter, Chandrasekaran told this paper that softness in Diligenta, and weakness in telecoms segment and Japan geography eroded about 2% growth from the company’s 11.9% growth on constant currency basis in 2015-16. TCS expects softness to abate in some of these weak spots. Investors and analysts will also want an update on client spend in the banking and financial services segment.

3. Currency fluctuation

Traditionally, cross-currency fluctuations has either hurt or benefitted TCS’s revenue growth by 1%. Last year was an exception as Euro and Latin American currencies hurt the company’s growth by 4.8%. For this reason, TCS at the start of the year was more bullish on its growth target for this year, expecting a more stable currency movement. However, an over 13% slide in sterling against the dollar, means the company which books its revenue from clients in the UK in pound will see an impact in business. Management commentary on currency movement for the year-ahead, and if fall of pound in the last of week of June impacted company’s performance in the last quarter will be important.

4. Is higher net erosion of existing business biting into TCS’s growth?

During the July-September period last year, TCS claimed its order book was the strongest ever, with about 30% more than the company ever managed in any quarter. TCS, however, did not disclose its order book size. Typically, IT firms lose about 3-5% of current business. In TCS’s case, this translates into a loss of about $500-825 million a year. Many outsourcing deals are long-term contracts, and IT vendors can generate only about 3-4% of revenue from new orders in the first year, according to Viju George, an analyst at JPMorgan Chase and Co. Understandably, TCS should report higher growth in the first half of this year than last year. For this year, revenue growth in the first quarter and TCS management commentary on the second half will be important.

5. More details on revenues from digital space

TCS defines $2.28 billion of $16.54 billion revenue as part of digital business, but the company does not spell out the individual constituents of this digital business, such as cloud computing, mobility platforms and internet of things. Further, the company did share one time last time the share of digital revenue from each of its industry segments, including BFSI, manufacturing and retail. For this reason, many believe that the TCS management could also give an update on digital from industry segments, and on the composition of digital revenue from each of the solution-development side, including application development and infrastructure maintenance.

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