TCS says $6.5 bn data-centre bet will lag IT business on profitability

“Yes, it (data centre business) won't get the same RoEs (return on equity) as you would expect from the TCS business, but we are confident we'll be able to maintain industry-leading return ratios," said chief financial officer Samir Seksaria in a fireside chat between the company's management and Kotak Institutional Equities.

RoE, a measure of profitability, shows how effectively a company uses shareholder investments to generate earnings.

On 9 October, the country’s largest IT services company announced plans to establish a 1GW AI data centre in India through a new business unit, which it later named HyperVault AI Data Centre Ltd. The company said it expects to achieve this in phases by spending about $6.5 billion over a seven-year period in setting up these data centres. These large servers are stacked on top of each other to store data, providing companies with computing power.

Given that IT services are an asset-light business and do not use large machines in factories, TCS’s data centre foray had raised questions about the operating model of this venture.

Citing a strong balance sheet and surplus funds, Seksaria said this particular investment will not be a significant drag on TCS’s return ratios. He said that the company will invest in its data centre business in a phased manner and that it will not entirely be a cash outflow for TCS.

The management didn’t specify how much TCS plans to raise from outside investors for its $6.5 billion investment. “We would not like to call that out, but we have a structure in mind, it would be typical of what data centres operate at," said Seksaria.

‘Less than exciting’

Analysts have flagged concerns about RoE of the new business.

“Profit generation of this data centre business is less than existing IT services business. How much of it will be lower is not mentioned. In asset-heavy businesses, RoE is not high," said Amit Chandra, vice-president of HDFC Securities.

ICICI Securities’ analysts Ruchi Mukhija, Seema Nayak, and Aditi Patil wrote in a 10 October note, “...our preliminary assessment suggests that the capex outlay may lower ROE, from ~50% to 40%, in the next five years."

However, the TCS management said that it would be “extremely competitive on the cost of electricity" to generate a higher margin.

These are high-density data racks of about 50KW-180KW and 370KW per rack on the upper end, because of which more than three-fifths of the cooling would be done through liquid and the rest through air, as servers tend to heat up quickly due to extensive data use, the group executives said.

The company is eyeing land parcels in Navi Mumbai, Hyderabad, Bangalore, New Delhi, and Pune. Collectively, these cities make up more than four-fifths of the country’s total data centre capacity.

“From the time we have land available, we are targeting completion of an 18-month full construction cycle. So from the start date, when we press the button of land being available, the delivery will happen in 18 months," said Deepesh Nanda, chief executive of Tata Power Renewable Energy Ltd, one of the subsidiaries of Tata Power Co.

Much of the demand for data centres is led by hyperscalers that provide cloud computing capabilities and AI companies. For TCS, too, AI companies and hyperscalers will drive the demand, according to TCS chief strategy officer Mangesh Sathe.

One Tata bet

The data-centre foray is also a step towards the One Tata policy, where the IT services company will work towards getting more business from group companies.

TCS will be floating tenders for network solutions to various companies, including Tata Communications Ltd, which once operated data centres in India and Singapore. In 2016, the company started selling this business, calling it “non core".

Since the data-centre announcement on 9 October, TCS’s stock has fallen 0.14% to ₹3,057.8 against a 2.15% rise in the benchmark Sensex 83,938.71 points. Infosys Ltd and Wipro Ltd fell 1.78% and 2.3%, respectively, during the period. On the other hand, HCLTech is up 3.7%

Chandra of HDFC Securities said investors are apprehensive. “Investors are saying they would have been more happy if this money would have been spent on making cutting-edge investments around AI in hi-tech companies, much like Microsoft invested in OpenAI."

According to Pramod Gubbi, founder of Marcellus Investment Managers, “Investors might prefer TCS to return excess cash and focus on what it does best - IT services."

However, JM Financial expects India’s data centre capacity to grow almost four times in the next five years.

India’s colocation data centre capacity as of 2024 stood at 1.35GW, up 38% year-on-year, said JM Financial analysts Abhishek Kumar and Nandan Arekal, in a 27 March note. “Despite this, India’s data centre density is 14 petabyte/megawatt (MW), one of the lowest in the world. We estimate that India needs a total capacity of 5GW by 2030, just to reach 50% of China’s data centre density."