Strategic Financial Management

Group I – Crew XV

D015 Priyanshu Doshi

E012 Shubham Bharati
C040 Sonakshi Mata
B039 Sristi Nanda
 Table of Contents

Industry Overview: Information Technology.............................................................................3

Tata Consultancy Services (TCS)................................................................................................5
1. Explain its business and financial strategy.............................................................................6
2. Does its valuation justify its business strategy?...................................................................12
3. Why is TCS valued at a premium over Infosys?...................................................................13
Industry Overview: Information Technology
The IT Industry’s Unique Selling Proposition (USP) has been its cost competitiveness in
providing IT services with cost savings of over 60-70 percent over source countries. IT
companies of India have set up over 1000 global delivery centres in over 80 countries in the
world. The industry has contributed around 7.7% to the Indian GDP. It occupies a mighty
55% market share in the sourcing industry and has been one of the largest job creators in the
private sector over the last decade. IT industry in India employs nearly 3.97 million people in
India and is expected to add over 100,000 jobs in FY19.
.
Ma r ket Size o f IT Indust y In India ( U S$ Billio n)
126
Domestic Export 117
108
98.5
87
69 76
59
50

34 35 37 41
29 32 32 32
24
FY1 0 FY1 1 F Y1 2 F Y1 3 F Y1 4 FY1 5 FY1 6 FY1 7 F Y1 8
Source: Nasscom

Growth Drivers and Trends

The IT apex body has already identified data analytics, cyber security and mobile app
development as the key growth drivers for the IT products sector in the days ahead.
The promise of cloud migration. As ‘Everything as a Service’ is substantial and is financially
and operationally efficient and feasible. Information Security continues to be a top growth
trend in IT. The threats keep coming. Factor in the new technologies such as IoT and their
interactions with enterprise architecture, infrastructure and applications, and a tightening
regulatory environment in most industries are causing some challenges to this industry.
The entire IT industry works through Talent Acquisition, Talent Development and Retention

Business Process
IT Services IT Infrastruture Services
Services

Digital Transformation Cloud Adoption Robotic and Cognitive

Core System IT Infrastructure Automation
Renovation Rationalization Analytics,Regulatory
Automation and Market Penetration and Compliance
Efficiency

Growth Drivers of the Industry

Structural Transformation

% share of fixed revenue

60% 56% 57%
52% 52%
55% 49%
47%
50% 44% 44%
42%
45% 39%
40%
35%
30%
Year Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar
-09 -10 -11 -12 -13 -14 -15 -16 -17 -18
Source: Nasscom

A dynamic change is seen in the IT Industry wherein the % revenue share from fixed
contracts has increased from 39% in 2009 to 57% in 2018.

FY18 FY25

18% 38%
62%
82%

India’s IT services industry is exhibiting a structural demand shift, with spiraling demand for
digital solutions and a weaker appetite for traditional services such as application
maintenance and BPO. Role of IT services is transitioning from operational enabler to a
source of competitive advantage.
Tata Consultancy Services (TCS)
TCS is an IT Services, consulting and business solutions provider with a legacy of over 50
years, providing transformational as well as outsourcing services to global enterprises. The
company offers a consulting led integrated portfolio of business, technology and engineering
services and solutions, targeting every C-suite stakeholder. The company sees its location-
independent agile delivery model as a source of competitive advantage and aims to move
entirely to agile delivery by 2020. TCS is headquartered in Mumbai, India, and has a global
presence in 46 countries with 190 Solution centres in 18 countries. A strong headcount of
over 4,00,000 employees engaged in servicing its client base worldwide. In FY18, the
company posted PAT of Rs 258.3 billion and revenues of Rs 1,231 billion.

The company has domain expertise in a broad set of industries, comprising Banking &
Financial Services, Insurance, Telecom, Manufacturing, Retail & Distribution, High Tech,
Life Sciences, Healthcare, Transportation, Energy & Utilities, Media & Entertainment and
others.

Geographically, TCS operates in all five continents, with North America and Europe
constituting the largest markets for our services. We derive over a fifth of our revenues from
emerging markets such as India, Asia-Pacific, Latin America and Middle-East & Africa.

Revenue by Geographies Revenue by Industries

BFSI
12% Americas 16% Retail & CPG
6% Europe Communication &
India 11% 39% Media
Manufacturing
54% Others
Others
27%
17%
17%

Source: Annual Report

 1. Explain its business and financial strategy.
Business Strategy of TCS

The business strategy of TCS is being driven by following key initiatives of the management.

 Business 4.0 – Digital Transformations

o TCS has introduced Business 4.0, a thought leadership framework to help customers
leverage digital technologies to address their growth and transformation agendas. There
is a greater focus on undertaking transformational deals and cases of enterprise systems
converting to cloud.
o By providing depth of offerings across industry verticals, TCS aims to increase their
wallet share through transformational deals, cross sell and upsell to existing and new
customers.
o TCS is betting big on its 'Business 4.0' strategy to propel its revenues from agile and
new age-technologies like automation, cloud and Internet of Things (IoT) to over USD 5
billion in FY19 (FY18 digital revenues: UDS 4 billion, FY19 Q1 digital revenues: USD
1.2 billion)
o Digital Revenues are driver for future growth for TCS:

Non-
Digital Total
TCS - Digital Focus Digital
Revenues Revenues
Revenues
FY18 Revenues (USD mn) 4,047 15,042 19,089
FY19 Q1 Revenues (USD mn) 1,263 3,788 5,051
4 Year CAGR (Year ending FY18) 39.2% 2.5% 7.3%
FY18 (Growth %) 37.9% 2.7% 8.6%
Q1 FY19 (QoQ growth %) 6.7% 0.0% 1.6%
Q1 FY19 (YoY growth %) 45.5% 1.7% 10.0%

Digital Contribution to Revenue on the Rise

30.00 60
48.5
25.00 43.5 45.4 50

20.00 40
32.6 32.6
30.3 29.8
15.00 25.1 30
22.2
10.00 20

5.00 10
15.9 16.1 16.8 17.9 18.9 19.7 22.1 23.8 25.0
0.00 0
Q4 FY17

Q2 FY18

Q3 FY18

Q4 FY18

Q1 FY19
Q1 FY17

Q2 FY17

Q3 FY17

Q1 FY18

Digital Revenue (% of Total) Growth in Digital (YoY, %)

Source: Company Website

 Agile Delivery System:

o New digital startups and changing client needs are disrupting the IT companies’ delivery
model. IT companies must expedite their work process to deliver faster results and
output to clients. Keeping employees in silos, where work would happen on parts of a
code, delays project delivery and can cause gaps in understanding between different
teams. Hence, communication between teams working in silos but involved in the same
process takes time. Also, in a traditional model, the client gets to see the product only at
the delivery stage, leading to possible dissatisfaction with project outcomes.

o Agile is a cross-functional and collaborative software development model, where the

focus is on teams working together in small “sprints” to finish the project. Offices are
more open as cubicles and cabins are replaced by a more collaborative workspace.

o The agile delivery system is thus replacing the

waterfall approach. Waterfall is a linear
approach to software development, while agile
is iterative, team-based approach to
development. Tasks are done in phases called
sprints. Each sprint has a defined duration with
a list of deliverables, planned at the start of the
sprint. If all planned work of the sprint cannot
be completed, work is reprioritized, and the
information is used for future sprint planning.
The agile method ensures consistency between
the client expectations and the end product. The software development happens in stages
and at each stage the version is deployed so that clients can experience the product and
need not wait for the result. The process is expedited as everyone in the team works
closely together.

o TCS is seen to have a significant head-start over its peers and this will help deliver large
digital transformation projects and could be a market share driver for the company.

o TCS has already trained more than 2,11,000 employees in agile delivery and is in the
process of creating new workspaces for them. The company has 400 agile development
zones and plans to increase this to 600 by the end of 2018. About 75,000 employees will
move to newer workspaces. The company plans to be 100% agile by the year 2020.

 Improving client metrics, ensuring exposure across geographies and industries,

providing a suite of products and services meeting needs of all C-suite executives

o Focus is on ensuring presence where there is a demand. Major growth has been coming
from UK and Continental Europe, while there is expectation of an uptick in revenue
 from North America, especially US. Through its Business 4.0 framework, TCS is
targeting transformational deals from its clients to increase the wallet share.

o In FY18, TCS has added 3 more clients in the $100 million+ revenue band, 13 more
clients in the $50 million+ revenue band, 17 more in the $20 million+ band, 40 more in
the $10 million+ band, and 66 in the $1 million+ band.

o The company has also put R&D efforts to provide technology led solutions for each
industry and their business needs. For example, it launched the Quartz Blockchain
Solution, which offers blockchain to enable all stakeholders in a financial ecosystem to
collaborate. TCS also built an Open Banking based API framework to help banks
accelerate their digital transformation journey. Ignio, the cognitive automation software
is helping companies leverage intelligent automation along with robotic automation.
TCS BaNCS has also been critical in deal wins for financial services industry – having
witnessed 29 new wins and 25 go-lives in FY18.

 Tweaking Business Model: US Visa headwinds

o While the rise in US GDP and renewal of growth increases business opportunities, the
protectionist tendencies are acting as a roadblock. TCS has been proactive in addressing
the issue and there is management acceptance that it will have to work in a visa
constrained regime going forward.

o The main aim is to ensure the right mix of resources onsite (local and expat) and to
leverage its near shore and global centers to execute projects.

Overseas Hiring

Hiring
Opening Overseas Local Net Closing Overseas
FY Attrition Growth
Headcount Hiring Hiring Addition Headcount Hiring %
%
FY15 3,00,464 15,596 51,527 47,931 19,192 3,19,656 23.2% 6.4%
FY16 3,19,656 16,173 74,009 55,995 34,187 3,53,843 17.9% 10.7%
FY17 3,53,843 11,584 67,328 45,532 33,380 3,87,223 14.7% 9.4%
FY18* 3,87,223 12,082 39,899 44,206 7,775 3,94,998 23.2% 2.0%
o Thus, the company has adjusted for these scenarios of fewer H1B1 visas by looking to
hire from overseas.

Source: Annual Report

Financial Strategy of TCS

We have tried to explain following financial decisions as a part of financial strategy:

 How company maintains growth? In terms of revenue, EPS etc.
 What are the factors that affect the earnings and how these factors are revealed in the
financial data?
 What is the capital structure of the company and future forecast?
 Qualitative Analysis
How TCS maintains its growth?

The focus of TCS has been on managing the business with optimal efficiency, while
investing for future growth. By maintaining rigor in pricing deals, managing employee and
non-employee costs, collecting and conserving cash and moving work off-shore, they have
achieved significant improvement in their margins and earnings per share. The market cap
has grown from around Rs 47,000 crore during listing to around Rs 6.8 lakh crore — a 14x
growth in less than 14 years. Considering a 33% CAGR, the numbers are impressive in a
post-global financial crisis era.

Also, the company has been able to maintain profitability by operating in a disciplined
manner while sustaining our investments in customer-facing initiatives globally. We have
also been able to significantly increase our cash generation due to efficient working capital
management.

Factors that affect the earnings of the company

1. Volume Growth
The strong sales and revenue growth of TCS reflects their higher business momentum and
many transformation and pipeline deals. There has been a strong progression of customers
into the higher revenue growth bucket on an annual basis vis-à-vis its peers.
29.10%

Client Metrics:
26.90% 26.50%
25.70%
Acquiring new 24.80%
customers and
increasing engagement
with existing customers

Operating Margin

Client Metrics
120
100
80
60
40
20
53 24 68 29 73 37 84 35 97 38
0
FY14 FY15 FY16 FY17 FY18

$50 Mn+ $100 Mn+

40,000

32,000

Operating Profit
24,000
Trends: Sustained
effort to maintain
16,000 margins

8,000

23,808 25,424 28,789 30,324 30,502

0 Operating Profit
FY14 FY15 FY16 FY17 FY18
Source: Bloomberg

2. Operating Margin

The past five years have shown TCS’s s EBIT margin has marginally decreased over the
years but has remained within range of 16.24% in average revenue growth which suggests
that the company has maintained the percentage of revenue that is converted in to net income,
meaning their top line growth has also coincided with an increase in earnings. The current
24.8% EBIT margin is quite competitive when compared with their peers as shown in the
below diagram.

Operating Margins of TCS w.r.t peers

140%
120%
15% Tech Mahindra
Operating Margins

100% 17% Wipro

80% 25% TCS
Infosys
60% 24% HCL Tech
40%
23%
20%
0%
FY 14 FY 15 FY 16 FY 17 FY 18
Source: Bloomberg

3. Attrition Rate

Attrition is a major concern in the industry and to a certain extent affects the earnings of the
company. But the company has maintained a 11.7% attrition rate YoY which is marginally
higher than the industry standards of 11%. Total employee strength at the end of Q1 crossed
the 400k mark and stood at 401,875 on a consolidated basis, the percentage of women in the
workforce rose further to 35.6%.

Attrition rate of TCS w.r.t peers

25.0%
20.0% FY 18;
15.0% 11.0%
10.0%
5.0%
0.0%
FY 14 FY 15 FY 16 FY 17 FY 18

HCL Infosys
TCS Linear (TCS)
Wipro Tech Mahindra
Source: Bloomberg

4. High Cash Conversion Ratio

Operating Cash Flow 121.7% of Net Profit which shows the good health of the company in
terms of converting its cash into payables or software packages sold. Dividend Payout has
increased over the years with the current cash usage and efficient usage of working capital,
being depicted as follows.

Cash Usage

1% 10%
Shareholder Payouts
Invested Funds
28% Acquisitons etc
Capex
61%

Source: Annual Report

5. Return on Invested Capital

ROIC for the company is Rs 26.64 million which shows a balance between investment and
consumption. Because of the high cash and cash equivalents of the company is also very high
(Rs 384,540 million), its ROE is comparatively less at 30.15%. The service based company
has about 40% of its balance sheet in cash and cash equivalents

5. Hedging Policy

As 94% of the company's revenues come from overseas markets, TCS follows a hedging
policy to reduce its risk to foreign exchange exposure volatility. An optimal mix of the
hedging instruments like forward contracts, vanilla options and range forward options is
incorporated in the company’s hedging strategy. The company gets into long term hedging
contracts to protect itself against the long-term exchange rate fluctuations as maximum of
their projects are for a longer tenure.
2. Does its valuation justify its business strategy?
The Valuation of the company has been done using two methods, Fundamental and Relative
and we have used FCFE and P/E respectively. (Please refer the excel model for detailed
calculations)
The summary of valuation is as follows:

VALUATION SUMMARY
METHOD TARGET PRICE WEIGHT
P/E 2,054 50%
FCFE 1,334 50%
Target Price 1,694
Current Market Price 1,993
Overvalued by 18%

The current market price is 18% overvalued than the target price, and the company enjoys a
P/E value of 28.03 whereas the industry average P/E is 19.43. The market is willing to pay
more the TCS stock because of following reasons:

1. Better preparedness to capture digital market:

TCS has the largest % share of revenue for digital as compared to its peers and
is spearheading this with its Strategic Initiative: Industry 4.0. TCS has also been
training its employees on the agile delivery system on a large scale. A structural
transformation is happening in the IT industry wherein the revenue % coming from
digital business is expected to double from 18% to 36% of the total revenue by 2025
and the revenue coming from traditional services is expected to decline. The company
trained 247k associates and 861k digital competencies were acquired as a part of
company’s strategic initiative Scalable re-skilling using Digital Learning Platforms.

2. Organic Growth:

The company has developed capabilities in-house and not gone for aggressive
acquisition to enhance its capabilities which is being followed my many other peers.
Inorganic growth might pose a risk because of differences in strategies of the two
companies and the higher premium required to acquire the target company making it
less viable. TCS has benefitted because of its organic growth and early upgradation of
its capabilities in AI, data analytics, cloud based digital platform and IoT because of
which it acquired mega deals from Rolls Royce and Transamerica.

3. Non-Linear Revenue Model:

TCS has the lowest attrition rate (11.6%) as compared to its peers and it trains its
own employees to upskill and reskill them because of which efficiency of the
employees have increased. The cost of employees which is the biggest component of
cost of revenue has not increased in pace with the industry trends and this lead to the
consistency in high operating margin for the company.
 Apart from these factors, currency depreciation has also played a vital factor as major
revenues and costs for the company are in dollar terms and the currency has
depreciated By 8.1% from Jan’18-Jul’18.

3. Why is TCS valued at a premium over Infosys?

Quantitative Analysis

 Market Capitalization

TCS’s Market cap of Rs. 7466 cr is 2.5 times that of Infosys’s market cap particularly
because of its large-scale, broader geographic mix and consistency in execution. Also, the
share price of TCS is almost 1.4 times that of Infosys so the investors have shown interest in
TCS share.

As of 30/06/2018 (in INR)

  TCS Infosys Ratio
Share Price 1,954.65 1,380.65 1.4
No. of Shares Outstanding(in billion) 3.8 2.2 1.8
Market Cap(in Rs billion) 7,466.8 2,996.0 2.5
Source: Bloomberg

 P/E Ratio

The higher P/E multiple will be supported by a rebound in earnings growth, return ratios and
high return of capital to shareholders.TCS has not only staged a better performance in the
March 2018 quarter but has also pipped Infosys by reporting faster dollar-denominated
revenue growth for FY18 after lagging in the previous two years. The valuation gap would
stay or even increase in the short term until Infosys shows signs of recovery.

As of 30/06/2018 (in INR) Source: Bloomberg

  TCS
P/E Ratio
Infosys
30 2013-14 21.84 17.6
25 2014-15 25.2 20.49
20 2015-16 20.46 20.64
15 2016-17 18.23 16.28
10 2017-18 21.23 15.93
5
0
2013-14 2014-15 2015-16 2016-17 2017-18

TCS Infosys
 Revenue Growth

The trajectories of the country's top two software exporters look starkly different. TCS, the
largest IT exporter, recorded 5.3% growth in revenue for the Quarter Mar-18. For Infosys, the
2.3% growth was amongst the lowest in many years.
 Dollar Revenue Growth in %
30

25

20

15

10

0
FY 12 FY 13 FY 14 FY 15 FY 16 FY 17 FY 18

Infosys TCS

Source: CapitalLine

 Operating Margins

In addition, TCS retained the margin band of 26-28% for FY19, while Infosys lowered it to

22-24% from 23-25%. Also, the rate of attrition for software employees shot up by 310 bps to
16.6% for Infosys in the March quarter from the year ago quarter. For TCS, it was a relatively
lower increase of 50 basis points to 11%.

 Client Additions

TCS fared well on the client additions on year-on-year basis in the March quarter. It added 16
clients with more than 50 million dollar of billing each including three with more than $100-
million billing each. In comparison, Infosys reported six new clients with more than $50-
millions of billing each, including one client above $100-million billing.

 Employee Cost/Total Revenue

The employee cost of TCS has always been lesser than Infosys in the last five years.

Employee Cost/Total Revenue

  TCS Infosys
2013-14 36% 58%
2014-15 41% 56%
2015-16 51% 55%
2016-17 52% 55%
2017-18 54% 55%
Source: Bloomberg

 Attrition Rate
Attrition Rate Attrition was under control
25.00 for TCS, at 11 per cent, compared
20.00 to Infosys' 20 per cent for the
15.00
10.00
5.00
0.00
2013-14 2014-15 2015-16 2016-17 2017-18

TCS Infosys
fiscal year 2017-18. Moreover, TCS witnessed a 2 per cent increase in volumes (person
months billed), indicating client traction even in a traditionally weak quarter for the
industry. Infosys managed a 1.1 per cent increase in volumes.

Attrition Rate
  TCS Infosys
2013-14 11.30 18.70
2014-15 14.90 18.90
2015-16 15.50 18.70
2016-17 11.50 19.20
2017-18 11.00 20.00
Source: Bloomberg

 Number of Clients and Revenue per Client

TCS has around 2150 clients as compared to 1344 clients of Infosys. Also, the number of
clients which accounts for more than $100MM revenue is 38 for TCS and 20 for Infosys.
Also, when we calculate the revenue per client for TCS and Infosys, the data showed that it
has always been more for TCS than Infosys in the last 5 years.

Number of Clients in 2018

TCS Infosys
For Revenue $50+MM-
$100MM 97 92
For Revenue more than
$100MM 38 20
Total Clients 2150 1344
Source: Bloomberg
Revenue per client(in Rs. Cr)
70 Revenue per Client (In Rs. Cr)
  60 TCS Infosys
50
2013-14 54 40
40
2014-15 56 48
30
2015-16 59 Bloomberg
Source: 52
20
2016-17
10 60 54
2017-18
0 57 52
2013-14 2014-15 2015-16 2016-17 2017-18

TCS Infosys

 Return on Equity
 Return on Equity
  TCS Infosys
ROE comaprision
50
2013-14 43.34 26.14
40
2014-15 38.82 26.26 30
2015-16 39.38 24.1 20
10
2016-17 32.85 21.98
0
2017-18 29.38 23.87 2013-14 2014-15 2015-16 2016-17 2017-18

TCS Infosys

Source: Bloomberg

ROE is a significant factor that will decide

how well the company is generating returns
for its shareholders. In IT sector, the high
ROE is not likely to be driven by high debt.
Therefore, investors may have more
confidence in the sustainability of this level
of returns going forward. This ratio is quite
high for TCS as compared to Infosys
showing better value and returns for
investors

Qualitative Analysis

 Leadership Stability

The consistency in leadership and smooth transitions between CEOs are among the reasons
why it has overtaken Infosys. Since its inception, TCS has been run by just four executives
who have maintained the stability in the organization.

In Infosys, the transitions were disruptive and reflected a dearth of internally top-level talent
at Infosys. Following Shibulal’s exit, Infosys founder and former CEO NR Narayana Murthy
returned for a year to stabilize the business while the board scouted for an external
CEO. Vishal Sikka’s exit was followed by co-founder and former CEO Nandan Nilekani
stepping in to pacify the situation before Salil Parekh was brought in from Capgemini.
  Optimally Leveraging its huge scale of business

TCS is better positioned w.r.t structural factors like greater stability in its strategy, strong
processes, execution engine and operational efficiency. This offers it a greater competitive
advantage vis-à-vis peers. Also, the communication of the strategies from the management to
the employees in a structured way helps TCS in aligning its employees’ vision with that of
the company.

Infosys’ 3.0 strategy was a failure because of the gaps in the employees and company’s
vision.
The then CEO blamed the market for Infosys’ struggle and there was a lack of clarity in the
roles and responsibilities assigned to the people of respective segments like sales, marketing
etc.