The Hindu Business Line : Focussing on large deals is a conscious decision

If I were to take the top five large deals, many are mature and have moved over to fixed state of margins. The negative effect that we had is largely gone. MR S. MAHALINGAM, EXECUTIVE VICE-PRESIDENT AND CFO, TCS

The big daddy of IT services, Tata Consultancy Services, has turned in a robust earnings scorecard for the third quarter (October-December), in what is traditionally considered a weak quarter for the sector on account of fewer working days. Closing the quarter with revenues of $1 billion, an impressive 8.4 per cent sequential growth, the company has also recorded an all-round improvement in its financial and operating metrics. Higher operating profit margins, sustained scale-up in clients across different revenue buckets (from $1 million to $50 million), better offshore mix, strong service offerings and geographic spread were the positives in the latest quarter.

In the backdrop of this strong quarter, Investment World interacted with Mr S. Mahalingam, Executive Vice-President and Chief Financial Officer of TCS, to dig deeper into some of the performance variables. One part of the interview with Mr Mahalingam featured in the daily pages earlier last week discussed the nitty-gritties of third quarter performance (http://www.thehindubusinessline.com/2007/01/17/stories/2007011703330400.htm).

After two good quarters of earnings and margin growth, do you think the leeway that you enjoy in improving offshore mix, controlling SG&A (selling, general and administrative) costs and higher pricing are coming down?

When you look at the different levers, one obviously has a certain plan and the time period in which it is to be effected. For instance, issues such as what stance should be taken on contracts coming up for renegotiation, how to look at profitability of projects, how to work around the price levers. That's how we work on a cost management of 19 per cent (for SG&A). The first stage is operational efficiency. Once we exhaust that, then you get into portfolio of services in a big way — as to what you have and how do you grow in a segment where there would be higher margins, and so on.

You have indicated that existing clients are coming in at 3-5 per cent higher billing rates. On an average, what proportion of client contracts come up for rate renegotiation/renewal every year?

We have drawn out a difference between time and material (T&M) and fixed price contracts. (In fixed price contracts, the client entrusts the entire project to TCS to manage at a fixed price decided upfront and TCS can extract its margins from productivity and efficiency gains). In T&M, you make master contracts, which typically run for 2-3 years. Every year 40 per cent comes up for renewal.

For fixed price projects, some part of it would be a part of the master contract. The client would still want information on rates we would be using, so as to fix those rates. Some of these come into the master contract. In other cases, I have to take a pricing position. In those, we adjust against the new contracts that are coming in.

How much of flexibility do you have in negotiating price increases in fixed price contracts?

If it's truly fixed price, where the customer is assured that this would be the cap (in billing rates) and we are assured that we have the ability to improve productivity and get greater gains, then it's a good fixed price contract. If only the customer gets the benefit, for example, a maintenance project where the customer says that he does not want to micro manage, then my ability to reduce costs is lesser. I would like to move that to T&M.

Large deals, according to you, are said to be far more profitable than the market is willing to concede. What factors have dictated the choice of deals? How have margins moved in the top three deals you have won in this and the previous quarter?

There has been some (positive) movement (in margins). Even in large projects where we went through the transition, we had to take in a lot of people, for example, in Sao Paulo, in parts of Europe and so on. Initially when they come in, there is very little we can do in terms of adding the offshoring part of the work. That is where you get into this hockey stick effect. You also have contracts that have blended rates. In the initial part of such contracts, more is done onsite because they have to learn the job... if I were to take the top five large deals, many are mature and have moved over to fixed state of margins. The negative effect that we had is largely gone.

Since large deals may start accounting for a rising proportion of your revenues, how do you plan to keep increasing your offshore mix every quarter?

So long as it (onsite growth) is a conscious decision, I don't have a problem. For instance, if I take a large project, it is going to be initially largely onsite. I take a conscious decision because I know that in time, I would get back into the offshore mode over a period of time. It's not faulty. But is done consciously. That's what happened. Turnkey projects tend to be more onsite oriented. We had said all this and we would like to move in that direction.

You had indicated that you had hedged $583 million for Rs 45-45.50 for the coming quarter.

We take certain positions. First point is, as I go into a quarter, I take stock of what receivables I have and whether I have hedged it appropriately. This maybe a 100 per cent in some cases, other times I might leave a part unhedged. In hedging, you are leaving the upside for the other guy whereas in options, you get the upside but incur certain costs. So we go ahead and do that.

Two points here: What am I going to do to receivables and the second is with respect to net revenues for that quarter, that is, to what extent I hedge. As for dollar receivables, we have $583 million. To a large extent I have covered my receivables fully. Many of those are revalued at Rs 44.24. And I will realise them at 45-45.50 for new receivables, which would roughly be to the tune of $700 million or so. In that part, some portion has been hedged and we will take a position as we go along.

Looking at FNS (in banking products), what impact has licence fee revenues had in your performance for the latest quarter? Will it be an expanding part of the revenue pie?

We bought that company because we want to be a bigger player in that area. That is an important constituent of our strategy. We recognise that (the revenues) on the basis of percentage completion. To that extent it follows a normal pattern. That's why you don't see a very big swing.

It is generally believed that licence portion of revenues (from banking products) can be lumpy, swinging from quarter to quarter?

I do not think so. We don't recognise licence in a short period of time and you go along with customisation and implementation... the critical thing we are paying attention with FNS is to have a continuous stream of revenue. If you take core banking installation, what you have is consultancy aspect and BPR (business process reengineering) comes in. Then you have the licence portion, then customisation, followed by implementation. Normally, for consulting, FNS itself would do it and customisation can be done by TCS. With implementation, a lot of FNS contribution will come in. If I have to maintain a lot of FNS people I would need a steady stream of work, else I would get into a situation where I would have a big bench at various points of time. We are trying to introduce a reasonable rhythm in their process.

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