TCS versus Infosys: The game gets interesting now

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Valuation gap may narrow in the coming quarter if Infy manages better growth

BL Research Bureau

TCS results were a shocker with revenues growing by a mere 1 per cent sequentially in constant currency terms in the September 2016 quarter. But, with revenue growth at 3.9 per cent and a margin expansion of 80 basis points, Infosys put up a good show.

On all leading indicators of growth, Infosys has done well.

New deal wins were over $1 billion (TCV of large deal wins in the June quarter was $809 million). Seventy eight new clients were added with one new client in the $100 million plus basket and two new clients in the $50 million basket.

Attrition reduced by 10 basis points sequentially to 15.7 per cent. High performer attrition continued to decline. Margins increased by 80 basis points to 24.9 per cent on operational efficiencies.

However, another downward revision in the full year revenue guidance to 8-9 per cent from 10.5-12 per cent (initially 11.5-13.5 per cent), is worrisome, raising doubts over the company’s target of $20 billion dollars in revenue by 2020-21.

After the company reported loss of the RBS project in August, a 100 basis points downward revision in revenue guidance for full year was expected during the second quarter. But, the company yesterday revised the higher end of the revenue guidance band by 150 basis points.

What is comforting though is that the company sees the challenges in revenue as temporary. The management highlighted that they are addressing the pain points on the consulting side and are also focusing on gaining market share through better delivery and use of innovation from the grass root level.

What is also worth noting is the difference in the way CEO Vishal Sikka articulated the challenges before the company. Unlike, TCS’ management that appeared quite disturbed with the trend of slowdown in discretionary spends, Infosys said the problems were limited only to a few accounts. Besides,while Sikka admitted downward pressure on pricing especially in rebid contracts and emphasized on the need to innovate to survive, N Chandrasekaran, claims that pricing is stable and that TCS will be able to maintain margins in the 26-28 per cent band.

Is TCS cutting prices?

Ray Wang, founder of Constellation Research, a global technology research and advisory firm, says Infosys and TCS differ in they way they are approaching the challenges. “TCS is going for scale and competing on cost. Infosys is trying to build more IP and diversify into higher margin offerings”

In an analyst conference before the silent period began in September, Sikka had said, “I am not in favour of ideas around dramatically lowering cost to artificially improve growth and then make margins suffer. We do not believe in that.”

But, focusing on higher margins currently may bring the problem of Infosys losing its relevance with smaller clients who are looking to cut corners. Presently, of all the new deal wins, only about 12-15 per cent turns into revenue in the subsequent year. This may buttress growth only to a limited extent and the balance has to be filled by rebids of existing contracts.

Pravin Rao, COO, Infosys, in a conversation with Business Line however appeared confident of gaining market share without letting go of margins by playing on quality of saleand winning new clients by virtue of their execution track record.

Though the strategy may not help in the near term, it will pay in the longer term, says Ray Wang. “I think in the short run Infosys may see a lower revenue growth. But, ultimately it is only platforms and software that win.”

Valuation

Valuation of the TCS stock hit a several month high vis-à-vis Infosys in August — when TCS traded at 20.6 times it expected one year forward earnings while Infosys trade at 16.8 times. But by mid-September, the gap narrowed as TCS came up with an earnings warning highlighting issues with BFSI clients. However, currently still TCS is at a little premium to Infosys.

On expected earnings for 2016-17, TCS trades at about 17.8 times and Infosys at 16.2 times. This valuation gap may narrow down in the coming quarter if Infosys is able to show better growth for a second quarter in a row.

Published on October 14, 2016
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