India Equity Research | IT TCS

Event Update

TATA CONSULTANCY SERVICES

10 relevant questions asked, answers all reassuring
Over the past month (27
th

INR 1,032

BUY

July 27

th

August), TCS has returned -12% (negative 12%)

August 29, 2007

underperforming the BSE-IT index (-6.5%), the sensex (-2.1%) and its primary peer Infosys (6.2%). We believe that one reason for the companys under-performance relative to the sector could be concern over its relatively concentrated exposure to the banking, financial services and insurance (BFSI) segment. At about 43% of revenues from the BFSI vertical, TCS derives a greater proportion of its revenues from this segment than its peers. Should we be concerned? We spoke to Mr. S. Mahalingam, CFO and Head, Global Finance Tata Consultancy Services (TCS), to understand if TCS senses any incipient impact of the ongoing weakness in the sub-prime mortgage segment in the US. We also wanted to understand whether the company is doing anything differently to deal with this situation. We asked TCS 10 questions on the above-mentioned subject, to which, the company responded in the following manner: Questions and Answers

Parul Inamdar +91-22-2286 4355 parul.inamdar@edelcap.com Viju George +91-22-2286 4295 viju.george@edelcap.com Kunal Sangoi +91-22-2286 4309 kunal.sangoi@edelcap.com

1.

How do you see the environment in the US affecting TCS?

A. At this point, its business as usual.

2.

Does your outlook, both near-term and long-term change for TCS given the crisis in the US?
A. We do not have any indications from our customers to suggest a near-term deterioration in our business prospects.

Reuters Bloomberg

: :

TCS.BO TCS IN

Market Data

Over a slightly longer period, we have some protection from a slowdown on account of the following: TCS has diversified its business across markets both developed and emerging. In FY07, 52.3% of our revenues came from North America and the remaining 47.7% came from other parts of the world.
Financials Year to March Revenues (INR mn)

52-week range (INR) Share in issue (mn) M cap (INR bn/USD mn) Avg. Daily Vol. BSE (000)

: :

1,920 / 900 978.6

: 1,010 / 24,614 : 1,301.8

Within ADM, we have a very high proportion of the revenues from Application Maintenance and Support, which is annuity revenue. TCS has had good success with large deals in various parts of the world and these too provide annuity revenue. A gradual slowdown in the US will act as a driver for further outsourcing by our clients as they are keen
FY 06 126,582
Share Holding Pattern (%) Promoters MFs, FIs & Banks FIIs Others : : : : 80.1 5.6 7.7 6.6

to

retain
FY 07

their

competitiveness.
FY09E 301,564

As such, there is no change in our outlook.

FY08E 233,685 186,334

Rev growth (%)

EBITDA (INR mn) Net profit (INR mn) Shares outstanding (mn) Adj. EPS (INR)

30.1
36,201 28,334 489.3 29.6

47.2
50,630 41,315 978.8 42.2

25.4
64,357 51,862 978.8 53.0

29.0
84,062 64,434

1,400 1,050 (INR) 700 350 -

10,000 7,500 5,000 2,500 ('000)

978.8 65.8

EPS growth (%)

P/E (x) EV/EBITDA (x) ROE (%)
1

35.7
34.9 27.8 62.7

42.6
24.4 19.7 55.8

25.5
19.5 15.2 50.0

24.2
15.7 11.5 47.7

Aug-06 Feb-07 Aug-07

Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.

TCS

3.

How is TCS looking at things at this point in time vis--vis it did at a quarter or two ago?
A. The demand environment continues to look positive. However, we are watching for signs to indicate the contrary.

4.

Are there any segments of your BFSI exposure (especially BFS), that you are worried about? Exposure to investment banking clients or any others?
A. Our direct exposure to sub-prime mortgage lenders is negligible, and to the mortgage segment as a whole, is less than 1% of our revenues. While over 42% of our FY07 revenues came from the BFSI segment, most of the work is done for large, diversified financial institutions. The quality of our clients limits our exposure to a single segment/subvertical. Furthermore, much of the work within BFSI is annuity in nature. In addition, many of our BFSI customers are diversified across geographies. Some of our key clients in this vertical such as ABN Amro are from Europe while some others are from Asia-Pacific.

5.

Are you seeing any impact on business that can be termed as discretionary spending?
A. High-growth services such as business intelligence, enterprise services and consulting are relatively more discretionary. At the moment they continue to show traction and so far we are not seeing a slow-down in such higher-margin discretionary services, but are keeping a watch. Also, outlook on the financial products space continues to be favorable. We have recently created a Financial Products SBU within TCS and are establishing a Strategic Initiatives Group with a view to further leveraging our product positioning & presence and bringing it greater focus.

6.

Is it impacting the way you are building order books, building sales pipeline or winning repeat business? New Clients and promised volume growth from existing clients are they all coming through?
A. There is no change in the near-term outlook for the business.

7.

Are your hiring plans on track or is there some element of a wait-and-watch policy you are now adopting given this global uncertainty?
A. At this point, hiring is progressing as planned. As our hiring is staggered through the year, we do have some flexibility to make tactical adjustments, should the situation so warrant.

8.

What about the impact on your mortgage clients in BPO?

A. Our BPO business has negligible exposure to mortgage clients. We have not seen any impact on our business from the recent events.

9.

Are you getting any sense of how CY08 IT budgets of your key clients is shaping up?
A. Currently, clients are yet to firm up their IT-budgets for the forthcoming calendar. We are carefully monitoring the situation and currently feel comfortable about our clients engagement levels with us. So far, we do not sense banks planning to cut their budgets.

TCS

10. Do you see any difference between the slowdown in 2001-02 and a potential slowdown now and how it can impact you?
A. The slowdown in 2001-02 was caused by a cutback in discretionary investment in internet technology. We do not have such a technology bubble existing today. Furthermore, our customers have come to appreciate our Global Network Delivery Model, which provides them the right skills at the right place, at the right time and at optimum cost. As a result, our customers are utilizing offshore for critical functions in a big way, unlike in 2001-02. So long as any slowdown is gradual, our GNDM positions us very well to help our clients retain their competitiveness, and should therefore do more good than harm to our business. What do we at Edelweiss think? From the chart below, we see that excluding that quick aberration in May 2006, TCSs valuations is currently reaching all time lows (12-month forward rolling P-E valuations), We believe that stock prices will continue to be volatile in the short-term. Observers are trying to assess the multiplier impacts of developments in the US. Investors are unlikely to rush into buy front-line technology stocks because they believe that the bottom is sometime away as further concerns continue to be priced in. In our opinion, further declines in stock prices hereon only make the risk-reward balance more favourable for investor. We firmly believe that TCS can give 25-30% stock returns (over 15-18 months) from these levels, (about 18-20% annualised), once FY10E and the associated gloom of higher taxes post FY09E (with the removal of 10A and 10B exemptions) is factored in. Earnings growth could be back on track post FY10E tracking PBT growth, but clearly the market is not looking that ahead. We estimate TCSs earnings to grow at about 25% over FY07-09E ascribing low risk to this growth. We believe that valuations have become too compelling for investors to ignore any longer, for a company of TCSs size, stature, performance track record, and market opportunity. TCS currently trades at 19.5x FY08E and 15.7x FY09E, and we maintain our BUY rating on the stock. Chart 1: 1-yr forward rolling P/E band Valuations reaching new lows too compelling to ignore
1,500

25x
1,260 (INR/share) 1,020 780 540 300 Feb-07 Feb-06 Jun-06 Dec-06 Feb-05 Jun-05 Dec-05 Dec-04 Jun-07 Apr-06 Oct-04 Oct-05 Oct-06 Apr-05 Apr-07 Aug-04 Aug-05 Aug-06 Aug-07 22x 19x 16x

Source: Edelweiss research

TCS

Company Description
TCS is India's largest and among the oldest IT companies which commenced operations in 1968. It provides a comprehensive range of IT services to industries such as banking and financial services, insurance, manufacturing, telecommunications, retail and transportation. With presence in 34 countries, TCS is positioned to deliver its services seamlessly. TCS has a large diversified client base (780 active clients) which includes seven of the Fortune Top 10 companies. TCS employee force stands at 94,902 (including subsidiaries) and its revenues for the last twelve months (TTM) stood at INR 197 bn (USD 4.5 bn).

Investment Theme
As India's largest and most experienced IT services firm, TCS is well positioned to benefit from the growing demand for offshore IT services. TCS is a serious contender for winning large deals as it has more experience than any of its peers in implementing large, complex, mission critical projects. TCS has multiple margin levers at its disposal, which we believe, will sustain its margins, shielding it from continued pressures on account of wage increases across the industry. These drivers include transition to offshore, leveraging fixed price business, and higher client mining.

Key Risks
Key risks to our investment theme include a) sustained slowdown in US, b) maintaining the margins while pursuing large deals, c) Significant increase in the salary hikes and attrition rate creating cost pressures, and d) Any substantial appreciation of rupee against US dollar, Euro and GBP.

TCS

Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai 400 021, Board: (91-22) 2286 4400, Email: research@edelcap.com
Naresh Kothari Vikas Khemani Shriram Iyer Co-Head Institutional Equities Co-Head Institutional Equities Head Research naresh.kothari@edelcap.com vikas.khemani@edelcap.com shriram.iyer@edelcap.com +91 22 2286 4246 +91 22 2286 4206 +91 22 2286 4256

Coverage group(s) of stocks by primary analyst(s): Information Technology:

Geometric, HCL Tech, Hexaware, i-flex, i-Gate, Infosys, Infotech, Mastek, Mphasis, Patni, Rolta, Sasken, Satyam, TCS, and Wipro

TCS
1,540 Buy 1,340 (INR) Buy 1,140 940 Buy Buy Buy

Recent Research
Date
27-Aug-07 24-Aug-07

Company
Sector Infotech Enterprises Infosys Tech. HCL Tech.

Title
IT Sector, Sector update

Price (INR)

Recos

Fundamentals intact, 280 risk-reward more favorable; Visit Note Ten questions asked, all reassuring answers; Event Update Consistently improving performance; 1,808

Buy

24-Aug-07

Buy

740 Aug-06 Dec-06 May-07 Aug-07 Sep-06 Jan-07 Feb-07 Apr-07 Jun-07 Oct-06 Nov-06 Mar-07 Jul-07
13-Aug-07

317

Buy

Result Update

Distribution of Ratings / Market Cap

Edelweiss Research Coverage Universe Buy
Rating Distribution* 92

Rating Interpretation
Rating Expected to
appreciate more than 20% over a 12-month period appreciate up to 20% over a 12-month period depreciate up to 10% over a 12-month period depreciate more than 10% over a 12-month period

Accumulate
43

Reduce
24

Sell
6

Total
176

Buy Accumulate

* 8 stocks under review / 3 rating withheld

> 50bn
Market Cap (INR) 75

Between 10bn and 50 bn

66

< 10bn
35

Reduce Sell

This document has been prepared by Edelweiss Securities Limited (Edelweiss). Edelweiss and its holding company and associate companies are a full service, integrated investment banking, portfolio management and brokerage group. Our research analysts and sales persons provide important input into our investment banking activities. This document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available data or other sources believed to be reliable, but we do not represent that it is accurate or complete and it should not be relied on as such. Edelweiss or any of its affiliates shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his own advisors to determine the merits and risks of such investment. The investment discussed or views expressed may not be suitable for all investors. We and our affiliates, officers, directors, and employees may: (a) from time to time, have long or short positions in, and buy or sell the securities thereof, of company (ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as advisor or lender/borrower to such company (ies) or have other potential conflict of interest with respect to any recommendation and related information and opinions. This information is strictly confidential and is being furnished to you solely for your information. This information should not be reproduced or redistributed or passed on directly or indirectly in any form to any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject Edelweiss and affiliates to any registration or licensing requirements within such jurisdiction. The distribution of this document in certain jurisdictions may be restricted by law, and persons in whose possession this document comes, should inform themselves about and observe, any such restrictions. The information given in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is subject to change without any prior notice. Edelweiss reserves the right to make modifications and alterations to this statement as may be required from time to time. However, Edelweiss is under no obligation to update or keep the information current. Nevertheless, Edelweiss is committed to providing independent and transparent recommendation to its client and would be happy to provide any information in response to specific client queries. Neither Edelweiss nor any of its affiliates, directors, employees, agents or representatives shall be liable for any damages whether direct, indirect, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. Past performance is not necessarily a guide to future performance. The disclosures of interest statements incorporated in this document are provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. Edelweiss Securities Limited generally prohibits its analysts, persons reporting to analysts and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The analyst for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about the subject company or companies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report. Analyst holding in the stock: no.
Copyright 2007 Edelweiss Research (Edelweiss Securities Ltd). All rights reserved

Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.