WHAT'S ALARMING ABOUT TCS' JANUARY-MARCH RESULTS

» Reports sales growth (according to US GAAP) of 0.2 per cent; Wipro does 9.8 per cent; TCS also sees PAT (as compared to the previous quarter) fall by 34 per cent » An accounting policy change sees inclusion of an EVA-based employee pay off in the last quarter; this results in a drag of Rs 102 crore on the bottom line » The forex related loss this quarter (on operations) is about Rs 50 crore; the market was expecting a no loss, no gain situation » Business from GE (a big client) dropped by about $8 million (Rs 35.2 crore) in the quarter (as compared to the previous quarter) » EBITDA (Earnings before interest, taxes, depreciation, and amortisation) margin is down by 250 basis points QOQ to 26 per cent

In the corporate offices of Tata Consultancy Services (TCS)-there are several of those in Mumbai (this reporter visited two for the story)-the reception sports a large plasma screen with the company's financial results for the year 2004-05 playing out in auto mode. The last slide of the PowerPoint presentation features the company logo and tagline, 'TCS. Beyond The Obvious'.

The obvious, in this case, would have to include the fact that the company's revenues for the most recent quarter (January-March 2005) remained almost the same as compared to the previous quarter, and its net profit for the quarter declined by 34 per cent. This in a quarter when competitors Wipro and Infosys grew their revenues by 9.8 per cent (up from 5.6 per cent) and 7.6 per cent (down from 11.6 per cent) respectively.

TCS' numbers stunned the stock market and caused its stock to go into a state of free fall (it fell some Rs 100 on April 19, the day the results were declared and another Rs 73 the next day). Then, these are just the sort of 'obvious' observations that annoy S. Ramadorai, the normally reticent CEO of the country's largest it services company who is visibly peeved. "We also posted a 36 per cent topline growth year-on-year," he says. "By what stretch of imagination do you call this a bad result?". "We've been taken to task for a good performance," he continues. "We have taken the company from $1 billion (Rs 4,400 crore) in revenue to $2 billion (Rs 8,800 crore) in just two years, are the first Indian it company to achieve this, and you (the media) choose to splash the worst." The man's anger has obviously made him a bit more voluble. "Besides, we have always maintained that we cannot be doing quarter-on-quarter predictions."

That might just be the crux of the issue. The investor community tracks the IT services sector on a quarterly basis (as would be the case for any sector that averages a 6-8 per cent growth in revenues every quarter). That translates into an annual growth of 30 per cent, and investors like companies that display a certain degree of predictability in their revenues. The fact that TCS has not grown at all in the last quarter (it grew in the preceding seven ones) has clearly shaken investors.

"I personally think they may be facing a few challenges with their sales and marketing engine and, given that this is an elephantine company, they need massive wins to swing the momentum on the topline," says Rashesh Shah, CEO and MD of Edelweiss Capital, a Mumbai-based brokerage and investment banking firm. "This happens with every large company once in a while. You need strong forecasting models."

Ramadorai disagrees with that view. "There is no slowdown in marketing," he stresses. "TCS has the best geographical presence and reach, and sustainability of contracts on a long term basis is what we believe in." He again reiterates his point that companies need to be looked at "on an annual basis". S. Mahalingam, the company's CFO, strikes a more conciliatory note by admitting that the company's numbers for the last quarter are below par (instead of blaming the media or instructing analysts on how companies should be studied). "Some growth that we expected to realise in this quarter did not happen," he says. However, he does not think this is an indication of what the coming quarters could look like for TCS. Not everyone believes that.

The Fixed Price, Fixed Time Conundrum

One reason for the lack of predictability in TCS' revenues is because a bulk of these (52 per cent) come from 'fixed price fixed time' contracts as opposed to 'time and material' ones. In the former (the one TCS specialises in) payments are milestone-led; in the latter, the client is billed on an ongoing basis. The latter offers high predictability (the service provider is always in a position to gauge how many employees are going to get billed every quarter on the job). It also leaves less room for cost management and provides lesser scope to take on complex engagements, say TCS execs like S. Padmanabhan, Executive Vice President, Global HRD. "Unlike time and material engagements where the customers ask for CVs (of professionals for the project) and then are in a position to pick the most expensive talent, in the fixed-price model we can structure our people costs with a couple of key people and others who can be guided by them, and thereby have the flexibility to structure the project the way we think is best." The message between the lines: it is less predictable, but more cost-effective.

That cost-effectiveness isn't really evident in the company's financial statements: its operating profit margin of 27.6 per cent is below Infosys' 28.6 per cent but above Wipro's 22.1 per cent (and Wipro's numbers include those for its hardware and consumer care businesses). However, this could also be because of the higher onsite component of its revenues (61.3 per cent) as compared to Wipro (56 per cent) and Infosys (48.1 per cent). Logically, this fits in perfectly with Padmanabhan's explanation that the company is taking on complex engagements (these would necessarily require a high onsite presence). "The projects we undertake often have a degree of complexity that calls for more of an onsite presence," says Ramadorai, adding that he wants to move another 5 per cent of business offshore.

Analysts like Motilal Oswal's Ganesh Duvvuri do see the logic in Ramadorai's argument: "TCS' model is unpredictable. In the third quarter they had achieved certain milestones and the topline bore this out with a 6 per cent growth in rupee terms. This is due to the high fixed-price business component but the company is playing by this model and believes that this is where the industry in general is headed." Only, investors would like more predictability. "When they know that there are no deliverables in a particular quarter that would hit sales, then they should forecast in a manner where the impact of that can be offset by some major wins for that quarter," says one analyst. "What sort of governance practice is that?" retorts a shocked Ramadorai.

Understanding The Business Model

Fact is, TCS' business model isn't very easy to understand. While the company's emphasis on fixed-time, fixed-price contracts might help it bag complex contracts, these would call for a greater onsite presence, thereby eating into profits. And when such business is transferred offshore, it reduces the billing rate. A case in point is the most recent quarter when TCS moved GE projects worth $8 million (Rs 35.2 crore) offshore, a move that hit its topline. Also hurting profits in the quarter was a charge of Rs 102 crore towards the payout on an Economic Value Added (EVA)-based employee incentive scheme (this comes from a change in the accounting practice and is a one-off charge; under the old accounting policy the company would have taken care of this payout in the next fiscal). Then there is a Rs 50 crore net loss (on operations) due to the depreciation of the dollar.

"Some growth that we expected to realise in the quarter did not happen" S. Mahalingam CFO/TCS

"We have had a 2 per cent improvement in operating margins this year despite the Rs 102 crore payout so there is definitely a growth momentum," says Mahalingam. "Investors would look at the returns we have given," adds Ramadorai, rattling off the specifics: 300 per cent dividend in the first quarter (after listing), 500 per cent in the third, and an issue price of just Rs 850 (the stock currently trades at Rs 1,113.70).

The Price Of Going Public

One complaint against TCS has been the lack of clarity in the company's communication to the investor and media community, right from the confusion around the exact date for the announcement of its first ever quarterly results following its IPO to the fact that the company has not provided accounts under the Indian GAAP (generally accepted accounting practices) norms for the years preceding its IPO (it has done so under US GAAP). "That should be sorted out in the next few quarters when there will be one full year of Indian GAAP accounts for comparison," says Mahalingam. "It was a complex transition (from being a division of Tata Sons to becoming a standalone company), we have marketing arms throughout the world, many of whom were owned by different entities and this created a complexity in consolidation under Indian GAAP since you cannot show the consolidation of what did not exist (as a separate entity) whereas in us GAAP you can," he adds.

The issues don't end there as one analyst points out: the communication during the results conference call last week was "managed quite badly" with too many clarifications for comfort.

It's a plethora of issues that need to be addressed and fast if a falling stock price is to be rescued.

"It's not going to be an easy year for