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Organic focus cause of concern for TCS; positive on niche acquisitions

Romita Majumdar/Mumbai 12 Jul 18 | 06:55 AM

TCS’ digital revenues on a smaller base grew almost 9% over the earlier quarter in constant currency terms

Tata Consultancy Services (TCS) beat Street estimates with a 16 per cent revenue jump and 21 per cent profit growth over the year in the June quarter, much in line with the positive numbers that global rival Accenture announced a week before.

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However, analyst have noted the big difference in digital revenues. While Accenture reported 60 per cent of its total revenue came from this segment ($6.8 billion), aided by their strong focus on acquisitions over the past three years, TCS has remained equally stubborn on an organic growth path, yielding 25 per cent of its overall revenues from digital. On a much higher base, Accenture's digital business, including cloud and security services, grew in high double-digits, above the company’s average growth rate.

ALSO READ: TCS shares jump 5.5% to Rs 1,979; m-cap Rs 392.82 bn after Q1 result

TCS’ digital revenues on a smaller base grew almost 9 per cent over the earlier quarter in constant currency terms. Going by the management commentary, much of this growth came from existing clients. This indicates the company is deriving more add-on revenues in digital rather than playing a pure-play digital role that sector watchers have been seeking. 

ALSO READ: TCS back on double-digit growth path led by rebound in BFSI vertical

“(Digital) has a role in terms of new client acquisition but, by and large, a lot of the digital revenue we see is coming from our existing customers and our participation in their digital investments, rather than this revenue coming from a new set of customers," chief executive officer Rajesh Gopinathan said during an analysts' call late Tuesday. 

“Somewhere down the line, this organic focus conveys the sentiment that there are fewer variations in service available from the company and that might affect customer sentiment, if not investors," said a leading analyst at a global research entity, requesting anonymity. 

ALSO READ: TCS starts FY19 with better than expected numbers, net profit rises 23.5%

Among the peer group, TCS continues to lead the organic growth table. However, a look at Accenture’s performance in the past accounting year shows the series of buys it had done in past years was a significant contribution to its double-digits growth.

During 2017-18, Accenture increased its revenue growth forecast range for a third time, to 9.5-10 per cent. At the end of the final quarter of FY17, it had initially said it expected growth of 5-8 per cent for FY18 which it revised to 6-8 per cent after the first quarter, and again to 7-9 per cent at the end of the second one. “Of this (revised guidance of 9.5-10 per cent) growth, 250 basis points will come from acquisitions (50 bps higher than previous years), indicating organic growth of 7-7.5 per cent, which is strong, given its size," said Nirmal Bang analyst Girish Pai in a recent report. 

ALSO READ: TCS Q1 net profit jumps 23.4% to Rs 73.40 billion; revenue up 15.8%

He noted a lot of incremental growth for Accenture in recent years had come from new areas, avoiding direct confrontation with price-competitive India-based players. In the past three years, Accenture has spent at least $3.4 billion on mergers and acquisitions, almost half of which was in 2017. The majority of the 70-odd acquisitions the NYSE-listed company has made are focused on digital and cloud-related businesses. 

"Companies do not bid out their digital requirements the way they would have done for legacy deals. As Accenture has been innovative in acquisitions, a lot more deals are now open for them," said Ashutosh Sharma, vice-president, Forrester Research. 

TCS seems to be changing its organic growth-led strategy a bit. After its first quarter results, the management indicated it was also looking at acquisitions in niche technologies.

ALSO READ: TCS upset over govt's decision to use postal staff at passport centres

“There's been skepticism about our strategy of growing in this particular business organically. We are very clear that people having that contextual knowledge will be the best way forward to deliver greater business value to our client," said N Ganapathy Subramanium, chief operating officer, after the quarterly results. “Having said that, we are open to keep looking at niche players, niche skillsets or niche competencies. If it's available and makes sense, we will go for it."

TCS leads its tier-1 peers in spending on research and development (1.4 per cent of revenue in FY18) but Accenture is spending around two per cent. 

The quarterly results pushed TCS' share price around 5.5 per cent to Rs 1,979.6 on Wednesday. It will be watched by analysts, given the already heavy nature of the stock.

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