Where are the new deal wins for TCS?

Tata Consultancy Services (TCS), with a revenue of $22 billion in 2019-20, is not just the ‘Big Daddy’ of the Tata Group. It is the largest IT services exporter from India, with a stellar operating margin of 26.6%. Unsurprisingly, it reported its strongest third quarter in nine years as a reaffirmation of the digital transformation narrative in the post-pandemic world.

The quarterly revenue of Rs 42,015 crore ($5.7 billion) is a 4.1% sequential growth in constant currency. More crucially, it attained parity of the pre-Covid quarterly revenue mark: 0.4% growth compared to the corresponding quarter a year ago.

TCS clocked a total contract value of $6.8 billion in this quarter, compared to $8.6 billion in the second quarter, with negligible revenue accruing from its deal with Prudential Financial, which was announced on November 12, 2020. And no revenue accrued from another deal of that sort with Deutsche Bank to acquire its Postbank Systems assets. 

What’s that about?

Here’s what TCS chief financial officer Venkataraman Ramakrishnan said, “Of the two large deals we signed in Q3, the Prudential Financial deal was closed in mid-December, but very little to the revenue was added in this quarter. And the Postbank Systems deal was closed actually on January 1.”

Both these deals entailed a transfer of employees from the sellers. So 1,500 staff members of Pramerica Systems Ireland, which is Prudential’s Irish subsidiary, are now TCS employees.
Similarly, Postbank Systems’ 1,500 employees are now on the payroll of TCS.

How does one begin to describe this?

It’s called a captive deal. And chief operating officer NG Subramaniam described it to TechCircle today in an email.

“Organisations build their captives for various reasons. Whenever they feel they have achieved their initial set of objectives, but the incremental value delivered is not so compelling or when they feel that they are unable to offer a sustained career path to people in their captive, they look for divesting this to someone who can offer a better career and use for the talent and at the same time, it unlocks certain economic value,” he said. 

Enterprise client advisors had foreseen this situation as a post-Covid phenomenon in April 2020.

Really?

Yes, ISG predicted that in the mid term, enterprises will monetise their captive centres. “Poor performing captives will likely be monetised to provide a cash infusion and improvement in business resiliency, thus creating opportunities for service providers to expand their portfolios,” Stanton Jones, director and principal analyst at ISG Research, said.

What’s in it for TCS?

TCS wants to consolidate its position, and grow its existing relationship with Prudential Financial and Deutsche Bank. Additionally, the deals give TCS a boost to its operations in Ireland, Germany and Europe. 

“Structurally, this is not different from good old outsourcing deals where one sometimes takes over their employees—mandated by Transfer of Undertakings (Protection of Employment), or the Acquired Rights Directive—and assets,” Subramaniam told TechCircle.

“The key is to ensure that we structure it carefully, making clients aware of what should be the retained organisation in such a way that it is value accretive for both,” he said. 

The acquired subsidiary is often an IT arm of the seller. Such an arrangement allows the buyer to focus on its core competencies, and outsource its entire IT operations to a TCS, Infosys or Wipro.

Each of the three IT services firms have signed a captive deal or two, in the December quarter alone, all in Europe—TCS with Prudential Financial and Deutsche Bank, Infosys with German carmaker Daimler, and Wipro with German wholesaler METRO. 

TCS CEO Rajesh Gopinathan said that the trend was only a normal progression, as the European markets have started to converge with other markets. 

For the sellers, IT operations become less expensive because it is available at the economies of scale that IT service providers can offer.

Even as economy of scale takes over with companies such as TCS, the firm is yet to project its strategy on how it intends to balance its profit margin between increasing revenues and re-waging of captive deals, in the immediate quarters. 

“The employees have just come at the end of the quarter,” Venkataraman Ramakrishnan told analysts on Friday. “Arithmetically, our denominator is higher, but the revenue from that will come from the subsequent quarter.” 

Remind me, what is TCS’ headcount?

It has 469,261 employees. And its attrition rate is down to 7.6% from 12.1% in April 2020. Employees are working from home, and don’t want to leave TCS amid the uncertainty.

And?

The digital transformation spiel is on and about. More than 200 TCS customers began cloud engagements in Q3 2020-21. “We are also very happy to share that we have been ranked as a leader by a leading industry analyst for the public cloud system integrator space in each of these platforms apart from this cloud infrastructure, brokerage, orchestration, services, etc.,” Gopinathan told analysts on Friday.

Wait, how many customers does TCS have?

As of December 2020, it has 1,077 clients, as reported in its classification across deal sizes. And here’s the thing to note—it’s up by just five clients from 1,072 in April 2020, when the world began to be locked in response to the pandemic.

But still...

TCS has 48 clients who contribute more than $100 million to revenue, as of December 2020--that is one client less than its April 2020 figure. It had 97 clients who contributed more than $50 million to revenue in December 2020--eight lower compared to the April 2020 figure. It has 229 clients who contribute more than $20 million to the December 2020 quarterly revenue, which is 11 less than the April 2020 figure.

And finally, it had 386 clients in December who contributed more than $10 million to revenue, which is five less than in April.

“Some clients would have reduced their spending in the June quarter due to Covid-led financial stress, which is why you will see a few clients go out of certain buckets. It should be noted this data is reported on a last twelve months (LTM) basis and hence quarterly comparisons should be interpreted carefully,” Sudheer Guntupalli, lead analyst (technology and internet), ICICI Securities, told TechCircle.

According to another industry source, the year continues to be challenging as enterprises in industries such as entertainment, airlines and travel have been hit by the pandemic. There is an “overall world slowdown” as enterprises “are still coming out of the pandemic.” In that wider context, service providers are focussing on growing revenue from existing clients.

So, let’s just say the captive acquisition deals have brought in a lot of IT work and 3,000 employees to TCS. But it is still difficult to win new deals, even as it expects double-digit growth in 2021-22 on the back of its existing customer base.

(Updates: A correction was made in the total number of clients. The perspectives of the equity research analyst and the industry source have been added to the article.)

---