12 October 2009

TCS Bonus Issue 2009: A Ride in Turbulent Times

Changing times may sometimes change the way one perceives particular news.

On April 20th 2009 TCS, the biggest IT company of India, declared bonus issue (Stock Dividend) in the
ratio of 1:1 at about 08:00 pm in the evening after the closing of trading hour, while declaring Q4 and
annual performance of FY2008-09.

At a different time, Prateek Shah might have appreciated this piece of news. However it actually
perplexed him now. Prateek is a fund manager at Nutan Mangalam Securities (NMS), a well known fund
management company. Though NMS maintained a fairly diversified portfolio, it had a fairly big chunk of
investment in the Indian IT companies, including TCS. These investments had earned impressive returns
over the past few years as the Indian IT companies had been performing exceedingly well. But the recent
global economic crisis had created trouble for the industries, even the Indian IT industry. The Big 3 (TCS,
Infosys & Wipro) of Indian IT companies had a majority of their client base in Banking, Financial Services
and Insurance (BFSI) sector of US & Europe. And the fact was that BFSI was the worst-hit sector and US
& Europe were the worst-hit regions during this crisis. The forecasts for IT industry in the near future, by
World Bank, IDC and Delloite were not encouraging. The NASSCOM report also confirmed the tough
times for Indian IT industry ahead.

Prateek knew that TCS had weathered the worst business environment of modern times reasonably well,
on the back of a decent performance of initial three quarters. But he had not anticipated a bonus issue,
when all surveys and pointers are indicating tough times ahead. He was surprised that TCS had decided
to declare bonus at such a critical time.

In such a scenario, the basic question in Prateek’s mind was; Whether TCS will be able to serve its
expanded capital after bonus issue without modifying its dividend policy in the current economic
scenario? So, he decided to tread cautiously and started analyzing the situation a little more in depth.

 Market Reaction to the TCS Bonus announcement:

Ahead of the announcement, the stock had lost 2.21% to Rs 560.40 on April 20, 2009. Meanwhile, the
BSE Sensex was also down 88.44 points, or 0.81%, to 10,891.06. It had also underperformed the market
in the past one quarter, rising 12.96% as compared to the Sensex's return of 20.65%.

After the announcement, 4.50 Lakh TCS shares were traded on BSE in the counter. The scrip had an
average daily volume of 2.70 Lakh shares in the past one quarter. The stock hit a high of Rs 599.70 and
a low of Rs 557.10 during the day. On the very next day (21 April 2009), TCS scrip closed at Rs. 551.70
but volume of share traded was as high as 10 Lakhs.

On 22 & 23 April, the closing price for the scrip was Rs. 542.95 and Rs. 567.95 respectively, with an
average volume of 3.5 Lakhs shares
__________________________________________________________________________

This case has been prepared by Ashwin Tirthakar, Chinmay Harpankar & Mahesh Rege (IGTC, Batch of
2008-10) under the guidance of Prof. Shuaib M Fakih. It is based on published sources and has been
prepared as the basis for class discussion rather than to illustrate either effective or ineffective handling
of an administrative situation.
TCS: An Overview1
 Birth of TCS:

A small and innocuous beginning marked the birth of Tata Consultancy Services. In 1968, Tata Sons,
the unlisted holding company of Tata Group, established TCS as a division to service their electronic data
processing (EDP) requirements and provide management consulting services. Over the next few years, it
was the genius of Mr. F.C. Kohli who realised a great potential for a new business opportunity and
started offering data processing services to clients outside the group.

The first breakthrough in India came in 1969, when TCS won a contract from Central Bank of India to
automate branch reconciliation processes. Later, TCS became the exclusive distributor for mainframe
computer maker ‘Burroughs’ and simultaneously started doing programming for the hardware maker’s
customers in the USA. A large export project for the Detroit Police Department in 1974 marked the
defining moment for TCS. In 1977, the exit of IBM opened up a new window of opportunity for TCS.

 IPO Of TCS

On 25th August 2004, TCS was listed. The IPO was priced at Rs. 850 for a share of Re. 1 Face value.
The listing was the biggest event of the day. The stock was listed at BSE at Rs. 1,050. During the day, it
touched a high of Rs. 1,080 and closed for the day at Rs. 987.50

 Bonus Issue 2006:

TCS had performed spectacularly in FY2005-06, registering a growth of 36% in revenues and 51%
growth in Profit after Tax (Refer Exhibit 1 & 2). The declaration of the bonus issue was in a way reward of
this growth and an assurance of future growth to shareholders. Even though the company declared the
bonus issue on April 17, 2006 after closing of the trading session, the stock price of TCS grew by 5.9% to
Rs. 1904 on April 17, 2006, in anticipation of good results. Next day the stock again grew by 5.7% to Rs.
2013 after declaration of the bonus issue. The stock also touched an intra-day high of Rs. 2099. The
record date for bonus issue was set as July 31, 2006. On July 27 2006, the stock closed on Rs. 1893. In
the mean period, the TCS stock fell by 5.9%, as compared to the market which fell by 11.8%. On July 28,
2006, ex-bonus price was Rs. 948, slightly more than half of the last closing price (Rs. 1,893) as the
bonus issue ratio was 1:1; and finally closed at Rs. 931, before reaching infra day high of Rs. 950.

 Scale:

TCS is now the biggest software & services Company in the India and its largest software exporter. It has
achieved consolidated income of Rs. 28,696 Crores at CAGR of (23.8%) over last five years. It has
recorded consolidated net profit of Rs. 5,311 Crores for the FY2008-09 at CAGR of (21.7%) for last 5
years. TCS has operations in over 42 countries with 140 offices. Total employee strength is 143,000
including 10,500 foreign employees.

 Geographical and Sectoral presence

USA is the biggest market for TCS contributing over 50% of its revenue. Also, UK and Europe are
significant markets. (Refer Exhibit 3). TCS has been also investing in emerging or new growth markets. It
has increased its presence in APAC region including China and the other Asean countries, as well as
Eastern Europe, Middle-East and Africa. It is also going aggressive in India as a significant revenue
growth driver.

1: TCS Annual Report 2009

The BFSI is the major sector for TCS by revenue (over 43%). The telecom sector also contributes
significantly (Refer Exhibit 4) to the TCS revenue.

 Current Ownership Structure

At Present, Tata Sons and Other entities of promoter group hold 76% of TCS equity (Refer Exhibit 5). For
Tata Sons dividend from TCS is the most important source of income. As per the news report, Tata Sons
“will use the dividend income to raise stake in group companies where its holding is low and also fund
Tata group’s expansion plans”2

IT Sector Outlook3:
An overview of IT sector showed the following:

 Clients are delaying or deferring final decisions to allow more time to understand the
implications of the current crisis for their company and industry. As a result of IT budgets being
deferred and sales cycles having elongated from 3-6 months to 6-9 months, companies are
seeing a significant drop in client additions and service providers are likely to see some of their
expected revenue gains slip into next year.

 Over 43% of western companies are cutting back on their IT spends & nearly 30% are
scrutinizing IT projects for better returns. Some of this can lead to off shoring, but the impact of
overall reduction in discretionary IT spends is certain.

 Clients have begun to renegotiate rates and prices with their current suppliers. As a result,
some providers have had to readjust their revenue expectations for this year. Vendor
interviews suggest that clients are asking for rate cuts in the range of 2% to 10% this year.

 The slowing U.S. economy has seen 70% of firms negotiating lower rates with suppliers and
nearly 60% cutting back on contractors. With budgets squeezed, just over 40% of companies
plan to increase their use of offshore vendors.

 Global clients are also looking to reduce their vendor base and work with fewer vendors to
derive maximum value from their IT spends.

 The global crisis has already resulted in a number of big corporate M&A, pointing to the need
for further industry consolidation across industries. In this environment, large transformational
outsourcing contracts may be postponed for at least six to nine months.

 Also in the current scenario, most outsourcing deals will be decided on the basis of cost rather
than value. Thus, flexibility will be the mantra of survival.

After analysing TCS financial statements and the IT sector outlook, Prateek felt that the Indian IT
companies including TCS have to face hard times for sure, at least for the next couple of years. So, it
seemed to him that it will be really difficult for TCS to maintain the existing dividend policy.

rd
2: “Tata Sons gets Rs 2,000-cr dividend booster from TCS” Economic Times, 3 September 2009

3: IDC, NASSCOM Study Report, Angel Broking Report

 Annexure

Exhibit 1: TCS - Income Statement (Rs. In Crores)

Mar 2005 Mar 2006 Mar 2007 Mar 2008 Mar 2009
Total income 9849.89 13415.91 18916.19 23741.64 28696.45

Total expenses 7864.86 10423 14661.87 18682 23385.33

Power, fuel & water charges 52.93 75.99 115.86 158.22 196.23
Compensation to employees 2427.22 4798.15 9146.19 11584.52 14595.13
Indirect taxes 18.97 21.5 49.48 63.48 81.31
Lease rent & other rent 126.08 189.03 300.77 423.85 595.89
Repairs & maintenance 90.71 83.42 122.15 145.53 176.53
Insurance premium paid 39.56 43.81 49.6 45.79 50.6
Other oper. exp. of non-fin. service enterprises 3573.63 2493.63 1257.19 2549.3 2719.64
Total provisions 45.13 33.94 12.13 30.7 73.79
Prior period & extraordinary expenses 186.79 0 0.69 1.45 0
Depreciation 158.82 282.43 440.17 563.71 564.08
Provision for direct taxes 462.01 547.6 666.55 1175.41 1365.79
PBDITA 2621.31 3836.22 5370.49 6828.77 7269.65
PBDTA 2605.86 3827.08 5361.04 6798.76 7240.99
PBT 2447.04 3544.65 4920.87 6235.05 6676.91
PAT 1985.03 2997.05 4254.32 5059.64 5311.12
Dividend (%) 1150 1350 1300 1400 1400

Exhibit 2: TCS – Balance Sheet (Rs. In Crore)

Mar 2005 Mar 2006 Mar 2007 Mar 2008 Mar 2009
Liabilities
Net Worth 3477.54 5998.81 8850.1 12300.12 15700.01
Issued equity capital 48.01 48.93 97.86 97.86 97.86
Paid up preference capital 0 0 0 100 100
Minority interest reserves 89.74 164.72 211.8 212.73 277.16
Reserves & surplus 3429.53 5949.88 8752.24 12102.26 15502.15
Total Borrowings 203.01 116.69 506.75 455.02 563.21
Current liabilities & provisions 1453.54 2298.1 3495.45 4477.18 5980.15
Deferred Tax Liability 80.79 47.26 71.7 140.59 196.05
Total liabilities 5304.62 8625.58 13135.8 17585.64 22716.58

Assets
Gross Fixed Assets 1773.59 3393.9 5059.09 6463.62 9810.75
Less: Cumulative depreciation 155.93 661.91 1079.16 1622.2 2359.72
Net fixed assets 1617.66 2731.99 3979.93 4841.42 7451.03
Investments 422.07 704.62 1256.87 2606.16 1614.41
Deferred tax assets 14.79 23.69 72.44 107.56 127.54
Current Assets, Loans & Advances 3250.1 5165.28 7826.56 10030.5 13523.6
Total assets 5304.62 8625.58 13135.8 17585.64 22716.58

Source: Prowess
 Exhibit 3: TCS - Revenue by Geography

Exhibit 4: TCS-Revenue by Industry Practice

Exhibit 5: TCS-Shareholding Pattern

Source: TCS- Annual Report 2008-09