Issue Summary

Type Public issue, 100% book building Min. subscription 7 shares Size Rs 43 bn to Rs 50 bn Lead Managers JM Morgan Stanley, DSP Merrill Lynch, JP Morgan Price Rs 775 to Rs 900 per share Listing BSE & NSE Face value Re 1 per share Promoters Tata Sons Limited Shares on offer 55.45 million Promoters post     issue holding 82.7% Issue Opens July 29, 2004   Issue Closes August 5, 2004

Issue structure

QIBs Non-Institutional Investors Retail Portion Number of shares 29,944,410 7,486,090 12,476,840 % of net offer to public (non-employees)* 60% 15% 25% Minimum Bid/Application size Rs 50,001 Rs 50,001 7 shares In multiples of 7 shares 7 shares 7 shares Maximum Bid/Application size Not exceeding the size of the offer Not exceeding the size of the offer Rs 50,000

* 10% of shares on offer are reserved for employees of TCS

Objects of the issue

	To create a public trading market for the equity shares of the company by listing them on the stock exchanges. To utilise net proceeds of the fresh issue to pay transfer consideration of Rs 23 bn to Tata Sons.

Background

	Business
	TCS is the largest software services exporter from India, ahead of the likes of Infosys and Wipro. In FY03, it became the first Indian software company to cross the coveted US$ 1 bn revenue mark. While it was operating as a division of Tata Sons till now, post the public issue, TCS will operate as a separate entity and would be renamed - TCS Limited. The company has a wide range of offerings and caters to industries like banking, insurance and financial services (40% of revenues), manufacturing (20%), telecom, (16%) and retail (7%).
	Promoters
	TCS is promoted by Tata Sons, which holds around 90% of the outstanding pre-offer equity shares. The principal business of Tata Sons is investment holding and TCS is one of its major operating divisions. In addition to the TCS division, Tata Sons has three other operating divisions: Tata Economic Consultancy Services Tata Financial Services Tata Quality Management Services The equity shares of Tata Sons are not listed on any stock exchange. Charitable trusts hold the largest portion (around 66%) of its outstanding equity shares.
	Sector
	Global technology spending seems to be on an up-trend after the past couple of years of slowdown. However, the demand seems to be shifting from low-end services to high-end ones, like IT consulting, package implementation and systems integration. While Indian software companies are increasingly facing competition from global MNCs who are replicating the Indian offshoring model, the need of the hour for them (the Indian companies) is to rapidly move up the software value chain. For the Indian software industry, one of the biggest concerns in the medium term is the outsourcing backlash in the US. However, to grow in the long-term, scalability and quality offerings would be the key. As per the leading IT research and consultancy firm, Gartner, total worldwide IT services spending is expected to grow from US$ 535 bn in 2002 to US$ 727 bn by 2007, a CAGR growth of 6.3%. Also, as per NASSCOM, India's software services exports grew by 25% in FY04, from US$ 9.6 bn to US$ 12.5 bn. This represents a mere 1.6% of the global IT services market. NASSCOM also expects Indian IT services exports to cross the US$ 56 bn mark by FY08, which would mean CAGR growth of over 45% in the four-year period (FY04-FY08). Both these factors combine to provide Indian software companies a huge growth potential going forward.

Reasons to apply

Management experience:  Like Infosys, this parameter is the biggest strength for TCS. And it is well indicated by the rapid growth of the company in the past. To put things in perspective, TCS has grown its revenues and profits at CAGR of 33% and 27% respectively since FY01. This compares well with Infosys' CAGR of 37% and 26% respectively during the same period. Also, the management can be credited with pioneering the global delivery model at an early stage that MNCs are trying to replicate now.

Huge outsourcing opportunity:  With the value proposition of offshore development being well established, corporates in the West are increasingly outsourcing to Indian software companies. However, for mission critical jobs, prospective clients generally look at larger well-known companies that can provide end-to-end solutions. Software majors like TCS are likely to be the key beneficiaries of the increased demand for offshore projects. Also, with India's share in global IT services market at a low of around 1.6% and the global IT services market expected to grow at a CAGR of over 6% till 2008, there is a huge potential for Indian software companies to garner larger long-term clients and grow rapidly going forward. As a matter of fact, TCS is increasingly getting larger contracts from its clients. For instance, the number of clients having more than US$ 50 m and US$ 20 m billings grew from 2 and 8 respectively in FY02 to 4 and 16 in FY04.

Scale advantage:  A large balance sheet size is a key competitive differentiator in the global IT services market. This is because clients, to benefit from economies of scale, generally prefer large vendors for outsourcing their IT requirements. TCS scores high on this account, as it is the largest software services exporter from India. Also, to meet clients' end-to-end IT requirements, the company has on offer a wide range of services, some of which are software development and maintenance, package implementation, consulting and IT-enabled services. Over that, the large size and ability to deliver quality services has helped TCS in cementing long-term relationships with some large MNCs. For instance, the company has over 10 year relationships each with the GE Group and P&O Nedlloyd.

Low attrition:  In the wake of increasing competition for talent, the average attrition rate for the Indian IT industry is high at around 16%-17%. However, the figure for TCS stands at a remarkably low 6.1% in FY04. Apart from being lower than the industry average, this rate is also favourable compared to its peers like Infosys and Satyam that had attrition rates of 10% and 17% respectively in FY04. Attracting and, especially, retaining key employees, plays a decisive role in an IT services company growth. Apart from helping in maintaining a common culture without much disturbances, a high retention rate also helps in keeping down training costs, thus helping an IT services company grow its profitability faster. Going forward, if TCS manages to keep the attrition rate lower at the current levels, it will be of immense benefit to the company's growth prospects.

Less leveraged on the US:  TCS, unlike its domestic peers like Infosys (71%) and Satyam (73%), derives a relatively lower proportion (62%) of its total revenues from the US markets. This is a positive, in the sense that a lower revenue share from a single region helps the company de-risk its business from unforeseen contingencies arising in that particular region.

Reasons not to apply

	Where is the cash?  TCS will have to pay Rs 23 bn out of the net proceeds of the fresh issue to Tata Sons as consideration for transfer of business. But where is the cash to make the payment? The TCS issue has two parts to it. Out of the 55.4 m shares on offer, around 32.7 m shares are offer for sale by Tata Sons, the money generated from which will go straight to its books and not add to TCS' balance sheet. The remaining, i.e., the fresh issue of 22.7 m shares, even if offered at the highest price of Rs 900 per share, will amount to only Rs 20 bn. Now, when we add another Rs 1.6 bn cash that TCS has on its books at the end of FY04, there is a shortfall of Rs 1.4 bn (Rs 23 bn minus Rs 20 bn minus Rs 1.6 bn). This means that TCS will have to resort to using cash generated in the latest quarter (1QFY05) to pay Tata Sons the complete due amount. When that happens, TCS (as a separate entity) will have almost negligible amount of cash on its books. We believe that this is a big negative as that would hinder the company's investment plans, at least till it generates sufficient cash going forward. This compares poorly with the company's peers, Infosys and Satyam, which had cash balances of Rs 17 bn and Rs 18 bn respectively at the end of FY04.
	Decreasing cost advantage:  In the software services business, Indian companies traditionally have had a cost advantage over their Western competitors in markets like the US and Europe. However, the downturn in the US economy forced these companies to trim billing rates to compete with Indian software companies. Also, unable to beat competition on the pricing front, global IT services majors are consistently setting up bases in India. This has not only threatened Indian IT industry's cost leadership, Indian software companies have also been made to face intense competition for talent. All these pressures mean stagnant billing rates and higher employee costs going forward. In line with the industry, this may also affect TCS' margins and, consequently, the profitability going forward.
	Political concerns:  Backlash in the US against outsourcing of jobs to low-cost countries like India has raised some medium-term concerns for companies like TCS that have significant business emanating from the US. While we believe that over the long-term, sound economics is more likely to take the front seat, near term concerns can have serious effects on valuations of the sector and consequently, of the company.
	Conflict of interest:  TCS' promoter group, Tata Sons, also holds interest in Tata Infotech (74%) and Tata Elxsi (38%), both of whom are engaged in software services business. Further, there is Tata Technologies, a subsidiary of Tata Motors, which provides specialized IT services in niche markets. Also, a number of directors of Tata Sons are on the boards of the other Tata-affiliated companies in the IT services industry. As such, there are risks of conflict of interest within these Group companies.

Financial Performance

(Rs m)	FY01	FY02	FY03	FY04
Sales	30,567	43,706	55,179	71,227
Other income	727	959	780	937
Total income	31,294	44,665	55,959	72,164
Expenditure	21,031	30,383	41,716	51,799
Operating profit	9,536	13,323	13,463	19,428
OPM (%)	31.2%	30.5%	24.4%	27.3%
Depreciation	631	793	1,039	1,331
Profit before tax	9,632	13,489	13,204	19,034
Tax	1,927	2,568	2,445	2,884
Net profit	7,705	10,922	10,759	16,150
Minority interest	-	55	(79)	(125)
Equity in affiliates	79	65	48	100
Extraordinary item	-	-	211	-
Net Profit after adjustments	7,784	11,042	10,939	16,125
NPM (%)	25.5%	25.3%	19.8%	22.6%
No. of shares	455.5	455.5	455.5	455.5
EPS (Rs)	17.1	24.2	24.0	35.4

*Consolidated as per US GAAP