TCS: perched precariously

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TCS recently announced the acquisition of Citigroup’s stake in Citigroup Global Services (CGSL), the India-based captive BPO arm of Citibank for an all-cash consideration of $505 million. The acquisition will also be packaged with a contract worth $2.5 billion for over nine years. Straight up, the company becomes a strategic vendor for Citigroup. And, Citigroup would now feature in the top five clients for TCS. Clearly, there is volume growth for the company. Moreover, the acquisition would enhance margin expansion as gains will accrue due to increased offshoring as well as bringing in process efficiencies, say analysts.

However, analysts consider this as a long-term positive development and in the short-term will be waiting with bated breath for the second quarter results. Consensus estimates are that the company will see a 11% sequential growth in its EPS. And here, analysts are concerned because TCS’s record for meeting or beating consensus estimates is not all that good, especially in the last two quarters. If the company beats these estimates, there is a likely rerating waiting to happen. A BNP Paribas Securities report states, “We believe that TCS faces the highest risk to internal targets and consensus estimates, and Infosys the least.”

Moreover, the CGSL acquisition will increase the share of the BFSI sector from around 43% of revenues to around 45%. This does not seem exciting in the given circumstances where the financial sector is witnessing a historical upheaval. Lehman and Merrill Lynch together contribute less than 1% of TCS’ revenue, but a slowdown in other accounts less in the news is likely to make meeting current estimates difficult – even with the help from a weakening rupee, the BNP Paribas report states. Moreover, for the $505 million acquisition, TCS will be using around 55% of its own cash, and this dilutes its strong cash position and one of the reasons for its premium rating.