Despite COVID-19 pressures, Tata Consultancy Services (TCS) has not shied away from enacting bold initiatives, evidenced by the announcement of Vision 25×25 during the company’s CY1Q20 earnings call. Even in the face of decelerating revenue growth in the first quarter, executives remained optimistic, suggesting that — unlike the broader trend in the IT services industry — TCS is not ruling out investing in M&A if the price is right. For TCS, key characteristics of its business model enable the company to kick the tires in the M&A market and take advantage of favorable valuations brought about by a dwindling number of interested buyers.
Massive scale and healthy balance sheet support M&A consideration
A strong financial model provides the foundation for TCS’ capital allocation strategy and gives the company more flexibility compared to its peers around strategic investments. For example, TCS’ operating margin was 25.1% in 1Q20, far exceeding TBR’s benchmark average of 9.6% and surpassing all of TCS’ India-based peers by over 400 basis points (Infosys’ operating margin trailed closest behind at 21.1% in 1Q20). Additionally, TCS is backed by massive conglomerate Tata Group and has limited long-term debt, putting it in a comparatively lower-risk position even during a time of global macroeconomic uncertainty, provided the company can mitigate impacts to its top line in the coming quarters.
In CEO’s words: “The best time to execute is when nobody else is buying”
Although TCS made two acquisitions in 2018, ending a four-year lull in the company’s M&A activity, competitors with more mature acquisition proficiencies such as Accenture, Cognizant and IBM usually tend to crowd the market and challenge TCS’ ability to gain market share in key areas. For example, Accenture remains committed to carrying out its $1.6 billion acquisition budget in FY20, evidenced by the five AI-centric purchases the company made in CY2Q20. Driving the optimistic viewpoint of TCS CEO Rajesh Gopinathan, however, are opportunities to pick up acquisitions at attractive price points as typically active buyers have lost purchasing power and/or voluntarily corralled investment strategies.
DXC Technology, for instance, remains weighed down by elevated integration costs and restructuring plans following six acquisitions in 2019, including the $2 billion buyout of Switzerland-based engineering firm Luxoft. India-based peer HCL Technologies (HCLT) is in a similar situation, as executives expressed a cautionary mindset while the company looks to complete remaining payments on the $1.8 billion purchase of several IBM software products such as Unica, Portal and Connections in late 2018. As HCLT CFO Prateek Aggarwal explained, “As you can imagine, these are turbulent times, and we don’t want to sort of fritter away the cash at this point in time.”
Previous investments display an audacious mindset amid macroeconomic turmoil
TCS’ acquisition strategy has historically been very selective, with the company opting to build its talent, IP and technology capabilities in-house and normally waiting several years before kick-starting new activity. During its most recent spending pickup, the company has stuck to low-risk and nonintensive purchases such as BridgePoint and W12 Studios in 2018, both consultancies with fewer than 50 employees and with estimated annual revenues of less than $5 million. In mid-2019 TCS also increased its stake in TCS Japan, a 2014 joint venture with Mitsubishi Corp., from 51% to 66%, in what was already a safe bet as the unit achieved double-digit constant currency growth in the two years prior.
TCS’ last large-scale acquisition came during a risky time for most companies — the peak of the 2007-2008 financial crisis. In the fourth quarter of 2008, TCS completed its acquisition of Citigroup Global Services Limited for $512 million cash and brought on 12,000 India-based employees to provide BPO services in the banking, financial services and insurance sectors. While TBR anticipates the company will likely stay true to its existing strategy around more tactical tuck-in plays versus making a bold large-scale merger, a reflection on the past reminds us that the option — and willingness — exists.
IP will remain at the forefront of TCS’ acquisitions strategy
TCS already touts scale and well-trained talent, leading TBR to believe that the company will focus on obtaining IP, filling portfolio gaps and expanding its addressable market when considering M&A candidates. Because of its selective M&A stance, TCS is often left playing catch-up in the M&A market, reflected in its 2018 purchases of BridgePoint and W12 Studios, which mimicked Accenture’s push around digital design capabilities, and TBR believes this trend will continue.
According to TBR’s 1Q20 IT Services Vendor Benchmark, “The acquisition pace slowed in 1Q20; the nature of acquisitions remained similar to that in 2019 as vendors look to build out emerging technology portfolios, including security and deepened software practices around Salesforce and Workday.” This sets the stage for TCS to follow in the footsteps of its India-centric peers Infosys and Cognizant, which recently completed the acquisitions of Salesforce consultancy Simplus, as well as Salesforce Platinum Partner and digital consulting firm Lev. In TBR’s view, the central component of TCS’ acquisitions strategy will be targeting M&A candidates that can quickly and cost-efficiently add to its IP portfolio, similar to HCLT’s purchase of several IBM software assets in 2018, as TCS has built lucrative services offerings around the success of its homegrown products and platforms, such as BaNCS and Ignio.