FCFF and valuation of infosys,tcs,zylog system

Business Analysis and Valuation of Indian IT Companies

Submitted by

Group no 7, Section ‘B’

Rohit Agarwal PGP02045

S Arun Kumar PGP02046

Sagar Choudhury PGP02047

Tanuj Maggon PGP02057

Varun Arya PGP02059

Contents

OBJECTIVE:.............................................................................................................................................. 3

DATA USED:.................................................................................................................................................. 3

OVERVIEW:................................................................................................................................................... 3

INDIAN IT INDUSTRY:..............................................................................................................................................3INDUSTRY OUTLOOK WORLDWIDE:...................................................................................................................3INDUSTRY OUTLOOK INDIA...............................................................................................................................4


TCS....................................................................................................................................................................5Background:..................................................................................................................................................5Products:.......................................................................................................................................................5Market share................................................................................................................................................6Revenue Composition...................................................................................................................................6

WIPRO...............................................................................................................................................................6Background:..................................................................................................................................................6Products:.......................................................................................................................................................7Revenue Composition:..................................................................................................................................7

ZYLOG................................................................................................................................................................7Background...................................................................................................................................................7Products........................................................................................................................................................8Revenue Composition...................................................................................................................................8

BUSINESS STRATEGY ANALYSIS..................................................................................................................... 9

PORTER’S FIVE FORCES MODEL:................................................................................................................................9EMPLOYEE RETENTION RATE..................................................................................................................................10CUSTOMER RETENTION RATE.................................................................................................................................10

OWNERS COMPOSITION............................................................................................................................. 11

DIVIDEND POLICY:....................................................................................................................................... 12

RISK:........................................................................................................................................................... 12

RATIO ANALYSIS:........................................................................................................................................ 13

VALUATION................................................................................................................................................ 14

RELATIVE VALUATION:................................................................................................................................ 16

CONCLUSION:............................................................................................................................................. 16

Objective: The objective of this report is to perform business analysis and valuation of the Indian IT companies. In this report we are analysing the IT industry of India with focus on the following three companies:

1. Tata Consultancy Services TCS2. Wipro 3. Zylog Systems


Data used:We used the database of Prowess to get the consolidated balance sheet and profit/loss statement of the companies. Annual report of the companies have been studied to look into the reasons for the accounting or financial changes. Nasscom reports have been used in predicting the future growth.

Overview:

Indian IT Industry:Indian IT sector can be classified into following types:

1. IT- Software – These companies help in developing and implementation of different software for their clients worldwide. These software could be for documentation, security services, banking softwares etc.

2. ITeS Business process outsourcing (BPO) – Major Corporations across the world outsource their back-office operations to some companies. E.g. Employee payroll for a US company’s global workforce is maintained by an Indian BPO. Slowly the definition is expanding to Human resources, accounting, logistics, legal processes etc.

3. IT- Hardware and peripherals - The stuff you can actually see and touch, and would likely break if you threw it out a fifth-story window, is hardware. This would include laptops, desktops, Storage devices, Networking devices, LCD, printers etc.

4. IT- Education This segment provides training for employment in the other segments. This would include companies providing various certification courses, like Java, Oracle etc. These companies also provide training for employees in corporate sector. Recently, some companies have also expanded this service to cater to schools and colleges.

Industry Outlook Worldwide:Gartner Report

Global IT spendings are expected to grow by 4.4 per cent in 2013 to reach $3.78 trillion. Gartner expects global enterprise spending on public cloud services to grow to $109 billion in 2012 from $91 billion in 2011. By 2016, enterprise public cloud services spending will reach $207 billion.

Business process as a service (BPaaS) still accounts for the vast majority of cloud spending by enterprises, but other areas such as platform as a service (PaaS), software as a service (SaaS) and infrastructure as a service (IaaS) are growing faster.

Industry Outlook IndiaNasscom


Global technology related spend expected to grow by 5 per cent in 2012 Global sourcing to continue growth trend as organisations aim to cut costs, access local

market and innovation and sourcing requirements Indian IT-BPO services exports expected to grow by 11-14 per cent while domestic services

to grow by 13-16 per cent (in Rs terms) India accounts for less than 5 per cent of global technology spending – tremendous untapped

potential for growth of Indian IT-BPO sector, in both core as well as emerging opportunities To achieve this growth, the sector has to continue to re-invent itself – through new business

models, global delivery, partnerships and transformative focus Prevailing global megatrends presents new opportunities and risks for the industry, which

will shape the technology industry landscape IT-BPO sector will need to build on its strengths and address challenges around competition,

talent, security and business environment In the future, the industry to drive transformation, innovation and inclusivity in business and

India

TCS

Background:

Tata Consultancy Services was founded in 1968 by JRD Tata. It is headquartered in Mumbai with Ratan Tata as its chairman. One of its first contracts was to provide punched card services to sister company Tata Steel (then TISCO). It is listed on the Bombay Stock Exchange and the National Stock Exchange of India and is a subsidiary of the Tata Group conglomerate. It has service revenue of US$ 10.17 billion and a profit of US$ 2.2 billion.

TCS is a leader in the global marketplace and among the top 10 technology firms in the world. It has more than 40 years of experience and adds real value to global organizations

http://en.wikipedia.org/wiki/Tata_Group

http://en.wikipedia.org/wiki/National_Stock_Exchange_of_India

http://en.wikipedia.org/wiki/Bombay_Stock_Exchange

http://en.wikipedia.org/wiki/Bombay_Stock_Exchange

http://en.wikipedia.org/wiki/Tata_Steel

http://en.wikipedia.org/wiki/Punched_card


through domain expertise plus solutions with proven success in the field and world-class service. It is the largest India-based IT services firms.

With around 238,600 employees TCS is one of the largest private sector employers in India and the second-largest employer among listed Indian companies .TCS has one of the lowest attrition rates in the Indian IT industry.

Products:TCS offers products in basically 2 domains:

Services: It provides IT consulting services in almost every vertical with BFS (business financial sector) being its major revenue sector.

Software: It has different software Technology, Knowledge, Engineering, Healthcare and banking products.

Market share

Top 10 IT companies in India commands over 95% market share of Indian IT Services Industry (Software excluding hardware) in 2011. Top 5 IT companies commands over 80% market share of indian software industry as of 2011. TCS enjoys 25% while Infosys has 18% market share.

Revenue Composition

TCS posted a net profit of Rs. 2,932 crore, up 22.6% year-on-year and 1.6% compared with the trailing quarter. Revenue grew 30.5% from a year ago to Rs. 13,259 crore, but a mere 0.4% from the preceding quarter, according to International Financial Reporting Standards.

http://en.wikipedia.org/wiki/Customer_attrition

http://en.wikipedia.org/wiki/Private_sector

http://en.wikipedia.org/wiki/Information_technology_in_India


TCS made a revenue of $10.17 billion in 2011-12.Its North America business rose 1% sequentially to account for 53.6% of its overall revenue. The company’s UK business, accounting for 15.2% of revenue, rose 1.6%. But business in continental Europe, accounting for 9.8% of its total revenue, fell 6.2%. The India business was up 1.6% to account for 8.5% of the overall revenue.

TCS’s banking, financial services and insurance segment accounted for 42.2% of its revenue, down 2% in the March quarter sequentially. Telecom was down 0.3% at 10%, while retail and distribution grew 2.4% and accounted for 12.5% of the overall business.

WIPRO

Background:

The company was incorporated on 29 December 1945 at Mumbai by Mohamed Hasham Premji as Western India Products Limited, later abbreviated to Wipro. It was initially set up as a manufacturer of vegetable ghee, vanaspati, refined oils including salad oil in Amalner, Maharashtra under the trade names of Kisan, Sunflower and Camel.During the 1970s and 1980s, the company shifted its focus and began to look into business opportunities in the IT and computing industry, which was at a nascent stage in India at that time. In February 2001, Wipro became the first software technology and services company in India to be certified for ISO 14001 certification. Wipro recently in 2012 made its 17th acquisition in IT business when it acquired Australian analytics product firm Promax Applications Group (PAG) for $35 million

Products: Wipro also offers following services and products:

Services: It provides IT consulting services, Cloud services, Analytics, Business process outsourcing, Infrastructure Management services, Eco energy, Business Application, Mobile and Product engineering services.

Products: It provides Desktops and Infrastructure Technology solutions.

Revenue Composition:


ZYLOG

Background

ZSL is a publicly traded IT solutions company with over 15 years of experience leveraging global workforce talent in software engineering and subject matter expertise to evolve products and technology solutions in a broad range of business applications. ZSL Inc, is an ISO 9001 certified provider of Onshore, Offshore & Near shore technology solutions and services to enterprises & technology companies across the globe. It works with some of the world’s leading innovative ISVs and software-enabled businesses, ranging from start-ups to established industry leaders.

ProductsZylog offers IT products and solutions and IT services to various verticals including banking, financial services and insurance (BFSI), telecom, retail, manufacturing, pharma/ healthcare and government etc. Apart from IT products and services, ZSL also offers wireless broadband services in the domestic market using Wi-Fi technology.

ZSL has recorded robust business growth over the last several years driven both by organic expansion as well as acquisition of several small and medium-sized entities during the course of its operating history. Like its domestic peers, ZSL derives the bulk of its revenues from the US market; although unlike peers, its business model differs in terms of effort mix which remains skewed in favour of onsite delivery resulting in relatively lower profitability.


Revenue Composition

Business Strategy Analysis

Porter’s Five Forces model:

Power of buyers: the Indian IT sector has a large number of players and few entry barriers for new entrants. Thus, the buyer has many options to choose from and can clearly articulate their needs. However, the bigger companies also enjoy the advantage of switching costs. It means that once a particular client selects a particular


company as its partner, it becomes dependent on that company for all its upgrades and technology requirements, making it difficult for the client to switch. Thus, the buyers have a MEDIUM bargaining leverage.

Power of suppliers: Knowledgeable human resource is the largest requirement for the IT Sector. Large supply of this human source, at low cost is available from around the world. Also, a lot of matured education and training is easily available. As there exist many competitive suppliers in the supplier has very LOW or NO power in the IT sector.

Competitive rivalry: No huge capital investment is required to start a new company, leading to very large numbers of small and medium-size companies. It is becoming increasingly difficult for players to differentiate, which has led to a decrease in margins. However, a few top and niche players still enjoy pricing power. Thus, the competition in the sector is HIGH.

Availability of Substitutes: certain countries e.g. China, Korea, Taiwan, Israel have started to develop an environment required for growth of IT sector and are emerging as suppliers of these products and services. Indian companies need to continuously innovate to have an edge over the others. Thus, the availability of substitutes is MEDIUM.

Threat of new entrant: Set up cost is almost negligible. Further the government policies also promote the entrepreneurs by providing benefits in terms of tax holidays an building software Technology Parks. Apart from this there are many venture capitalists who are ready to fund new start –ups enabling them to scale up. With increased demand and higher margins the threat of new entrant is HIGH.

Employee Retention RateTCS

The rigorous focus on talent engagement, deployment on right projects, role & career progression and benchmarked compensation & benefits helped the Company to attract and retain the best talent. The Company has launched Employee Assistance Programme, which would provide employees 24X7 confidential counseling services, to enable them to cope more effectively with stressful situations. The Company improved its talent retention globally which is reflected in the attrition dropping from 14.4% in the year 2010-11 to 12.2% in the year 2011-12.

Wipro

In IT Services segments, wipro had 135,920 employees as of March 31, 2012.Attrition for the year in wipro IT Services business segment (excluding BPO operations, Indian IT operations and other overseas subsidiaries) was 19.5% compared with 24.1% last year. Voluntary attrition stood at 17.6% compared with 22.3% last year.


Customer Retention RateTCSOver the last 12 months TCS added 141 new customers across the world to take its active customer base to 1076. The movement of customers across each revenue band from $1 million onwards is very positive, including growing the number of $100 million customers to fourteen from eight in the previous year.

WiproWipro added 173 new customers in the current year, compared to 155 in the previous year. Its top customer contributed 3.6% of our revenue, top 5 customers 11.3% and the top 10 customers accounted for 19.6% of our revenue. Wipro has 7 customers contributing more than $100 million revenues in the current year, an increase from 3 in the previous year. Revenue contributed by the customers added during the year was at 2%, the same level as in the previous year.

Suppliers

WiproAt an aggregate level, nearly 88% of its supplier base is based in India which translated into 73% of the procurement by value for the reporting year. It also started an exercise in consolidating its supply chain base in order to make our engagement more focused and meaningful. In FY13, wipro will also be launching its supplier engagement program on ESG principles with a select group of suppliers.

Owners Composition

TCS

Share Holding Pattern in (%)View details

DEC' 11 SEP' 11 JUN' 11 MAR' 11

Promoter 74.08 74.08 74.08 74.05

FII 13.41 12.81 12.80 12.64

DII 7.67 8.10 8.10 8.11

Others 4.84 5.01 5.02 5.20

Total 100.00 100.00 100.00 100.00

http://www.moneycontrol.com/company-facts/tataconsultancyservices/shareholding-pattern/TCS/72.00


Wipro


SEP' 11 JUN' 11 SEP' 10

Promoter 79.17 79.23 79.36

FII 5.08 5.37 5.28

DII 4.15 3.74 3.52

Others 11.60 11.66 11.84

Total 100.00 100.00 100.00

Zylog


SEP' 11 JUN' 11 MAR' 11 DEC' 10

Promoter 41.22 36.68 36.68 35.95

FII 0.35 0.37 0.66 0.73

DII 3.81 3.06 3.21 3.70

Others 54.62 59.89 59.45 59.62

Total 100.00 100.00 100.00 100.00

Dividend Policy:In 2011-12 TCS paid dividends 4 times to its shareholders. The dividend expense of TCS increased by 78% in 2011-12 from the previous year. The company recently paid dividend of Rs8 per share in June 2012. The dividend payout of TCS however is non uniform with low dividends in 2010-2011.

The dividend policy of Wipro has been conservative. The dividend per share of the company has been low and is close to 6 as compared to TCS whose DPS was 25 in 2011-2012. The company only paid high dividend in the year 2004.

The dividend policy of Zylog Systems has been more liberal than that of Wipro. The DPS of Zylog has been 8 for the previous year. For the past four years Zylog has come out with only 4 dividends.

Risk:Some of the major risks faced by the IT companies of India are:

1. Dependency on the US Economy. The major clients of IT companies in India are in US leading to a high dependency on US market.

http://www.moneycontrol.com/company-facts/zylogsystems/shareholding-pattern/ZS/71.00

http://www.moneycontrol.com/company-facts/wipro/shareholding-pattern/W/71.00


2. Volatile currency movements3. Exposure to high wage inflation and attrition rate.

For TCS the individual risk would be to maintain the momentum which Infosys failed to maintain. A lot of new companies are coming up with expertise in newer technologies or sector eating up the possibility of TCS to enter in those areas. Disruptive technology can also hinder the growth of the TCS.

Wipro has been overtaken by Cognizant making it 4th largest IT Company of India from the previous position of third. The news of Wipro joint CEO Girish Paranjape and Suresh Vaswani leaving the organization citing personal reasons in January 2011 was also a difficult pill to swallow. The results of Wipro haven’t been impressive. The tough competition leading to loss of market share poses a high risk to the growth of Wipro.

For Zylog Systems risk is obviously to compete with Giant Players like TCS, Infosys, Cognizant, Wipro etc. Few other risk were delays in leveraging synergies with Brainhunter which it acquired in 2010. Also Zylog has entered into capital intensive business like Wi-fi and e-governance causing a reduction in the profit margin.

Ratio Analysis:TCS:

Mar-12 Mar-11 Mar-10 Mar-09 Mar-08 Mar-07 Mar-06 Mar-05 Mar-04 Mar-03Key RatiosDebt-Equity Ratio 0 0 0 0 0 0.01 0.02 0.15 4.47 0Long Term Debt-Equity Ratio 0 0 0 0 0 0 0 0 0 0Current Ratio 1.74 1.56 1.63 1.91 1.99 2.08 1.96 1.15 0.02 0.01

Turnover RatiosFixed Assets 5.84 5.37 4.99 5.9 6.58 7.45 8.21 12.7 0 0Inventory 8172.2 4819.04 1942.25 1312.6 1250.78 853.83 979.6 0 0 0Debtors 5.59 7.19 6.52 5.99 5.59 5.83 5.92 10.97 0 0Interest Cover Ratio 816.02 435.8 668.75 691.82 1464.12 1216.94 685.71 204.09 16.8 0PBIDTM (%) 36.21 31.62 29.72 24.84 29.88 30.23 29.69 28.02 0 0PBITM (%) 34.44 29.79 27.68 22.97 27.37 27.94 27.4 26.36 0 0PBDTM (%) 36.17 31.56 29.68 24.8 29.86 30.21 29.65 27.89 0 0CPM (%) 30.02 27.69 26.42 22.82 27.16 27.44 26.47 24.4 0 0APATM (%) 28.25 25.86 24.38 20.96 24.65 25.15 24.18 22.75 0 0ROCE (%) 59.31 49.87 44.55 42 52.34 60.69 67.77 109.87 1.46 4.8RONW (%) 49.53 43.83 39.5 38.67 47.55 54.98 60.85 108.75 6.86 2.77


A quick glance at the financial ratios of TCS, suggests that company has been in healthy position which is only possible due to sound management techniques. PAT has remained steady over the period of previous 5 years. Though sales has increased there seems to be tremendous pressure on the profit margin in the last two years. TCS is a zero debt company and all the ratios are fairly constant throughout the year.

Wipro:

Mar-12 Mar-11 Mar-10 Mar-09 Mar-08 Mar-07 Mar-06 Mar-05 Mar-04 Mar-03Key RatiosDebt-Equity Ratio 0.09 0.19 0.35 0.37 0.19 0.02 0.01 0.02 0.02 0.02Long Term Debt-Equity Ratio 0.09 0.1 0.22 0.37 0.19 0.02 0 0 0 0Current Ratio 1.73 1.58 1.66 2.11 2.15 1.57 1.46 1.32 1.6 2.97

Turnover RatiosFixed Assets 3.83 3.63 3.68 5.39 8.99 6.86 4.97 4.7 4.16 3.81Inventory 42.12 39.65 43.14 47.62 51.29 70.73 74.37 63.42 57.82 53.09Debtors 4.63 4.89 4.86 5.34 5.7 6.1 6.12 5.95 5.6 5.64Interest Cover Ratio 10.77 42.95 58 19.03 30.71 442.14 748.5 316.29 308.37 319.8PBIDTM (%) 22.86 24.4 27.68 19.8 22.89 25.75 25.67 26.77 23.84 26.61PBITM (%) 20.51 22.13 25.16 17.33 20.31 23.14 22.83 24.21 20.92 23.19PBDTM (%) 20.96 23.88 27.25 18.88 22.23 25.7 25.64 26.69 23.78 26.53CPM (%) 17.08 20.62 23.81 16.23 19.93 23.27 22.53 23.1 20.56 23.54APATM (%) 14.73 18.35 21.29 13.76 17.35 20.66 19.68 20.54 17.63 20.13ROCE (%) 25.76 24.85 28.41 22.72 28.7 39.72 41.01 41.15 30.98 31.45RONW (%) 20.52 24.83 32.43 24.71 29.35 36.11 35.72 35.59 26.76 27.74

Interest cover ratio Wipro has fallen down to 10.77 from 42.95 shows that company paid high interest in Mar 12. The debt to equity ratio remained the same but low interest cover ratio was due lower turnover. The asset turnover of the company is also decreasing was due to low turnover recorded.

Zylog Systems:

Mar-12 Mar-11 Mar-10 Mar-09 Mar-08 Mar-07 Mar-06 Mar-05 Mar-04 Mar-03Key RatiosDebt-Equity Ratio 0.46 0.33 0.21 0.19 0.3 0.31 0.22 0.15 0.06 0.11Long Term Debt-Equity Ratio 0.12 0.09 0.07 0.04 0.16 0.31 0.22 0.12 0.02 0.11Current Ratio 2.58 3.15 4.21 4.05 4.24 9.44 18.04 7.44 2.4 2.27

Turnover RatiosFixed Assets 4.04 3.97 4.63 5.56 5.13 4.62 3.65 2.86 2.72 2.94Inventory 0 0 0 0 0 0 0 0 0 0Debtors 3.16 3.13 3.31 4.14 4.44 4.46 4.12 4.14 3.89 4.14Interest Cover Ratio 8.28 11.12 18.34 22.16 14.81 18.71 18.73 26.47 42.97 20.2PBIDTM (%) 24.75 20.2 16.54 18.03 17.16 18.5 16.21 17 24.77 31.27PBITM (%) 21.45 16.57 13.9 16.31 14.83 15.45 14.19 13.44 21.94 22.19PBDTM (%) 22.16 18.71 15.78 17.29 16.16 17.67 15.46 16.49 24.26 30.17CPM (%) 16.53 15.39 14.22 15.29 15.73 16.98 14.52 15.6 17.59 23.26APATM (%) 13.23 11.76 11.59 13.57 13.4 13.93 12.5 12.04 14.76 14.18ROCE (%) 21.67 18.49 18.88 26.72 28.67 36.55 28.45 24.68 43.48 52.42RONW (%) 19.54 17.49 19.06 26.38 33.79 43.26 30.68 25.34 30.9 30.37


The current ratio of the company has fallen which was due the acquisition of Brainhunter by Zylog in the year 2010 and other acquisitions. The sales of the company increased by 95% in the year 2012, though it was not reflected in the various ratios because consequently there was increase in the values on the asset side of the balance sheet.

ValuationKey Points in Valuation

Risk free rate is taken as 6.5%. Market Risk premium has been taken at 9%. Book Value of Debt is taken by dividing the interest by total borrowings. Beta is taken from annual risk and return profile. Terminal growth rate is taken as 5% which is less than the GDP growth rate of India to take

care of the point that Stable companies will grow at a slower rate than GDP because a country would comprise of growing and stable companies.

Risk free rate calculations:The Indian government had 10-year Rupee bonds outstanding, with a yield to maturity of about 8.5% on January 1, 2012. In January 2012, the Indian government had a local currency sovereign rating of Baa3. The typical default spread (over a default free rate) for Baa3 rated country bonds in early 2012 was 2%.

risk free rate= yield to maturity on the 10-year bond – Default spread = 6.5%

Tata Consultancy Services

Valuation is done using a two stage model. We have forecasted Sales to grow by 23% in the next five years which is the CAGR of sales of the

past five years. We have taken 23% because TCS has been consistently beating market expectations.

After the first 5 years, sales have been forecasted to grow at 14% which is the current forecast for the Indian IT Services Industry by NASSCOM till 2020.

Depreciation, EBITDA and Capital Expenditures are taken as percentage of sales based on the CAGR of the past five years.

WACC comes to 11.03%. And the final stock price is 1034.77. The detailed DCF valuation of TCS is TCS valuation.xlsx

Wipro

Valuation is done using a two stage model. We have forecasted Sales to grow by 21% in the next five years which is the CAGR of sales of the

past five years. After the first 5 years, sales have been forecasted to grow at 14% which is the current forecast

for the Indian IT Services Industry by NASSCOM till 2020.



WACC comes to 11.03%. And the final stock price is 369.65.The detailed DCF valuation of Wipro is Wipro valuation.xlsx

Zylog Systems

Valuation is done using a two stage model. We have forecasted Sales to grow by 45% in the first year which is the CAGR of sales of the past

five years and decreasing by 5% every year till 2018 and then stabilizes at 15% till 2020 based on NASSCOM Report.


WACC comes to 7% because of high percentage of debt. And the final stock price is 268.89.The detailed DCF valuation of Zylog Systems is Zylog Valuation.xlsx

Relative valuation:For relative valuation we have used P/E method.

The industry P/E average for software industry =18.10

INDUSTRY P/E

EPS PRICE BY MULTIPLE VALUATION

TCS 18.1 59.84 1083.104WIPRO 18.1 18.68 338.108ZYLOG SYSTEM

18.1 55.11 997.491

The values of TCS and WIPRO are coming near to their market price but ZYLOG system is coming out to be very high above the market price. This is because zylog system is a mid cap company and its P/E is way better than the industry P/E.


Conclusion:Company Current Stock price Estimated Stock PriceTCS 1277.45 1034.77Wipro 353.65 369.65Zylog Systems 297.4 268.89

If we compare the current stock price and the estimated stock price it seems that all the stocks are fairly valued. TCS seems to be little overvalued with the current market price of 1277.45. The business fundamental of TCS seems to be strong but it seems that it had been slightly overvalued by the market. Hence we recommend that you can hold the stocks at the current price but do not buy them.

FCFF and valuation of infosys,tcs,zylog system

Economy & Finance

Transcript of FCFF and valuation of infosys,tcs,zylog system