After Mitsubushi, TCS eyes more expansion in Japan

Tata Consultancy Services (TCS) has been posting sector-leading revenue growth for several quarters, notwithstanding its already huge size.

The company has now added another lever, relatively untapped Japanese market. TCS had a small presence there; it formed a joint venture with Mitsubushi Corporation in April and merged its two subsidiaries with IT Frontier Corporation (the IT services subsidiary of Mitsubishi).

TCS owns a 51 per cent stake in the new information technology (IT) entity and has an option to scale it up to 65 per cent over five years.  

TCS now has a better footing in the $100-billion Japanese IT services market, dominated by four domestic companies that control 40 per cent of it.

Global IT players have been finding it difficult to grow here, given the language constraints, cultural differences and lack of sustainable relationship with local companies.

TCS should manage to overcome these with the help of Mitsubishi.  

Notably, the lead time would be less and it provides TCS the first-mover advantage among Indian firms.

The new entity started operations on July 1, and, hence, should start contributing to TCS' financials from the current quarter.

Analysts expect the new entity to book annual revenues of $600 million. TCS' management though expects growth to pick up and add to earnings by FY16.  

"TCS, by gaining scale in Japan through its joint venture with Mitsubishi Corp, may benefit from first-mover advantage and partnership with a local firm.

We see potential for $2.4 billion of new revenues (seven per cent of business in FY20), implying Rs 100/share incremental valuation upside," says Rishi Jhunjhunwala of Goldman Sachs in a recent report.

He believes the Japanese market could take up TCS' compounded annual revenue growth rate to 20 per cent over FY14-16 from the estimated 18 per cent.  

TCS' strategy on growing this business and pace of penetration in the Japanese market, though, will be key to the joint venture's success.

The Ebit (earnings before interest and taxes) margins of IT Frontier Corporation are slightly lower than that of TCS' Japan business.

The management hopes that as revenues scale up and the joint venture company achieves higher cost efficiencies, the margins would remain stable.

However, compared to TCS' margins, they are distinctly lower and, hence, contribution to profit growth is likely to lag revenues.  

Overall, thanks to its consistent financial show over the past two to three years, strong deal kitty and robust visibility, TCS remains a top pick of most analysts.

Its well-diversified portfolio across verticals, service lines and places have enabled it to outperform consistently.

The stock, up 25 per cent in the past three months, made a new 52-week high of Rs 2,639 on Monday and now trades at 20.2 times the FY16 estimated earnings, a strong 20-30 per cent premium over peers.

While analysts believe this is likely to sustain, significant upsides are unlikely, given the current valuations.

Image:  N Chandrasekaran, CEO and MD of TCS addressing a conference.

Photograph: Reuters