TCS And Infosys Expanding In China

A recent Gartner study claims that the global spending on technology will increase 5% in 2011 to $3.6 trillion. IT outsourcers are pleased by the report. However, in India, currency volatility continues to pose a threat. During the previous quarter, the U.S. dollar fell more than 5% against the euro and around 2% against the pound, but the rupee rose an average 3.5% against the dollar. The U.S. market claims nearly 80% of the Indian outsourcers’ revenues. As the rupee continues to strengthen, the cost advantage for the region is wearing off faster than expected. But even amid such concerns, India’s largest IT outsourcer, TCS, posted better-than-expected results.

TCS’s Financials
Tata Consultancy Services’ (NSE: TCS) Q3 revenues grew 31% over the year and 7% over the quarter to $2.14 billion. Net income rose 35% over the year and 14% over the quarter to $517 million. During the quarter, volume grew 5.7%.

TCS’s Operating Metrics
Utilization was flat for the quarter at 83.8% excluding trainees and down marginally from 77.7% in the previous quarter to 77.1% utilization including trainees. Attrition grew marginally to 14.4% from 14.1% a quarter ago. During the quarter, the company added 10,827 employees to end it with nearly 187,000 employees.

TCS’s China Focus
China remained a priority area for TCS. According to a KPMG report, China’s total outsourcing market is projected to grow to $43.9 billion by 2014 compared with $20 billion in revenues reported in 2009. TCS has already established a strong presence in the Chinese banking sector: four major Chinese banks, including Bank of China and Hua Xia Bank, use its core banking system. TCS also has 1,200 employees in China and plans to increase this number to 5,000 in the next three years.

TCS’s stock is trading at Rs 1,202.40 (~$26.50) after having touched a 52-week high of Rs 1,186.85 earlier this month.

Infosys’s Financials
Infosys (NASDAQ:INFY) saw Q3 revenues increase 6% to $1.585 billion with earnings of $0.69 per American depositary share compared with the Street’s expectations of revenues of $1.56 billion and EPS of $0.67. On a constant currency basis, revenues grew 4.7% over the year. Revenue growth was driven by a 3.1% increase in volumes and an impressive 1.6% increase in prices.

For the current quarter, Infosys projects revenues of $1.6 billion–$1.62 billion and earnings of $0.69–$0.70 per ADS compared with the market’s expectations of revenues of $1.6 billion and earnings of $0.68 per ADS.

Infosys management is concerned about the coming quarters and have expressed concerns regarding weaker economic recovery in developed markets, high unemployment rates, and risk of sovereign default that may impact the industry’s growth.

Infosys’s Operating Metrics
During the quarter, the company added net 5,311 employees, taking their headcount to 127,779. Neither utilization nor attrition fared well in the quarter. Q3 utilization including trainees was 72.6% compared with 74.3% a quarter ago and 68.8% a year ago. Attrition increased to an annualized rate of 17.5% compared with 17.1% in the previous quarter and 11.6% a year ago. However, the company is hopeful that attrition has stabilized because the industry has now built up capacity.

Infosys’s Strategy
Infosys is working to move up the value chain within the IT outsourcing business, an identified outsourcing trend of the decade. They attribute the quarter’s increase in their prices to the movement to higher-end consulting engagements with billing rates of over $150 a day. Within the value pyramid of the IT outsourcing industry, they are looking at moving to operating at “middle of the top” from their current position of being on “the top of the middle.” They are thus hiring more consultants and aim to add nearly 100 of them each quarter.

Infosys’s China Focus
Like TCS, Infosys has been focusing on China. They already have nearly 3,000 employees working out of their China-based offices. Earlier last year, they established a China Education Center to develop software talent in research and education institutions at Jiaxing Science City. Through the program, they are looking to train more than 1,000 engineering graduates from universities for entry-level positions and impart soft skill and leadership training to another 2,000 employees annually.

The stock is trading at $71.09, taking the market capitalization to $40.6 billion. It touched a 52-week high of $77.92 earlier this month.

I had identified broadening geographic reach as a key outsourcing trend of the decade. The Indian IT players do seem to be addressing that by expanding in countries like China to establish themselves as players outside India. They should also be looking at expanding their existing capabilities in Mexico and Canada. I strongly believe that these companies need to look into establishing themselves in rural America which not only offers cost advantage but also helps address concerns of time zone and near shore management. I have yet to see compelling near-shore strategies from the Indian outsourcers in the United States.