tcs, and its glory

TCS is planning a buyback worth Rs.160 b at a price of Rs.2,100 per share. That should reduce its March 2018 cash to Rs.272 b. Never mind the current cash position, it's only 3 months since after all. Let's work with the March 2018 numbers. It had 1914 m shares then; subsequently in May 2018, it carried out a 1:1 bonus; so there are 3828 m shares outstanding as of now. After the buyback they will be 76.1 m lower. Is Rs.2,100 a fair price for the stock? There are two things necessary to do a buyback: First, it should have excess cash which TCS has in plenty. Second, the price should be lower than its intrinsic value. If not, the selling shareholders will benefit. That is a conundrum for both the managers and shareholders. What the heck is the value per share of the stock? The market price is about Rs.2,000 now. 

TCS had revenues of Rs.1,231 b in 2018. More than 80% of that comes from Americas and Europe. It serves the services sector much more than the manufacturing sector, with leadership in banking, finance and insurance space.

The revenues increased by 14% and 18% annually in the past 5 and 10 years respectively. However, it did clock its lowest revenue growth in a decade at 4.36% last year. Is that any indication? In fact in 2017 also the revenue growth was lower than double digits. 

TCS does not spend much on research and development. It is about 1% of revenues. I prefer not to make any adjustment to its operating profits. Operating margins are pretty stable at around 25%. Earnings per share was Rs.25.68 (2008), Rs.70.99 (2013), and Rs.134.91 (2018); these are all pre-bonus numbers. It had a double digit growth in the past 5- and 10-year periods. Yet, the growth was as low as 1.12% for 2018. This was despite a buyback of 56 b shares at a pre-bonus price of Rs.2,850 per share in May 2017. Since then the stock has gained 40% to date; the buyback turned out to be a bargain for the existing shareholders. Net margins have also been stable at around 20%. Return on capital and equity have remained very healthy. It had a book debt of Rs.2.5 b, and lease debt of Rs.37 b. Yeah, TCS has some non-cancellable operating leases. 

How much can its EPS grow in the next 10 years, for instance? Adjusted to May 2018 bonus, if it grows at 10%, it will be Rs.175 per share after a decade. At a multiple of 25 as a reward for growth, the market price will be Rs.4,375, giving an annual return of 7.25% for the period. Make it 9.50% including dividends. Are we happy with that rate? What are the alternative opportunities available? What if the growth rate is 7%? Well, the return also will be lower at about 4.25% including dividends, assuming a lower multiple of 20 for lower growth. That's the risk all equities carry. 

Historically TCS has been priced at higher price-to-fcff multiples. Let's assume that a multiple of 20 is fair as it stands today as an aging information technology services business, and that its average free cash flows annually are Rs.200 b. If these free cash flows grow at 10% annually over the next decade, our expected return from the stock will be about 7.55% for the period.

I also did a dcf valuation for the business. At its current price, the implied rate of return for the stock is 7.36% based on my assumptions regarding growth rates and reinvestment of course. 

If our expected returns are higher than 10%, we need to expect higher growth rates in revenues, earnings, and cash flows from the business. Is that possible? TCS managers have found Rs.2,100 as a fair price for the share buyback; may be they know more about its story than we do. 

TCS was available at Rs.709 b in 2008, at its low price. In 2013, the low price for the business was Rs.2,082 b. Today it is priced more than Rs.7,500 b. That's hypothetical because Tata Sons owns more than 70% of the business; and it ain't going to sell. In addition, TCS paid out a total of Rs.663 b in cash dividends in the last decade. Of course it has been a super business. Whether TCS and its peers in India are aging IT services businesses which have matured already, or there is more innovation and growth in store is the question before the analysts.