Investment in geographies paying off handsomely; positive outlook for FY18: TCS

In an interview with CNBC-TV18, Rajesh Gopinathan, CEO & MD, NG Subramaniam, COO, V Ramakrishnan, CFO and Ajoyendra Mukherjee, Executive VP & Head-Global HR at Tata Consultancy Services (TCS) spoke about the results and gave their outlook for the company.

Below is the verbatim transcript of the interview.

Q: Tell us about the setup for FY18 in the backdrop of FY17 and is FY18 going to be better than FY17?

Gopinathan: We have had a steady year. We have done about 8.3 percent of constant currency growth, about USD 1.4 billion in constant currency revenues added, margin wise also it has been a good year, cash performance has been exceptionally good. We have crossed 100 percent in terms of cash conversion on the net profit line and if you look at it from our customer portfolio, we have had very good growth across multiple customer portfolio levels.

Similarly, from a vertical industry perspective also, we are diversifying our industry mix very nicely. Our smaller industry groups are growing at strong double digit growth across. Our investments in geographies are paying off very handsomely. Europe has come in at close to 15 percent growth.

So, all in all, structurally we think that considering the environment that we are in, it has been a very good performance and sets us up for a good positive outlook for FY18. As you know, we don’t give guidance, but within the constraints of that, I would say that directionally we are positive.

Q: Let me come on the margin front. 26-28 percent, is that in constant currency or in reported terms when you reiterate that you will hold on to the margin band and second if currency remains at the levels it currently is, do you think achieving this margin band will be a stretch for TCS?

Gopinathan: Couple of things I want to clarify. We have always maintained that 26-28 percent is our target that we are carrying and we will come out if we believe that the target is no longer achievable and as of now we are quite positive and confident that it is a doable target and that continues to be the target. We don’t give guidance, but within that. Our margin targets are independent of currency but we have always mentioned that the near term currency volatility will play through into it and whenever you see a very sharp movement in currency, it will take a period of time for the model to get adjusted to it and we give you transparency within that.

So, that is the same thing that has happened, we ended this quarter at 26.1 percent but very sharp currency movements, much unexpected currency movements took away almost 40 basis points out of it to end at 25.7 percent. So, within the parameters of that, we are quite confident that on a reported basis that is the target with short-term volatility due to currency.

Q: In one word, if you can tell us, do you think it will be a stretch to achieve it, yes or no?

Gopinathan: It wouldn’t be fun if the targets were not to be a bit stretched, right?

Q: The biggest disappointment this time has come in from banking, financial services and insurance (BFSI) because the commentary from the management up until now was fairly positive but it has not translated into numbers, your revenues were negative in constant currency in BFSI, what went wrong in BFSI compared to three months ago and also you spoke about a delay in spending patterns in BFSI, when do you think that will pick up? Has it already picked up, do you think it will reflect in June or will it be a back-ended pick up in BFSI?

Subramaniam: BFSI as a vertical for us has grown annually at about 7.6 percent in terms of constant currency rate. In Q4 we have seen a dip and that is a one-of. One of the large product they were executing in Q3, it round up and it did not ramp up as we expected. So we believe that it is a one-of and what we see is a very good momentum.

The deal pipeline BFSI is quite good and both Rajesh Gopinathan and I have met with a large number of customers in the banking financial services sector over the last six weeks. All of them have given a very positive commentary. They do not believe that their budgets are under stress. They continue to have an investment agenda.

However, they are waiting for some cues whether it is interest rate regime softening or decrease in regulatory and tax burdens and these are some of the cues, probably they are waiting to release the budgets from a discretionary spend perspective.

However, we are seeing enormous amount of agile projects, which means that a lot of small projects that are coming in which are tended to get completed in about 6-8 weeks sometimes. Sometimes within a quarter so there are a number of agile projects which are happening in the digital work is something that we are actively participating in it.

From an insurance perspective, we see phenomenal amount of deal pipeline, a lot of large projects which hare happening and we are very close to winning a large insurance deal. Hopefully that should all pay out positively for us including the Diligenta thing which should do well this year and Japan as well should turnaround very well for us this year.

The last half year we have secured a lot of new wins, all this should play out well in the banking, financial services space in the current quarter.

Q: So the client have the intent to spend but they are holding back as of now? The release of funds has held back, so what is the sense you are getting from the clients, do you think they will be willing to start spending in June by the end of the year, some timeline?

Subramaniam: It is difficult to say but I do believe that our indications, which we are getting is that they should be doing it from our Q1 and Q2.

Q: So Q1 and Q2 should be good for a TCS BFSI?

Subramaniam: Absolutely.

Q: What about retail? There the commentary suddenly changed, earlier it was a cyclical downturn, now you are talking about structural changes, the structural impact on the industry, the challenges there, what has changed and therefore do you think retail will have a negative growth here in FY18, should we even brace ourselves for that?

Gopinathan: I wouldn’t go as far as that and over the last two-three quarters, our commentary has been moderating on retail. It is an interesting industry, it has been at the fore-front of adopting digital and our participation in digital has been very good but what we are now seeing is increasing financial stress building up in a few clients, which is resulting in a net reduction in the overall spend itself and our commentary now is more a reflection of that -- our expectation that it is likely to probably become a bit worse before it gets better.

Overall across all retailers, they are very clear that it is a technology transformation agenda that they have and their business model transformation is acutely dependent on a technology transformation. So our participation there continues to be good. The issue is the overall price shrinking and how it plays out, we will have to wait through the year but I do not think we are going to end with a net negative year but probably in a single digit.

Q: What about this visa, Trump has signed the executive order on Buy American, Hire American, do you think the H1-B wage cost goes up because now visa allocation will no longer be lottery based, it will be based on merit which basically means, your higher skills, higher wage employees are likely to go through.

Gopinathan: Let us put it this way. When we send people to client site, we always send our best and rightest. And TCS’ retention record is very good. So our ability to attract and retain and we believe that on a like-to-like basis, our talent base is far superior to anybody else’. So per se visa system that is predicated on talent quality we have absolutely no problem with that. Overall we would like to go through the details of the whole thing before commenting on it but we have always maintained that a visa system that is transparent and fair across all participants, we are comfortable with that. It does not matter what the specifics of it is. We will modify our own business models in accordance with that.

Q: You had earlier spoken; I think it was in the last quarter where you had said that you had applied for 1/3rd the visas that you had earlier applied for. However, now the FY18 visa system is just closed. If you could tell us how many visas did TCS apply for and how would it compare with the prior year just to get the sense of how proactively you have reduced your dependence?

Gopinathan: The comment that we had given earlier was last year compared to the year prior to that. So, this year is similar to last years. So, we are maintaining a low regime.

Q: So 1/3rd of your historical average as a broad benchmark?

Gopinathan: Approximately yes.

Q: You spoke about how Diligenta, the pipeline is looking very good and therefore it should have a good year. The absence of drags from Japan and Diligenta are expected to be tailwinds for FY18. So, if you could tell us what was the impact on the FY17 constant currency growth because of the soft year on these two, on Diligenta as well as Japan, which will not be there next year so we could get a sense of the tailwind?

Gopinathan: If you look at overall Asia-Pacific (APAC) which is where the bulk of the -- both APAC and UK are the places where you see that coming through. APAC has done about 5 percent, UK has done about 6 percent and a lot of the drag has come from these two entities in these markets. So, while we are not quantifying that, you will have to wait for our full year annual report where we will give you subsidiary numbers and that will give you good idea about what that is. Japan has been a negative year for us and Diligenta has also been negative.

Q: One-two percent would be the rough impact on FY17 constant currency (CC) growth which should not be there next year?

Gopinathan: We have not quantified that; I would not like to comment on it. However, as I said, you can see it in the impact on the numbers at the geographical level and UK and APAC.

Q: On India, it has been two good quarters on the trot. You have always classified India; at least the TCS management has always said India is volatile. However, is something changing over there, should we still classify it as volatile or are you seeing signs of a sustainable pickup with respect to India geography?

Subramaniam: India will continue to be volatile. There has always been a yo-yo effect in our ability to build book, deals in the India geography. However, we see that there are a lot of opportunities which are coming in with increased government spending on digital.

Q: How are the margins on the Digital India spend?

Subramaniam: It is quite comparable. India geography, the margins are always a tad low but it is catching up. However, from a digital perspective I believe that it is quite comparable to what we get in emerging market. For example, we launched recently the Aadhaar Merchant Pay and that should do well because that should really accelerate the digital payment ecosystem within India as well.

Q: What about communication. Q3 was weak, Q4 has bounced back but what is the trend that you see on communication because even your peer Infosys had a fairly good quarter?

Subramaniam: Media, communication, telecom, we see a phenomenal amount of convergence - that has played out well for us. Communications, media, and information (CMI) as a vertical has grown significantly and for the first time it has posted higher growth than the company average. So we see phenomenal amount of opportunities in that particular space.

Q: Apart from retail, is there any other headwind that you would want to call out as we step into FY18?

Gopinathan: From a vertical industry perspective - no. The three - BFSI, retail, hi-tech are weaker. Hi-tech, over the last three quarters is picking up nicely and we think it has got good trajectory to go through. In BFSI we are seeing decent pipeline and that should come through. So retail continues to be, from a vertical perspective, the one where there is a clear structural challenge.

Communication, it's a first year that it has delivered 10 percent growth over the last five years, if I am not mistaken. So we need to be a bit careful about it, there is a clear uptick in that but likely to be a bit volatile because as it comes off low period, it is likely to be a bit volatile but we are quite confident about what we are seeing there.

However, from a geography perspective, the two big underperforming regions - UK and Asia Pacific, the structural challenges which were driven by Diligenta and Japan, we are constructive on Diligenta. As NG mentioned earlier, a very strong pipeline, with one which we expect to sign shortly, in which case Diligenta should do quite well and that should take care of the negative drag on UK.

Japan has been a net negative year and we expect it to be net positive in FY18 and that should continue to provide that support on Asia Pacific. So geography wise also we are not seeing any weakness in any specific region. Emerging markets are always volatile. However, going back to your question on India, we have never defocused India; in fact we have been the most invested in India. Our focus is to move from project based revenue stream to annuity based revenue streams and that is the key issue in most emerging markets. When you are on project based on, the volatility is very high. As you shift slowly into an annuity based streams, you get more certainty into revenue side. So that continues to be the focus in India as well.

Q: So retail soft. You will wait and watch on communication and Japan also may not be a phenomenal growth year but it will not be a negative growth - so these are the only sort of headwinds we could call out as we step into the next year.

Gopinathan: That's right

Q: What about digital. In a way do you think digital growth has slowed down? The reason I say that in the prior years, you had about 30 percent YoY growth in digital. In the last quarter it was about 22-23 percent YoY growth. I am not saying that the difference is very large but in a way do you think it is slowing down now that the size is getting bigger and you have also given a number USD 10 million in terms of deal size. How do you see that progressing as the year?

Gopinathan: In terms of digital for the full year FY17, we touched USD 3 billion in digital revenues in FY17 and that is up about 28-29 percent for the full year. So it continues to be growing far ahead of the company average and continues to power growth. It is likely to continue that way with over time a slow moderation.

Q: What would you classify as slow moderation growth for digital?

Gopinathan: It used to be in 50s earlier. It is in 30s now. FY18 will be in 20s - that will be more natural expectation as the size becomes larger. However, deal size wise we had commented that in the context of BFSI where we had said that digital projects are moving from the pure frontend into the backend part of relooking at core systems and re-architecting them for more digital friendly kind of architectures and that is increasing the deal size. So we are moving away from deals in the few millions in deals in 10 million plus kind of a range and that is a natural progression as technology starts permeating deeper inside the enterprise for these large customers and that is net positive for us as we look forward into the year.

Q: I want ask you more on the margins - what gives you the confidence that you will be able to maintain it? You have spoke about a few levers - 1) demand 2) lower hiring and 3) higher margins in newer technology. If you could elaborate how all three of them could incrementally contribute. What are the margins in newer technology as you see? How much the hiring would be lower compared to the prior year? 

Gopinathan: Margins from newer technologies -- a very interesting way of thinking about it is people have been talking a lot about pricing collapse and we have been saying that net realisations are fairly stable and that comes from a portfolio mix strategy. So newer technologies typically come in at a better price point but initially the better price point is married with a higher cost point also because project sizes are small, they are more onsite centric, more touch intensive, the pyramid is not optimised and as we start increasing scale, all these levers come into play; the project size become much larger, our delivery maturity keeps on increasing. So newer technologies definitely, as they sale up, provide margin support and the other levers that you mentioned, each of them are incrementally positive.

Q: Let me start straightaway about margins. Rajesh said it is not a margin band or it is not margin guidance if it is not a bit of an aspiration. Take us through how the company will reach it and according to you, do you think it will be tough for the company to achieve this band of 26-28 percent considering the headwinds you are facing?

Ramakrishnan: This is obviously not guidance. This is a target which we have been operating for at least the last three-four years.

Q: But you missed it this time so how confident are you?

Ramakrishnan: The miss is more due to the currency in this quarter and in the overall year, based on the impact was about 80 basis points, but this is something which we are definitely focusing on to getting back to 26 and to work from there. So, the headwinds will be there. In any given year, there would be. In the short-term of course, on the increments and promotions, there would be some impact, but that will probably be in the near-term.

The pricing pressures would be there, but considering the broad based across the industries and across also the geographies in which we operate in plus also the fact that more and more digital engagements are coming in and where we have the ability to get the value for the offerings and value for the customer. So, we believe we will be able to address that and some of the businesses which had been below the company average in the past, for instance, in Diligenta, etc. we definitely expect more positive outlook in this current year.

So, we will work on that and as I said, Rajesh also said, we strongly believe that we can work towards it, but it is not our guidance, it is our target.

Q: Let me come to the point you made about wage hikes. In the press conference, you indicated that wage hikes this time would be in the mid to high single digits. Last year around, for offshore, it was 8-12 percent, so in a way, wage hikes this year appear to be lower than what they were in the prior year. Second, you also spoke about hiring being lower in FY18 compared to FY17. Therefore, I want you to quantify what will be the impact on account of wage hikes on your margins. Will it be the same as it was last year or do you see it being lower?

Mukherjee: Overall, wage hikes yes, we announced, it will be effective April and it is lower than what we had done last year, it was 8-12 percent. This time we are saying the mid to high single digits. And similarly, onsite we have said, which is for our local workforce which we have across the globe which will be from 2-5 percent which is similar to what we had done last year and there is no further change.

As far as hiring is concerned, we have said is that last year our net was 33,000, the year prior to that was 34,000 and overall, what we are saying is given our retention levels going up, as far as our gross addition is going to be, next year is going to be lower.

Q: By?

Mukherjee: That we have not announced yet, but it is going to be significantly lower than what we have done in the current year - that is what we have said and it also depends on the way the business improves, the way the business demand comes up because the technology, the skill set that is needed is all very dynamic at this point in time. So, these are the two things we have said, wage hikes we have announced and we have said the hiring is going to be lower.

Q: So, typically, you see about a 200 basis point wage hike on your margins?

Ramakrishnan: Last year around 2.4, but we had some operational efficiencies which brought the overall down to around 1-1.25.

Q: So, 200-250?

Ramakrishnan: Yes.

Q: So, this year, how much do you anticipate?

Ramakrishnan: Considering the fact that -- Ajoy gave some indications of how the hikes, you will have to look at current year versus interpreted with last year, plus also the lower hiring, etc. So, we do not give out the number in that, but you can get the cues from where we were.

Q: It could be lower than 200 also.

Ramakrishnan: It could be.

Q: How worried are you about a potential cost increase on account of visa? First, give your thoughts on the executive order which has been signed by Trump overnight. How do you read the impact on the Indian IT industry and second, if you could also tell us that if potentially – this is a hypothetical question – if the minimum wage hike is raised to USD 100,000 from the current USD 60,000, what percentage of your H1B employees would be below USD 100,000?

Mukherjee: As far as the directions that is being talked about, it is in terms of 'buy American', it is in terms of protecting American jobs, but if I come to the specific executive order, it is in the same direction, but it has not given any specific things which is going to impact us as far as this financial year is concerned.

So, as far as FY18 is concerned, there is no impact from a visa point of view or there is no impact from a prevailing wage point of view, that remains very similar and the prevailing wages changes in July every year based on the surveys. So, I do not see much of an impact from that angle. So, that is as far as the visas are concerned.

Now, over a period of time, when it comes to the USD 100,000 vis-à-vis what our costs are, our H1Bs, over a period of time, our wages are converging between what our expats get versus what our local workforce is getting. So, we are pretty close. There will be an impact, but at this point in time, it is hypothetical to say how much will be the impact because I still do not know what the minimum prevailing wage is going to be.

Q: So, that is what I am saying. Hypothetically, if raised to USD 100,000, you would have how many employees as a percentage below that number?

Mukherjee: It will be very difficult to give you the exact numbers and we are not giving those numbers at this point in time because the impact will be very difficult to understand because there are multiple things we will have to do at that point in time. We do have our plans in place to counter what will come out. So, we are just waiting for what the situation is going to be, what legislation comes out and we will act accordingly. So we are saying two-three broad statements that we will definitely be compliant, that's one. Second, as far as US is concerned, it is a large market for us. We will definitely continue to operate in that market, we will continue to meet our customers' requirement and serve them and third, we are hiring locally and we have been hiring locally and we are going to increase that local hiring, so that is going on.