Is listing good for TCS?

The revival in the stock market and the success of the Maruti IPO is probably indicating to the Tatas that the time is ripe to list Tata Consultancy Services.

A listing by TCS will be greatly beneficial to the investing public and the economy. The Tatas would have probably gone in for a TCS listing earlier, were it not for the downbeat mood in the stock markets.

Conventional wisdom holds that by listing TCS, the Tatas will be able to leverage its value and garner substantial investor resources for expansion of other group companies. But this may be problematic.

A publicly listed TCS will have large institutional shareholders, including FIIs. They will watch over investments by the company and keep asking if these are in the best interests of TCS shareholders.

For example, if TCS was listed several years ago and had decided to invest in the emerging telecom service business, institutional shareholders may well have taken a dim view of it then.

But there is a deeper reason why public listing may not be good for TCS. The best Indian software companies are under increasing margin pressure and having to do all they can to keep shareholders happy.

This is resulting in a shorter outlook and maximum focus on current performance. The short-term outlook, prompted by what is called the tyranny of quarterly results, can have a negative long-term impact on these companies.

Are they investing sufficiently in technology without which innovations cannot come? These provide a key route up the value chain. Investment in technology brings return only in the longer term.

Some entry barriers are indeed created by the scale that these companies have been able to achieve and the efficiency of their delivery model, but these are rather easily overcome.

There are also counter arguments. Some analysts hold that regular shareholder scrutiny will be good for TCS. It is also asked as to what great investment TCS has been able to make in technology, by not having to answer to shareholders, given the freedom to do the right things in future, even if that freedom has not been put to the best use in the past.

There is some urgency in all this as the leading Indian software companies need to reinvent themselves, as the returns from their highly successful model are plateauing.

There is some unanimity on the view that they have only one way to go -- up the technology ladder. At this juncture, TCS may be ill advised to have its freedom curbed by public listing.

The beneficial role of listing will not be apparent if we look at the way the markets have lately interfaced with Infosys. Barely three months ago, the markets were in a tizzy after Infosys issued results and guidance for the current year, which were far below expectations.

The resultant fall in the share price of Infosys led to a downslide in technology stocks with talk that these stocks had lost their shine for quite some time to come. But the Infosys results announced last week have dramatically reversed the process.

The results have been better than anticipated, the Infosys stock has improved sharply and taken not just the technology stocks but the whole market up with it.

In April, one complaint heard among analysts was that when the company was going to so decidedly revise downward the scenario, it should have taken the investing community into confidence earlier.

This, despite the fact that the company had first met its guidance for the year that was ending and, as the occasion arose, issued fresh guidance for the new year. What the analysts were effectively saying was that there should have been a guidance on the guidance!

After the first quarter results, which have been so well received, analysts are now inclined to believe that the guidance issued in April was very conservative.

Hence, it was easy enough for Infosys to have bettered it and slightly revise upwards the guidance for the rest of the year. This seems to be a classic manifestation of the established Infosys syndrome of under-promising and over-delivering.

As Infosys has been known to do this, the question arises: why didn't the market discount the negative implications of the April figures? The market has every right to be volatile so long as no one is rigging it but when does volatility begin to make the market inefficient?

Guidance apart, what is it that Infosys has done, by its own admission, to improve its performance in such a way that the market reaction has been so dramatically opposite?

The company has done away with some costly overseas contracting, slightly raised the proportion of work done offshore which fetches a better margin, improved the share of value added work which fetches better margin and made a marginal gain from rupee appreciation, when this should have had a negative impact, by having covered its future positions.

All this is fine but the changes are very marginal. What is more, Infosys's operating margins have remained virtually the same, in fact gone down slightly, from 33 (Q4/03) to 32 per cent (Q1/04)!  The margins are virtually unchanged because the productivity gains have been passed on as wage increases. It is doubtful if this is what the market is applauding.

Nandan Nilekani, the Infosys managing director, has boldly asserted that the company's global delivery model remains intact and a winner despite offshoring to India by global software service leaders.

So why did not the intrinsic and long-term merits of this model impress the markets a bare three months ago? Nothing changed in Infosys in the last three months, except a few marginal aspects. But the markets first jumped one way and then another. You cannot tell the markets what to do but what is there for TCS in listing right now?