Can Ratan Tata Program His Software Dreams?

The Tata Group's exit from the hardware business will spur the group to consolidate its software business.

F.C. Kohli, Dy Chairman, TCS: "When we want to raise funds, we will merge these entities. But the time hasn't come--yet"

Ratan Tata had 2 dreams in 1990 to power the House of Tatas' charge into the 21st Century. The first one became a reality when TELCO launched the Indica-India's first indigenously-developed passenger car. But Tata's second dream is still in the making: to build a significant beach-head in the sunrise sector of infotech.

To begin with, there have been a couple of false-starts. The group forged joint ventures in both software and hardware that were ill-fated. Although infotech is close to Tata's heart, his grand blueprint, which was drawn up 10 years ago, is yet to fall in place.

Tata's infotech dream may now become a reality after all. Ironically, because of 2 break-ups in the group. In 1997, the software major, Unisys, pulled out of Tata Unisys (now Tata Infotech Ltd, TIL). And, early this month, the Tatas decided to part ways with the hardware giant, IBM, selling their 50 per cent stake in Tata-IBM to the American partner. While that marks the group's exit from the hardware business, it also underscores Tata's strategy of concentrating on the software business. He is now readying to grow the software business into a Rs 2,000-crore monolith.

BIG BLUE'S BLUEPRINT

Ta-ta! Post the departure of the Tata Group from Tata-IBM and IBM Global Services, it is business as usual at Big Blue. Although it owned a 50 per cent stake in Tata-IBM, the Tata Group had little say in the management of the 8-year-old joint venture. With IBMer Ranjit Limaye in charge of Indian operations, the $81-billion global infotech giant will now, more or less, completely own the 2 companies, and it is almost certain that they will be merged. The combined turnover of IBM's business in the country is about Rs 835 crore: Rs 485 crore from Tata-IBM, and Rs 350 crore from IBM Global Services. After 8 years-and accumulated losses of about Rs 85 crore-IBM says its businesses in India have turned the corner in 1998-99, but refuses to reveal the figures. Says a IBM spokesperson, rather blandly: ''We are focused on world-class solutions, and increasing our market participation.'' Besides an added thrust on the enterprise solutions business, IBM is now even selling stand-alone PCs to the office and home market: in June, 1999, it re-launched its Aptiva home PCs. But mirroring global trends, IBM Global Services-IBM's software solutions business-has grown by 79 per cent in 1998-99; its hardware cousin, Tata-IBM, grew by a mere 14 per cent. No, the Tata Group's exit is not going to change that.

For starters, Tata Consultancy Services (TCS)-a division of the group's holding company, Tata Sons-will be spun off into a separate company. Then, the group's 2 other software entities, TIL and Tata Elxsi, will be merged with it. The new Tata entity will be 4 times bigger than Infosys Technologies, and 6 times Satyam Computers' size. Even F.C. Kohli, 75, Deputy Chairman, TCS, who had always opposed the idea of spinning off the Tata Sons' division into a separate company, does not rule out a merger. Says he: ''When we want to raise funds or integrate all the software companies in the group, we will merge these entities. But the time hasn't come-yet.''

You can bet your bottom dollar-this is the age of NASDAQ listings-that it'll be sooner rather than later. While the arguments for a merger have been around for a while-so have the denials from the Tatas-they are intrinsically sound. Says Jigar Shah, 25, Analyst, K.R. Choksey Shares & Securities: ''TCS and TIL have to merge since it will result in improvement across the entire value chain.'' Adds Nirmal Jain, 33, Managing Director, Probity Research & Services: ''The merger (with TIL) will enhance TCS' size, a critical factor before taking the company to the American Depository Receipt market.'' On the other hand, there is opposition to the merger within the group.

The arguments range from differences in work-culture to even the fact that the group companies compete for the same markets. Nirmal Jain (no relation to Probity's Jain), 52, Managing Director, TIL, while denying any merger moves, insists that competition between the software companies in the group can be healthy. He points out that, in February, 1999, both TCS and TIL bid for the Rs 1-crore contract to make the Bombay Stock Exchange software Y2K-compatible. TIL bagged the contract. But, in the face of intense external competition, Tata's companies will have to stop competing for internal tourneys.

The bottomline: despite the fact that the $375-billion global software business has been growing at 17 per cent per annum, TCS has failed to fully capitalise on its potential. In fact, in the past 5 years, TCS' growth of 106 per cent per annum was lower than Infosys' 312 per cent and Satyam Computers' 209 per cent. Although the latter two were growing on a much smaller base, TCS had the advantage of 67 offices in 18 countries with an accumulated 40,000 man-years of software consulting experience. Agrees Probity Research's Jain: ''TCS could have done better if it had leveraged its strengths.''

Like TCS, TIL also gets large part of its revenues (70 per cent) from the software solutions business. However, TIL-which plans to increase its turnover by 2.50 times to Rs 1,000 crore by 2001-has its share of problems. About 60 per cent of its business is on the Unisys platform. This has not only limited its growth, but also put pressure on its margins.

The Rs 392.79-crore company's gross margins have come down from 16.40 per cent in 1995-96 to 13 per cent in 1998-99. TCS, on the other hand, has a long list of independent clients worldwide. Thus, after a merger, TIL can leverage this marketing strength. Agrees Ajit Chandgude, 30, Analyst, Anand Rathi Securities: ''Once TIL's weakness in marketing is taken care of, the company will have a winning edge.''

With a turnover of Rs 393 crore, TIL is just one-fourth the size of TCS, and, in profits-at Rs 54 crore-about one-tenth. Yet, it makes sense to merge the two. For, it will not only boost sales and profits, but the higher employee productivity of TCS (Rs 13.33 lakh per year) will also induce TIL's employees to improve their productivity from the current Rs 9.35 lakh.

That brings us to the smallest of the trio, Tata Elxsi, which has a turnover of Rs 95 crore. Over 80 per cent of the company's business comes from the conceptualisation, distribution, and re-sale of systems integration solutions based on Unix and NT platforms for domestic industrial and image business clients. While this business does not actually fit into the other companies' software exports business, 18 per cent of Tata Elxsi's turnover is accounted for by software exports. Moreover, it would feel more comfortable being part of the merged entity. Says an infotech consultant in Bangalore: ''Since Tata Elxsi is in a niche market, its growth has been poor.''

However, there are a few bottlenecks too. For one, as Kohli puts it: ''If we merge TCS-once it becomes a separate company-with TIL and Tata Elxsi, there will be problems of work-culture. Hence, one has to work out the entire merger scheme, and do the homework well in advance.'' True, given TCS' 12,000 employees and TIL's 4,000, there are bound to be problems. For instance, the annual productivity level per employee in TIL is 30 per cent lower than TCS'. And TCS' employees are more highly-paid than TIL's: an average of Rs 5.42 lakh per annum against Rs 1.70 lakh in TIL.

More than anyone else, Tata Sons has reasons to be upset with a merger. However, BT's calculations indicate that the holding company for TCS can generate huge amounts of cash through the merger route. Initially, TCS will be hived off as a 100 per cent subsidiary, and the Tatas can sell 25 per cent of the holding to foreign or domestic institutional investors. That itself can raise Rs 7,500 crore on conservative estimates of TCS' market capitalisation of Rs 30,000 crore.

Even Kohli feels that the market value of TCS-which, in 1998-99, is expected to earn net profits of Rs 500 crore on a turnover of Rs 1,600 crore-should be around Rs 20,000 crore. Kohli's estimates are based on a Price-to-Earnings multiple (P-E) of 40, which is much lower than the existing P-Es of 78 for Infosys, and an even higher 90 for Wipro. Agrees a Mumbai-based M&A consultant: ''The Tatas are sitting on a gold-mine. They will have to take only a small step to unlock this treasure-trove.''

Such a divestment-and the subsequent merger with TIL and Tata Elxsi-will not affect Tata's holdings in the new entity. For, with a 75 per cent stake in TCS, 73 per cent in Tata Infotech, and 40 per cent in Tata Elxsi, Tata can easily maintain his holdings at over 50 per cent after the merger since the swap ratio will be in favour of TCS' shareholders. This will also allow Tata to offer stock options to his employees.

Obviously, the next step in the grand software plan would be to list the combined entity's stock on the NASDAQ. International exposure would follow. ''Your company is tracked by international analysts, and you are written about in the Wall Street Journal and the Financial Times,'' smiles the managing director of a Bangalore-based software company. Clearly, Tata has little option but to merge his infotech entities if he has to realise his software dreams. But he will need to act quickly to take advantage of the new opportunities in this sector. Only that way can he ensure a soft landing at great heights for Tata Software.