Will TCS’ acquisition of its clients’ tech units boost its BFS business?

On November 9, TCS announced that it would acquire its client Deutsche Bank’s IT business by 2020 end. Three days later, the company in a statement said that it would acquire staff and select assets of its client, Prudential Financial subsidiary Pramerica Systems in Ireland.

The acquisitions will strengthen India’s largest IT services company’s banking and financial services portfolio. According to analysts, the move is a bid to reignite growth in its financial services segment.

“TCS hasn’t made a significant acquisition before, so this is a major statement,” said Phil Fersht, founder, HFS Research, an analyst firm.

Indeed, unlike its global rival Accenture, and local peers such as Wipro and Infosys, which, in addition to building in-house products, make acquisitions that complement their portfolio, TCS has been building digital products and platform solutions in-house for clients. It would not be a stretch to say that the company’s robust digital portfolio has been built from scratch.

However, with its peers Infosys and Teaneck, New Jersey-based Cognizant closing in, Fersht explained, TCS needed to change its BFS playbook. He added that Wipro, under new CEO Thierry Delaporte with his proven capability in the space, poses a threat as well. Wipro recently overhauled its business units to accelerate growth.

BFS growth slump

Banking and financial services is the largest revenue generator for TCS, accounting for about a quarter of its total revenue.

From 31.1 percent in FY19, banking and financial services accounted for about 30.5 percent of its total revenue in FY20. For the last two quarters Q1 FY21 and Q2 FY21, however, the revenue contribution has risen to 31.3 percent and 31.9 percent, respectively.

During the company’s results announcement in October 2019, CEO Rajesh Gopinathan explained that BFS growth continued to slow down as large banks continue to be under pressure. During the earnings call in January 2020, the company’s third quarter, Gopinathan said that the decline in the BFS vertical continues on account of cost optimisation activities banks had undertaken in the US and UK.

Growth from the retail and consumer packaged goods (CPG) vertical, which accounts for about 14.6 percent revenue, also declined in Q2 FY20.

“Financial services has been slow for all service providers as the sector has moved to take more of its functions in-house and lessen its dependence on third-party providers,” said Peter Bendor-Samuel, CEO, Everest Group, an IT consultancy firm.

As financial services firms began to face stiff competition from the new-age Fintech sector, they began making their own investments in technology.

Though this slowdown impacted other IT firms as well, firms such as Infosys fared better. Infosys, whose BFS vertical accounts for about 30 percent of revenue, posted 8.6 percent y-o-y growth for the quarter ending September 2019.

Nilanjan Roy, CFO, Infosys had then said during earning calls that the company was able to capitalise on demand in the mortgage area through its acquisition Stater.

Though Covid-19 had impacted growth, in Q2 FY21, Infosys reported 3.7 percent year-on-year growth in BFS compared to the marginal decline TCS saw in the same quarter.

This is where the TCS’ acquisitions can help, say analysts. At the back of Covid-19, Bendor-Samuel said, TCS is getting rare opportunities to expand its business through carve-outs, particularly in Europe, where financial institutions are under more pressure.

“These wins are nice pickups and will strengthen TCS’ position as a leading provider of services to the financial services industry,” Bendor-Samuel added.

One-off event?

However, though these moves could potentially benefit TCS’ BFS growth, there are couple of things one need to watch out for, say analysts. Fersht said given TCS’ limited experience with M&A and its distinct culture, one needs to see how the IT major will manage these investments.

According to Bendor-Samuel, such carve-outs are likely to be a one-time event in the wake of the crisis and do not indicate that financial services firms’ dependence on third-party providers could increase.

“This (the acquisitions) will create a nice short-term boost for TCS but does not signal that the financial services sector will be a strong growth area for TCS or any of its competitors,” he added.