TCS - An IT Company or an Employment Agency?

Well I have not been a big fan of IT companies in India whether it's about working for them or investing in their stocks for long term. The recent run up in stock prices of TCS, HCL Tech, Tech Mahindra and other IT staffing companies has only increased my worries as they are being perceived as technology companies and getting valuations accordingly.

TCS is now valued at around $90 billion in market value and is trading at a PE of 21 times FY-16 EPS. If one believes that TCS is an innovative technology company like Apple, Oracle or Google then the valuations are justified but what PE would you apply to an employment agency who has just grown at the rate of growth in number of employees in the company. With employee billing arbitrage gradually getting narrowed due to very high wage inflation in India and less than 2% wage inflation in western world the margins will gradually decrease over next 10 years on this business model. 

In FY-14 TCS had over 3,00,000 (3 lacs) employees and reported a revenue of $13.44 billion. To grow it's revenue at the rate of 15% for next 5 years it has increase it's employee base to 6,00,000 (6 lacs) by FY-19. Managing attrition, productivity, quality and very high fixed wage costs will be a huge challenge for the company. Any downturn in business from western world would severely hurt the company's financials and profits.

Financial Year*	No. of Employees*	Revenue ($ million)*	Rev per employee ($)
FY-05	45714	2240	49000
FY-06	66480	2970	44700
FY-07	89419	4300	48000
FY-08	111407	5700	51000
FY-09	143761	6000	41700
FY-10	160429	6340	39500
FY-11	198614	8200	41200
FY-12	238583	10200	42700
FY-13	276196	11600	42000
FY-14	300464	13440	44700

*TCS employee and revenue data taken from TCS official website

As can be seen from the line chart below, the revenue per employee has been largely constant with slight negative bias which clearly suggest that the company is growing on the back of increase in staffing to it's clients. Also it can be easily calculated from the data above, the employee growth at TCS from FY-05 to FY-14 had been 557 % while it's revenue growth had been 500 % (less than the growth in no. of employees).

TCS is a very well managed company but largely mispriced by the market as most of the people believe they are technology company. TCS, Wipro, HCL Tech, Cognizant, Tech Mahindra all are largely staffing companies and deserve forward PE multiple of less than 15 unless they can show significant non-liner growth in revenues on the back of innovation.