TCS says $6.5 bn data-centre bet will lag IT business on profitability
In a conversation between the company’s management and Kotak Institutional Equities, CFO Samir Seksaria said, “Yes, (the data center business) will not generate the same RoEs (return on equity) as you would expect from the TCS business, but we are confident that we can maintain industry-leading rates of return.”
RoE, a measure of profitability, indicates how effectively a company uses shareholder investments to generate earnings.
On October 9, the country’s largest IT services company announced plans to set up a 1GW AI data center in India through a new business unit, which it will later name HyperVault AI Data Center Ltd. The company said it expects to achieve this in phases by spending about $6.5 billion over a seven-year period to build out these data centers. These large servers are stacked on top of each other to store data, providing companies with computing power.
Considering that IT services are an asset-light business and factories do not use large machines, TCS’s data center foray had raised questions about the operating model of the venture.
This private investment will not have a significant impact on TCS’s rates of return, Seksaria said, citing a strong balance sheet and excess funds. He said the company will invest in the data center business in phases and it will not be entirely a cash drain for TCS.
The management did not specify how much TCS plans to raise from outside investors for its $6.5 billion investment. “We don’t want to say this openly, but we have a structure in mind; this would be a typical structure in which data centers operate,” Seksaria said.
‘Not exciting’
Analysts expressed concerns about the profitability of the new business.
“The profit generation of this data center business is less than that of the existing IT services business. It is not stated how much will be lower. Return on equity is not high in asset-heavy businesses,” said Amit Chandra, vice president at HDFC Securities.
“…our preliminary assessment suggests that capex could reduce ROE from ~50% to 40% over the next five years,” ICICI Securities analysts Ruchi Mukhija, Seema Nayak and Aditi Patil wrote in a note dated October 10.
However, TCS management said that achieving a higher margin would be “extremely competitive on the cost of electricity”.
These are high-density data racks of around 50KW-180KW and 370KW per rack at the top end, so more than three-fifths of the cooling will be done through liquid and the rest through air, as servers tend to heat up quickly due to heavy data usage, group executives said.
The company is eyeing land parcels in Navi Mumbai, Hyderabad, Bangalore, New Delhi and Pune. These cities collectively account for more than four-fifths of the country’s total data center capacity.
“We aim to complete the full construction cycle of 18 months from the time the land is in our possession. So from the start date, that is, once we press the land availability button, the delivery will happen within 18 months,” said Deepesh Nanda, managing director of Tata Power Renewable Energy Ltd, a subsidiary of Tata Power Co.
Much of the demand for data centers is driven by hyperscalers and artificial intelligence companies that provide cloud computing capabilities. For TCS too, AI companies and hyperscalers will drive demand, according to TCS chief strategy officer Mangesh Sathe.
A Tata bet
The data center move is also a step towards the One Tata policy where the IT services company will work to acquire more business from group companies.
TCS will issue floating tenders for network solutions to various companies, including Tata Communications Ltd, which once operated data centers in India and Singapore. In 2016, the company began selling this business, calling it “non-core.”
Shares of TCS are down 0.14% since the data center announcement on October 9. ₹3,057.8 points against a 2.15% rise in the benchmark Sensex’s 83,938.71 points. Infosys Ltd and Wipro Ltd fell 1.78% and 2.3% respectively during the period. On the other hand, HCLTech increased by 3.7%.
HDFC Securities’ Chandra said investors were worried. “Investors say they would be happier if this money was spent making cutting-edge investments around AI in high-tech companies, just like Microsoft is investing in OpenAI.”
According to Pramod Gubbi, founder of Marcellus Investment Managers, “Investors may prefer TCS to return excess cash and focus on what it does best – IT services.”
But JM Financial expects India’s data center capacity to grow almost fourfold in the next five years.
India’s colocation data center capacity is 1.35 GW by 2024, up 38% annually, JM Finance analysts Abhishek Kumar and Nandan Arekal said in a March 27 note. “Despite this, India’s data center density is one of the lowest in the world at 14 petabytes per megawatt (MW). We estimate that India needs a total capacity of 5 GW by 2030 to reach 50% of China’s data center density.”
