The Hindu Business Line : Acquisitions getting less expensive for IT cos

The slowdown being witnessed by the IT industry has thrown open opportunities for companies to scout for acquisitions at discounted valuations, going by what was paid for eight significant acquisitions in the last couple of years. Notably, the domestic deals in the sector have been valued at a discount to overseas acquisitions made by Indian companies.

In 2007, two large acquisitions — Wipro buying Infocrossing for $600 million and Firstsource Solutions acquiring Med Assist for $330 million — were valued at 2.6 times and 3.3 times the target companies’ revenues respectively.

Cut to 2008, and five large deals were stitched at 1.4 (MindTree-Aztecsoft) to 2 times (HCL-Axon) the acquired companies’ revenues, a sign of possible slowing down in the IT/ITeS sectors. An odd case of 3i Infotech acquiring US-based Regulus for a measly 0.7 times its annual revenues also dotted the acquisition landscape.

More recently, Tech Mahindra managed to lap-up the scam-ridden Satyam Computer Services at 0.5 times the latter’s estimated annual revenues.

In the Indian scenario, Citigroup Global Services (CGSL), which was bought-out by TCS, and Citi Technology Services (CTS), which was acquired by Wipro and enjoyed EBIT margins of 20-21 per cent, were valued at 1.8 and 1.6 times their revenues respectively.

But in the case of overseas acquisitions, Axon and Infocrossing, which enjoyed EBIT margins of just 4 and 14.4 per cent respectively, were valued at 2.6 and 2 times their annual revenues. One possible reason for this may be that the revenue per employee of the acquired domestic companies tended to be lower when compared to those acquired abroad.

On an average, while every employee of GGSL and CTS brought in $22,400 and $39,024 respectively, the revenue per employee from Axon and Infocrossing was at $72,333 and $2,58,222 respectively at the time of their deals.

The difference in valuations may also be due to the varied areas of operation. A company that operates in areas that enjoy higher billing such as infrastructure management services (Infocrossing), package implementation and consulting (Axon) may command a premium rather than a target company operating in areas such as application development and maintenance or BPO services.

Regulus, despite its high revenue per employee, and Aztecsoft, with low margins and operating on relatively lower-end services such as transaction processing and independent testing, were nevertheless both examples of non-premium acquisitions.

Captives on way out?

The CGSL and CTS deals are also suggestive of an interesting trend — the slow phasing-out of captive IT/BPO companies. These companies were the BPO and IT arms of Citigroup and have both been sold.

Having a captive IT/BPO unit creates a fixed-overhead cost structure for these companies. Hiving off such divisions, especially in an economic climate necessitating cost management and deriving better service level agreements, may have been prudent as third-party vendors would be better suited to provide comfort on both these factors.

Interestingly, Citigroup has given revenue assurances over several years to both the companies that acquired their captives. Despite this, valuations have been much lower than overseas acquisitions.

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More Stories on : Software | Mergers & Acquisitions | Wipro Ltd

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