The Hindu Business Line : Fishing for small deals

Indian IT vendors may not go in for big-ticket buyouts in the near term and might be contented with the small to mid-size acquisitions to fill niche gaps in their capabilities.

L. Balachandar

Small is attractive.

Shamik Paul
Vishwanath Kulkarni

If Winter comes, can Spring be far behind?” posed the English poet Percy Bysshe Shelley. The oft-quoted line underlines humanity’s belief in recovery after disaster, in good fortune after tragedy.

But in the modern world fraught with uncertainty, every winter is not necessarily followed by spring, and silver linings to dark clouds are not as bright as one would expect them to be. A case in point would be the current economic downturn that has been termed as the darkest winter in recent times. While some are optimistic that a recovery is in sight, others are sceptical about the possibility of a quick turnaround.

The Indian IT industry that felt the impact of the crisis was also caught in this prolonged twilight zone, which lies between downturn and recovery. As a result, mergers and acquisitions in the sector had come to a near standstill.

Silence broken

In the last one month or so, the silence has been broken and a few deals have been inked, but industry experts believe this is not the beginning of big ticket M&A activity in the Indian IT industry. The sentiment has definitely improved from what it was six months ago, and companies are looking at acquisitions more seriously now, but are still shy of large deals, experts say. For some time, small to mid-sized deals will dominate the space, they feel.

The US-headquartered Cognizant Technology Solutions, which delivers a bulk of its services from India, acquired the Hyderabad-based captive unit of United Bank of Switzerland (UBS) in a $75-million deal.

The Bangalore-based mid-sized firm MindTree Ltd, which is eyeing a billion dollars in revenue by 2014, acquired the captive unit of CDMA phone maker Kyocera to strengthen its R&D services team. The Chennai-based Polaris Ltd, another mid-sized firm, announced the buy-out of smaller rival Lasersoft.

The global IT services arena has started seeing consolidation with hardware vendors showing appetite for the services companies. Personal Computer maker Dell Inc acquired Perot Systems in a $3.9-billion deal to improve its services capability, while documentation and imaging firm Xerox Inc bought out ACS in a $5.5-billion deal.

Big-ticket purchases unlikely

However, such deals are unlikely to prompt the large Indian services vendors to make big-ticket purchases immediately, industry experts predict.

“These deals may not change the way the large Indian vendors think,” says Manohar Atreya, Head, Technology Investment Banking, o3 Capital.

“They are still fishing around and looking at things, but perhaps need more clarity before they can do an Axon kind of acquisition.”

Deal makers feel that Indian IT vendors, who are flush with cash, may not go in for big-ticket buyouts in the near term and might be contented with the small to mid-size acquisitions to fill niche gaps in their capabilities. At present, there is no business case for the vendors to do very big acquisitions, Atreya says.

“The buyers are more specific and most of the M&A deals will be small to mid-sized,” says Sanjeev Gandhi, Partner, Mergers & Acquisitions, Grant Thornton.

They have spent the last couple of months considering what the downturns means to them, how things will shape outside the country, which are the growth areas, whether they need to set up delivery centres in places such as Latin America or continue to service clients from India. “Our clients are saying ‘if you bring us specific opportunities we are ready to transact’,” he adds.

There is some fatigue in the market as well. “There are not too many big assets that fit the requirement of the large Indian IT vendors,” says Atreya. “There are some $300 to $400 million assets in Europe and the US. But it is not to the liking of the Indian biggies. They have very stringent requirements,” he adds.

Only in the case of exceptional SAP or Consulting kind of assets, the top IT vendors might consider buying bigger companies. “Infrastructure Management Services providers would also have a high priority with these companies,” Atreya adds.

The Infosys CEO, S. Gopalkrishnan, says the company would be comfortable with a deal size of up to 10 per cent of its revenues. The company is looking at areas such as healthcare and BPO, among others.

Wipro Ltd, which has stuck to its string-of-pearls strategy all this while, continues to believe in buying companies that will add to its existing service offerings. “We will buy units that will fill in Wipro’s gaps,” says Suresh Senapaty, CFO, Wipro. “While doing that we will look at companies that are worth $50 million, or $100 million, or $200 million. So, we will not stay away by saying that ‘if a deal is more than $100 million we do not want to do.’ But because we are looking at those niches, the buyouts tend to be smaller,” he adds.

For example, take the case of a vendor that wants to find an acquisition with capability in SAP, and buys a particular company, says Senapaty. Now consider that that company has only 40 per cent of revenue from SAP.

So what does the vendor do with the rest of the company? The remaining 60 per cent of what the vendor has bought is waste because that is not what the vendor requires, he says.

“When we pay a price, we must pay for the full 100 per cent. It makes financial sense. But when you buy a company that is 100 per cent SAP, it tends to be smaller,” he says. So it is not by design that the company chooses to make smaller acquisitions, he adds.

BPO consolidation on the cards

Deal makers anticipate heightened M&A action in the BPO arena where vendors are looking to strengthen their capabilities.

“Not many transactions have happened in the recent past, but definitely the interest has increased,” says Atreya, predicting a round of consolidation. “It (consolidation) has not happened yet. We think it will happen in the next few months.”

A probable reason for BPO to hasten the M&A process would be the need to add capabilities at a faster pace.

“There are a lot of ‘verticalised’ and niche areas in BPO, and it might not be possible for the companies to develop all the capabilities organically,” Atreya says.

Thornton’s Gandhi, who feels the BPO market is fragmented, also foresees consolidation in the domestic market.

Gandhi says the infrastructure management space comprising companies that provide mission critical outsourcing services based around server, network and security, is a big area of interest for many Indian vendors.

Such companies could be based in India and servicing clients in the US and Europe, or it could be companies based in Europe.

The second area of interest is platform BPO. The vendors are looking at knowledge process outsourcing (KPO) kind of opportunities in the analytics space, and such assets are seriously in demand at the moment, Gandhi says.

The probable geographies would be the US, the UK, France and Germany, and a number of vendors are looking at the Nordic region as well, he says.

Vendors are also looking for buys in the ERP space, he adds. Gandhi says there would be a lot more activity around captive centres (across sectors) over the next one year.

“Most of the big guys would be interested in captives. It would be an easy transaction, commercially it makes a lot of sense — they get the capability and the infrastructure,” he says. “All of them are looking at captives, including mid-market companies,” he adds.

Though Atreya shares the same enthusiasm about captives, he feels it might be a while before such a deal is struck. “Everybody wants it, but I don’t see deals happening easily,” he says.

“Opportunities are far and few between. I think the captives are also trying to play the game right. They will do it over the next two years whenever they think the price is right,” he adds.

shamik@thehindu.co.in

Related Stories:
On the prowl for buys
IT sector heads for new round of acquisitions
Kyocera buy adds to MindTree portfolio

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