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Krishnan Thiagarajan
Bharat Kumar

Patni Computer Systems made a dramatic move last November by acquiring the US-based Cymbal Corporation specialising in the telecom vertical for a total consideration of $68 million. This inorganic move has given Patni a foothold in the telecom vertical in which it had no presence earlier and expanded its range of vertical offerings from financial services, insurance and manufacturing.

This consideration has been structured in an innovative way, with $35 million paid upfront and $33 million (including a $10-million bonus) payable over three years, based on projected revenues and profit targets.

At the time of acquisition, Cymbal clocked revenues of $32 million as of June 2004, had SBC Communications as its top client and about 600 employees as of September 2004. The Cymbal integration is now complete and the telecom vertical accounted for about 9 per cent of Patni's revenues in the October-December quarter.

To understand the strategic intent behind this acquisition and how Patni proposes to leverage this to grow, Business Line caught up with Mr Deepak Sogani, the company's Chief Financial Officer, for a detailed tête-à-tête.

Excerpts from the interview:

What is the strategic intent of the Cymbal acquisition that Patni completed in November?

Fundamentally, the acquisition really filled a strategic gap in our organisation. We wanted to add on a telecom-related practice for quite some time. But we did not have any large customers to bid on. In several other verticals, we have been able to bid internally.

We have been looking at the telecom space for inorganic acquisition so that we can get an entry into verticals and Cymbal really provided the right kind of fit, with a good service in the telecom service provider segment.

It has both American and Indian operations, so it was not a pure systems integration kind of operation located out of the US. It had a management team that was dynamic and conversant with the Indian culture, because the CEO and several of at the senior level were Indians. It was, in that sense, an `integratable' kind of an organisation, because otherwise it becomes difficult to get cross-cultural teams and then integrate them. Given all of this, Cymbal fitted well into our overall scheme of things.

Compared to other deals in the IT services space at 1-1.5 times revenues in the past year or so, do you think the Cymbal deal, at 2.1 times, is on the high side?

We believe that we paid a completely fair value for the company. We have to compute the value and come to terms with the benefits that particular value will bring to you. We are comfortable with the value.

The structuring of the transaction takes away the downside risk in valuation. We are not paying $68 million upfront and then hoping that the business will deliver. It is a difficult level of risk that you are taking.

Here, we are paying only 50 per cent of the transaction value upfront. Business has to scale up and if that happens, only then we end up paying $68 million.

Second, we saw a lot of value in the acquisition, on multiple fronts. One, it helped us build a vertical and this will not only help us diversify our revenue stream but also build a more robust organisation.

And we also saw enough value in our ability to cross-sell our services such as BPO, embedded technology or other applications to customers of Cymbal.

There was enough synergy that we saw in all these issues. If you were to value all the business that you can potentially get from this acquisition and computation were to be done on valuation principles, be it the discounted cash flow or any other principle, it will be a fair value.

If the business stacks up the way it has been projected, we are comfortable paying $68 million.

If it does not stack up and a certain risk gets built up, that risk actually results in a lower transaction value.

As Cymbal has two offshore centres at Pune and Hyderabad, how do you propose to leverage that to increase the offshore component and thereby raise the operating margins?

Cymbal was incorporated in 1999 on the US West Coast. Fundamentally, it had a consulting arm or systems integration model of operations. And in 2002, started the UK operations and in late 2003 the Indian set-up. By the time we acquired it, it had already developed a delivery model from India and close to 200 billable people were employed out of India.

The US end is at a higher price point, because it has domain-specific consulting as well. Its roots are in telecom and that has given it the advantage.

Over a period, Indian operations will scale up and increase the offshore component. I would think it will take two-three years to stabilise the way we currently are, with large proportion of revenues coming from India. But it is not necessarily our end-goal. If we are able to add value, with domain and consulting skills, we are able to get price points that are significantly better and make gross/operating margins that are reasonable even in the US.

However, in the US-centric business model, there is a bench that gets built up onsite (with people who are not billable sitting in the US). In our current business model, we send people only if they are billable, otherwise they are offshore, at significantly lower rates. That is a model that is workable.

What was the thinking for creating the telecom vertical in which you had no presence, as opposed to strengthening other verticals such as insurance or financial services where you are established?

The question at the core is: Whether it is useful to create a niche position or a broad-based one? In the IT services market, the landscape changes very rapidly. I do not think in services, one can strategise and then execute. It is an experiential process. Hypothetically, if you say that if we need to focus on insurance, we need to put all our energies into that vertical. As we generate operating cash flows in excess of $50 million, we need to invest them in insurance.

Why can't we invest in telecom and also in insurance (or any of the other verticals)? Is capital a constraint? I do not think so. All you need is a couple of million dollars for us to invest in hardware, licences and others to build our insurance practice. So, capital is available.

The second thing is manpower, which is not a problem, both in leadership and executive positions. Having done this, we think, one cannot underestimate the importance of diversification.

The revenues from GE has been coming down in percentage terms. Is there a conscious decision at work?

The IT budgets of GE have not increased significantly the last two years. They have optimised their IT strategy as best as they can. By and large, GE's growth has been reasonably flat. This year GE, as an organisation, is doing extremely well.

Will that lead to additional IT spends? I do not have an answer. But if it decides to do it, we will fight for our share of that spend. GE is still a profitable customer, a long relationship and still has a lot of referral value.

What the benchmarks are you adopting in taking on clients and how are you defining strategic clients with potential for ramp-up?

Internally, we define a strategic account as a client that has the capability to ramp up to $4-5 million in 24 months. It could be a client that exists as a non-strategic account becoming strategic or we become serious to our client. We have close to 30 strategic customers right now

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