The Hindu Business Line : Acquisition by Oracle — Keep the i-flex stock on hold

THE "the hottest banking products stock" in the Indian financial services space is set to change hands. The acquisition by Oracle Corporation of a 41-per cent stake in i-flex solutions from Citigroup Venture Capital International at Rs 800 per share and the announcement of an open offer for an additional 20 per cent stake at Rs 882.62 per share have triggered heightened trading interest in the i-flex stock.

Considering that Flexcube, i-flex's flagship product, is built on the Oracle technology platform and the two companies have had commercial relationship since 1997, the deal spells significant synergies.

How should the shareholders of i-flex react to this deal at this stage? In our view, three key elements will have to be examined before taking any investment decision:

Revision in offer price

Since the i-flex stock is trading at Rs 950, significantly higher than the open offer price of Rs 882.62, does the market expect an upward revision? It is quite possible that the offer price will be revised upwards as Oracle will be keen on acquiring a controlling interest (above 51 per cent) in i-flex.

But going by some high-profile offers the last couple of years, acquirers do not easily buckle under such pressures to make the offer attractive. It has been found that sticking with the original price makes greater sense, as even if the prices are raised, the market quickly readjusts and runs ahead of the new price.

Mr Charles Phillips, President, Oracle

The day the i-flex deal was announced, Mr Charles Phillips, President of Oracle, indicated that the offer price is unlikely to be revised and that Oracle will be comfortable with its existing equity stake of 41 per cent in i-flex. All that can be inferred at this point is that even if Oracle decides to raise the price, it will not be announced before October 5, the last date for upward revision of the offer price, as stated in the public announcement made by the acquirer. Shareholders can retain the i-flex stock, but those taking fresh exposure purely expecting a price revision may not making the right move at this stage.

Fundamentals: A different call

This agreement to acquire i-flex by Oracle does change the rules of the banking game and improves the fundamentals of the former. There are two key positives that the deal offers to i-flex:

One, the association with Oracle will open the doors for i-flex in the North American market in a big way. As Oracle products/solutions run in 17 of the world's top 20 banks and 23 of the top 25 North American banks, the market access for i-flex's products would change dramatically.

Moreover, as i-flex has also been struggling to establish its foothold in the US market, this deal can straightaway strengthen its pitch among Tier-I banks. The ability to compete in every large deal in the banking space with SAP, Temenos or others will be a huge positive.

Two, as i-flex gets access to Oracle's brand, scale and resources, it will be able to scale down substantially its selling and marketing expenses. Now, i-flex spends about 15 per cent of its revenues on these expenses; the operating leverage it can derive by reducing the spending on this head can be substantial. Any margin improvement on operating profits will flow straight to the bottomline of i-flex.

But this deal also has risks on at least three fronts: One, the product business in the banking industry that i-flex targets is typically lumpy, where deal breakthroughs take a fairly long time of happen. While the association with Oracle will open the doors for i-flex, it may take a while — even years — to convince banks to switch from in-house systems to packaged software.

Mr Rajesh Hukku, CMD, i-flex

As Mr Rajesh Hukku, Chairman of i-flex, said in a recent interview to Business Line, "...the point that in-house teams will resist is a known fact as banking systems are quite complex. Even for Citibank, it took us four years to sell them Flexcube... "

Hence, to infer that the earnings growth of i-flex will straightaway jump from a projected 25-30 per cent over the next two or even three years to 40-50 per cent is going out on a limb. Two, the risks associated with cultural and people integration of Oracle and i-flex are fairly high. Retaining the top management team and integrating a 5,500-strong workforce of i-flex with Oracle will present a host of challenges.

On top of that, the marketing channel overlap between i-flex and Oracle will also be high, as the former has built alliances and partnerships with companies for marketing Flexcube in 50 countries. There may be considerable attrition on this front.

Three, there is limited clarity on the role of i-flex's services business, which accounted for 46 per cent of the revenues of Rs 1,140 crore in 2004-05. For i-flex, services that catered to the in-house development work for banks (Citi and non-Citi) have primarily been a derisking strategy for its lumpy products business.

It remains to be seen whether Oracle considers services to be as strategically important to its overall growth as it has been for i-flex.

Is delisting a possibility?

It is too early to consider the possibility of delisting of i-flex by Oracle, as the first open offer has just been considered. While Oracle can increase the size of the offer, the prospects seem bleak at the moment.

In all probability, Oracle will consider delisting only if its integration with i-flex reaches a fairly advanced stage, say, one year down the line. Leaving aside the delisting aspect, based on the fundamentals, we recommend that shareholders of i-flex stay invested and participate in the business upside from this deal.

As the i-flex stock has run up by nearly 65 per cent since late April, it has already factored in some upside linked to this deal. In this backdrop, fresh exposures at the prevailing price may be appropriate only for investors with a penchant for risk.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page