The Hindu Business Line : Mphasis BFL: Hold

Offer aims to avoid the Oracle experience
Synergy benefits likely to be significant
Prospect of offer price revision
Critical offshore presence for EDS
Downside if EDS does not get 52 per cent and dumps the bid

EDS's plans to acquire MphasiS BFL fit in neatly with its global strategy. The combine will be formidable in the BPO business as strengths are complementary.

Mr Jerry Rao, Chairman & CEO, Mphasis. - Paul Noronha

The possibility of the Big Six global IT vendors adding India-based offshore capability the inorganic way has been doing the rounds for some time. This finally happened last week when the second largest global IT vendor, EDS, made a conditional offer to acquire a 52 per cent equity stake in MphasiS BFL at Rs 204.5 per share.

Smart offer

This is a smart offer as EDS has apparently learnt from the Oracle-i-flex acquisition put through last year. When Oracle bought out the 43 per cent equity stake from Citigroup in i-flex solutions, it expected to secure the controlling interest through an open offer of 20 per cent made at Rs 882.60. Instead, the open offer mopped up only 0.7 per cent stake from the shareholders. Recently, Oracle enhanced its stake by another 4 per cent from the secondary market at a steep premium of 40-60 per cent of the offer price. And it still finds itself 4 per cent short of the majority stake of 51 per cent in i-flex. Realising this pitfall, EDS has made a conditional offer to acquire 52 per cent, with the right not to accept, if the shares tendered do not touch that ceiling.

Strategic to EDS

From EDS's standpoint, the move assumes strategic significance for four key reasons:

Catch-up with peers: If this acquisition goes through, EDS will be able to match the offshore scale and capability of its global peers, IBM and Accenture, in mega application and infrastructure deals. Compared to IBM and Accenture, which have an India-based workforce of 38,000 and 17,500 (or 15-20 per cent of their global tally) respectively, EDS, with fewer than 5,000 people, is at a competitive disadvantage. If EDS gets the controlling stake of 52 per cent, it will have access to 11,000 offshore employees of MphasiS BFL and move closer to its global peers.

Complementary in BPO: The expertise that EDS has in business process outsourcing (BPO) will be complementary to that of MphasiS, as the two entities operate in separate domains. EDS operates in the areas of human resource outsourcing (in a joint venture with Towers Perrin), customer relationship management and Medicaid (for public sector healthcare in the US). MphasiS specialises in inbound and outbound customer care primarily for banking, financial services and insurance (BFSI), apart from logistics, retail and telecom. Of the 11,000 employees of MphasiS, 7,400 are in the BPO arena, entirely offshore. As of December 31, 2005, 67 per cent of its revenues accrued from BFSI.

Cross-sell for IT services: The acquisition has the potential to open up substantial additional opportunities for EDS in the BFSI and logistics/retail space. As EDS services premium BFSI clients such as Bank of America, Barclays and Societe Generale, the scope for cross-selling in application-related services would be high. Or, consider the new and enhanced orders bagged by EDS in 2005 from clients such as Ahold or United Airlines. As these are infrastructure-cum-application based contracts, EDS will have the scope to experiment with offshore-based infrastructure management in these cases.

Protect existing clients: According to the global sourcing advisors, TPI, the number of deals that are coming up for renewal/renegotiation, both in the large (above $1 billion) or mid-sized category ($ 250 million plus) is set to rise sharply in 2006 and 2007. Without a credible offshore presence, EDS is likely to cede ground not only to IBM or Accenture, but also to some of the frontline Indian vendors. Over the past year, EDS had to shed its mega ABN Amro contract to a host of vendors, including IBM and Indian companies. . If this acquisition goes through, EDS will be able to use its India-based presence to protect existing clients.

Offer dynamics

We recommend that shareholders retain their exposure in MphasiS in the run-up to the open offer for three main reasons:

Institutional investors, the key: Barings India Investments, MphasiS Holdings and Mr Jerry Rao (in his personal capacity) hold about 43.5 per cent equity in MphasiS as of December 31, 2005.

There is a good chance that these investors will tender, as they are sitting on attractive gains; the success of the offer will hinge on the remaining 9 per cent with institutional/retail investors.

Institutional investors, with a 42 per cent stake, hold the key as they can tender a part of their holdings to allow the offer to sail through.

And on the remaining holdings capitalise on either the integration benefits arising from the acquisition or a possible reverse book-built offering by EDS to buy out the remaining equity in MphasiS at a later date.

Tender late: If the stock price holds up at the current price levels till mid-May, the possibility of a revision in offer price by about 10 per cent (to Rs 225) is fairly high.

Shareholders will be better off retaining the stock till June 1, the last date for revising the offer price or the number of shares in the open offer.

The probable downside: Investors will have to exercise some caution as EDS has made a conditional offer, with the right of refusal.

Though the synergies from the acquisition are compelling, EDS will keep the shareholders guessing about their intentions till the close of the offer.

The MphasiS stock has moved up nearly 20 per cent over the past month, linked to the acquisition-related upside. If EDS were to reject the offer for any reason, the stock may suffer downside at least to this extent.

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