The Hindu Business Line : MphasiS BFL: Buy

With EDS acquiring a majority stake in MphasiS, the stage is now set for the latter to derive synergistic benefits. However, risks relating to integration remain.

The MphasiS BFL stock, which has shed over 20 per cent since the market meltdown in May, offers a good entry point for investors with a one/two-year perspective. With Electronic Data Systems (EDS) successfully acquiring a majority (52 per cent) equity stake in MphasiS, the stage is set for the latter to derive synergistic benefits from the acquisition over the next few quarters.

At the current market price, the MphasiS stock trades at a price-earnings multiple (PEM) of 14 times its projected FY-07 earnings, assuming earnings growth at 20 per cent. This, however, will not come without the share of risks. The downside risks arising from the EDS acquisition are those of integration, both within the MphasiS organisation and with the Indian operations of EDS. Second, the scale of business transferred from EDS in both IT services and BPO and the pricing terms will have to be watched carefully. Finally, with EDS enjoying the right to appoint a majority of directors on the board, the possibility of extensive changes in the management structure cannot be ruled out.

A strategic integration

The focus with which EDS has pursued the MphasiS acquisition and its decision to keep the latter as an independent EDS company, at least for now, have been driven by strategic interests. These range from:

Offshoring strength: With this acquisition going through, EDS will be well-positioned to compete with its peers — IBM and Accenture — on both offshoring deals and big bang application /infrastructure deals that will be coming up for renewal or renegotiation. With this acquisition of majority stake, EDS will have access to over 11,000 employees (3,500 in IT services and 7,800 in BPO) of Mphasis. It plans to enhance this total India workforce (which includes its own India operations) to over 20,000 by this year-end.

BPO to be the core: 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 in human resources outsourcing (in a joint-venture with Towers Perrin), customer relationship management and Medicaid (for public sector healthcare in the US); and MphasiS in inbound and outbound customer care primarily for banking, financial services and insurance (BFSI), apart from logistics, retail and telecom.

The scope for moving operations offshore in the areas of HR and CRM, using the best practices of MphasiS, is quite high. This will also help increase the transaction-oriented revenues for MphasiS, which typically enjoys higher average billing rates and operating margins.

Cross-sell IT services: The acquisition has the potential to open up additional opportunities for EDS in the BFSI and logistics/retail space. Since EDS services marquee BFSI clients such as Bank of America, Barclays or Societe Generale, the scope for cross-selling in application-related services will be high.

Or consider the new and enhanced orders bagged by EDS in 2005 from clients such as Ahold or United Airlines. Since these are infrastructure-cum-application based contracts, EDS will have the scope to experiment with offshore-based infrastructure management in these cases. As competition intensifies from its global and Indian peers, EDS will have no choice but to explore these avenues seriously over the next few months.

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