With valuations at historical low, M&A activity to pick up pace in IT industry

Our Bureau Bengaluru | Updated on July 09, 2020

The hunt for the right acquisition in the IT industry is expected to pick up pace as valuations are down to a historical low, with the possible merger of mid-tier players Mindtree and L&T Infotech playing out earlier than expected.

Over the last five years, multiple midcap IT companies such as iGate, Polaris, KPIT, Mphasis and Mindtree have witnessed M&A activity. Going forward, more such activities could see a reshuffle of the pecking order of the top-5 Indian IT services companies once two equal-sized mid-tier entities merge.

Benoy CS, Frost & Sullivan’s Vice-President, Digital Transformation Practice, said the scale of operations for the IT services sector will be one of the key differentiators for winning projects. “The time and material model is getting replaced with the outcome-based model, and only those that have the scale of operations can hope to bag contracts,” said Benoy. He said when the markets are down, the M&A activities pick up pace, and this is perhaps the right time for IT services companies to start looking at acquisitions.

In a recent report, SN Subrahmanyan, CEO and MD of L&T, had said that the merger of Mindtree and L&T Infotech is one or two years away. Infosys CEO Salil Parekh, at the company’s recent AGM, had also indicated that it is actively looking at acquisitions outside India focussed on cloud, data and business platforms as the current situation could offer more of such opportunities.

But analystssaid that because of the current situation, the possibility of the merger of the two entities might be brought forward.

While L&T Infotech’s core strength lies in having exposure to various verticals because of its parent’s wide portfolio, Mindtree’s focus is more on digital and cloud. PhilipCapital analysts said if one or more of these midcap IT companies could be merged, it could lead to the formation of a formidable IT company that could perform much better than its individual components, and would also command a valuation premium.

“LTI+MTCL is a dream merger for any management. The two companies have a highly complementary profile with very little business overlap. LTI has a very strong base in BFSI (44 per cent of revenue), while MTCL is very strong in retail (20 per cent),” said analysts with PhilipCapital.

They said that after the merger, the entity will have a diversified revenue profile across BFSI, manufacturing, retail and hitech, very similar to large-caps. LTI+MTCL will also have minimal client overlap. Among their top-25 clients, we found only one in common: all others were mutually exclusive, giving the entity a highly exhaustive coverage of all verticals, they pointed out.

Economy of scale perspective

Sanchit Vir Gogia of Greyhound Research said the merger between the two should happen from an economy of scale perspective. “There are enough and more reasons. Cost pressures are expected to only increase and there are too many uncertainties now. When the forces are joined it makes a lot of strategic sense,” said Gogia.

The analysts at PhilipCapital said they expect the combined entity of L&T Infotech and Mindtree breaking into the top-5 club of the Indian IT sector over the next two years. In the last decade, only TechM has managed to break into the club – and that was driven by its merger with Satyam. LTI+MTCL will lead to the formation of $3.5-billion IT Services Company by FY24, with a significantly superior profile to TechM – higher growth, higher margins, higher ROEs, the analysts said.

Published on July 09, 2020

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