Dissecting a complex deal

With Japanese companies looking to expand their footprint in Indian IT (information technology), there may be interesting times ahead for the industry in terms of M&A, foresees Mr Sujit Sircar, CFO, iGATE (http://bit.ly/F4TSujitSircar).

Shortly after the company announced the Patni deal – valued at more than $1.2 billion and to be financed through a combination of cash, debt and equity – Mr Sujit interacted with Business Line over the e-mail, and expressed his anticipation of a lot more deals in the IT sphere, going forward, as a trend of consolidation in the IT industry.

“Prior to this deal, iGATE had been scouting for acquisitions for sometime now. During this process, we came across a number of companies that were interested in striking M&A deals. I believe it is only a matter of time before you find a lot more happening in this space.”

Excerpts from the interview.

First, give us an overview of the complexity of the deal from a financing point of view and why it had to be so.

This is possibly the most complex deal in the Indian IT industry not just from the fact that a smaller company is taking over a company that is two-and-a-half times its size but also from the financial structuring as well as the funding of the deal. As part of the funding exercise, this acquisition involves cash, equity, debt, and convertible loan.

The size of the deal was itself a big challenge. Almost one-third of the deal is subject to open offer to the public shareholders of Patni. It also rested on the non-promoters'/PE firms' bet on the future of the company and their belief in the management that would take forward this company into its next phase of growth. The amount of $300 million is more than the current revenues of iGATE.

We had to ensure that we size our debt and equity commitment according to this varied need for funds. In the order of priority, we chose our sources and quantum of fund based on its cost — debt to begin with, and then preferred equity. The structure of the debt is further subdivided from bridge financing to bond placement.

Can you describe in detail how you dealt with two or three challenges in funding the deal?

One of the first challenges in terms of funding the acquisition of India-headquartered Patni was the location where the funds were to be raised. In India, banks cannot disburse funds to companies where the purpose is to finance an acquisition. Given that scenario, iGATE had to necessarily tap the offshore market for fund raising.

In a cross-border transaction, transfer of funds becomes a costly affair especially when it involves repayment of debt. Typically, in such a scenario, there is loss of money on account of dividend distribution tax. Also, the receiving entity would have to pay tax on receipt of income.

The second important challenge was the general perception that IT companies are debt-free and the related challenges of having debt in the balance sheet. So, funding the deal via debt with a 3-3.5 EBIDTA multiple was a mental block to start with.

While the debt of $700 million does seem large, given that the combined entity has a cash in balance sheet of $350 million (after utilising $100 million from iGATE's cash for this transaction), and an EBIDTA of $220 million, we are confident that the challenge on the debt front can be tackled, and is not as monstrous as it is made out to be.

And, the structure of the deal itself was a big challenge. It was important for us to balance it on a tight rope between the cost of funding and the ability to service the debt over the period of the repayment.

As the CFO, what key metrics will you be seeking to achieve post-deal, in the near to mid-term?

While structuring the deal and bringing the deal to a finite closure was an important first phase of the acquisition, equally important from a CFO's perspective is this second phase which is the post-deal scenario. This phase involves strategising the financial integration between the two companies.

Given the size of the debt and the importance of its repayment, one of the key metrics that I will be focused on is the cash flow. Another key metric to track would be the cost synergies between the two companies.

Yet another focus area that will be of importance is the stability and health of the global customers as that will have a direct impact on the cash flows that I referred to above. Employee engagement in both the companies is another key metric, as high attrition could lead to increased costs on the people front.

The last but not the least is a transparent communication programme with the investor community and to educate them on the integration as well as our growth strategy. While in the short-term, given the size of the debt, there are concerns for investors, we do believe that in a 3-5 year period, this acquisition is strategic, as it will create value for shareholders. The fact that we will be cash-accretive by 2012 is itself a positive sign that this deal will create that value for them.

Would you like to specify the different things that one should keep an eye on when looking at financing a big-ticket acquisition?

Working out a steady cash flow has to be an essential part of any big-ticket acquisition. Irrespective of the structure of the deal, there has to be a clear strategy and a reasonable certainty on the future cash flows. This assumes even more of an importance if there is a debt component to the deal. Having said that, given the possible uncertainty in any business because of external factors and those beyond the control of the company, it would be good to have an alternative line of credit to ensure that there is no default.

While working out the structure of the deal, it would also be judicious to look at the cost of funding on an ‘after tax' basis. Given the nature of M&A transactions, there is always the possibility of negative surprises. It would be important for the M&A strategy team to ensure that covenants in the agreement do not choke the future business operations of the company.

Can you highlight a few issues relating to accounting integration?

The accounting integration is quite complex and interesting for me as the CFO, especially with the new IFRS reporting framework and the change management associated with it. This starts right from the person entering the data to the investor community that is so used to seeing the data in a particular way.

Putting two companies under one system for control, having a unified accounting policy and a unified reporting calendar and reporting under various GAAPs are some of the challenges on the accounting front that we will have to work towards.

COMMENT NOW