India-centric acquisitions:Let me buy you out
posted in Outsourcing News and Top Outsourcing deals |Source:sify.com
Global information technology suppliers are on the prowl, grabbing companies that have a strong India presence.
In the last one year, eight India-centric acquisitions, especially companies with large offshore presence in India, worth over $4 billion (over Rs 16,000 crore) have happened. And, around 35,000 employees changed hands. The number could be more if small companies are also taken into account.
The trend started back in 2004 with IBM’s acquisition of Daksh (an India-based BPO provider). IBM adopted a model where the merged entity not only provided offshore support to IBM’s BPO clients, but also went to market independently. Encouraged by IBM’s success story, other global players such as Capgemini, CSC and EDS acquired companies in India, says a report by Morgan Chambers, a UK-based independent sourcing firm.
The motive for acquisition is simple - the ‘India Advantage’ of labour cost and quality manpower. A few years ago, companies had to explain the India Advantage to clients. Today, the first thing clients ask vendors is whether they have an India presence, says Subu D. Subramanian, Director and Senior Vice-President, Satyam Computer Services.
There is tremendous pressure on global suppliers to expand offshore presence in India, and acquisition is one of the easierways. Global companies have realised that to remain ahead of their rivals they need to reduce costs; provide the best quality; and be reliable and innovative.
Acquiring India-centric companies provides all these, he says. For instance, EDS, in one swoop, more than tripled its employees in India by acquiring Mphasis, which had around 11,000 employees. This enhanced EDS’ offshore capability, and keeping pace with its outsourcing rivals. It was a similar story with companies such as CSC and Capgemini.
Supplier maturity
Sridhar Vedala, Director, Global Sourcing, Morgan Chambers, says global suppliers, apart from Accenture and IBM, did not treat India strategically until recently. It was believed that the India Advantage might not be sustainable as other destinations would emerge that would challenge India’s dominance.
However, though many other destinations seem attractive, they have failed to offer serious competition to India. The key reason is supplier maturity. Indian suppliers are mature; offer scale and a wide range of services. Many global suppliers previously were sub-contracting to Indian suppliers, but now find these suppliers their competition. In such a scenario, they are left with no option but to expand their footprint in India, he says.
Target companies
Several small/mid-size suppliers in India are yet to reach critical scale, making them prime targets for acquisition, by western or global providers, states the Morgan Chambers report. The Tier 1 suppliers, including Cognizant, HCL, Infosys, Satyam, TCS and Wipro, command 40-50 per cent share of the Indian offshore market. If one excludes the next set of 8-10 Indian suppliers, the Indian operations of global players such as Accenture and IBM, and the top 8-10 captive units, one is left with over 3,000 offshore providers who account for a miniscule share of the market, it says.
These players have revenues ranging from less than $1 million to $100 million and are looking at ways to grow to the next level. Some of them are exploring the sell option, optimistic of the high valuations of the Indian IT and BPO firms. Acquiring firms are looking for targets that have complementary offerings, culture fit, and, of course, the right price, says Vipul Taneja, Country Manager, India, Morgan Chambers.
Acquisitions to increase; Captives on the radar
The trend of acquiring companies with large presence in India is likely to continue in the near future; in fact, the pace should increase, says Taneja. And it is not only the Indian vendors but captives of global organisations (such as Philips sale to Infosys) will continue to sell out. Some of these captives are finding it difficult to scale up owing to a mix of lack of strategic direction within the parent firm, scale of current operations not able to justify overheads, as well as supply issues, he says.
The client pull
Manpower is important. But multinationals also want to buy companies with prominent clients and efficient processes. Some mid-size firms are ‘captive shops’ for large western companies, and acquiring one of these firms brings in not just the company but also important clients, says Michael R. Guilbault, Senior Analyst, Professional Services Business Quarterly, Technology Business Research Inc, a research company.
Acquiring companies can get more ‘bang for their buck’ by purchasing well-functioning smaller firms to enhance their service lines. Infosys, for instance, would like to avoid buying large companies that do not have models as streamlined and functional as its own model, he says.
The Rupee factor
With the appreciation of the Rupee, smaller and mid-size Indian IT companies that have not achieved critical mass are ripe for consolidation. The further the Rupee appreciates, the more these companies will seek association with larger firms to remain profitable.
The Indian IT industry is poised for consolidation as appreciating wages make smaller shops unprofitable. Going forward, a lot of the captive units of multinational corporations are likely to be sold off and consolidated with larger players. If a company were to buy a captive BPO unit, it would immediately acquire a dedicated workforce, processes and skills sets, along with a new major client: the seller, says Guilbault.
One is not enough
Companies will not stop with one acquisition. They will look at more inorganic opportunities to ramp up their India operations in a big way. If they have acquired an IT services company, they will look at a BPO company or a focused testing company, says R Chandrasekaran, President and Managing Director, Cognizant Technology Solutions.
Consolidation is bound to happen in the IT industry and there will emerge a Global list of 10 or 20 companies, he says.
Challenge from Indian vendors
Indian providers are becoming more global on the one hand, and global companies, previously located elsewhere, are increasing their India footprint. There is a demand for acquiring more competencies, skills and talent all around to address the market needs, according to T.A.N Murty, Head Investor Relations, Satyam Computer.
Valuations have also been fair to the companies being acquired; if not better, as acquirers have valued the targets from a strategic perspective, rather than simple financial terms, he says. Valuations would continue to be fair in response with the market demand and potential for the services or products, and may not change upwards significantly as such, because Indian IT service companies generally have enjoyed higher valuations than European or American service providers, he says.
Acquisitions to continue
A lot of the acquisitions will continue over the next 18 months, and primarily by global service providers that have so far ‘missed the boat’ in establishing an organic footprint in India, as IBM and Accenture, for example, have been doing for some time now.
Companies have realised belatedly that not having an India delivery story is actually hurting them even with their mainstream clients and hence there has been - and will continue to be - a flurry of acquisitions to at least be able to ‘immediately’ claim to have an India presence. The talent acquisition for actual delivery is actually -strangely enough - a secondary driver in these situations, says Partha Iyengar, Vice-President, and Regional Research Director-India, Gartner.
A wider pool of even Tier 2 global vendors, including in newer markets such as Western Europe, are feeling the heat of not having a viable offshore strategy, he says.
China card, valuations
A wild card that will also emerge in the next 18 months is the strong possibility of Chinese service providers acquiring smaller Indian providers to establish an India presence as well.
Also, valuations will go down. However, it is quite likely that there will be some surprising (shocking) high-end acquisition of a high-end provider as well, in which case the valuations will most likely be at a significant premium to fair market value, says Iyengar.
“I will not be surprised if one of the latter also happens during the next 12-18 months,” he says.
The early acquisitions were at significant premiums to what might be construed ‘fair price’ in a rational market.
The acquisitions these days are probably more rational or, in some cases, quite advantageous for the buyer, since many of the smaller companies that are now the targets struggle to maintain growth and hence are willing to be acquired for a much more attractive (from the buyer’s perspective) valuation, he says.
Even as the larger companies see and maintain hyper-growth, the smaller companies are starting to struggle and actually have growth rates that are much lower and slowing further.
Thus, they will increasingly see their future tied to being acquired by a larger player, and hence are willing to be acquired for much lower valuations than in the past.
Challenges to momentum
According to Subramanian of Satyam, the India Advantage is being threatened by factors such as attrition (15 per cent in IT companies and as high as 50 per cent in BPO companies); availability of employable people (only 25 per cent of engineering graduates are readily employable) and increasing labour cost.
The industry, academia and government should collectively work to overcome these problems, he says.
