Mergers and acquisitions have always played a key role in market consolidation. This time of the year, the situation is no different... every other Indian software company—and that includes big guns like Wipro, HCL Technologies, Infosys Technologies, Satyam Computer and NIIT—has been singing the M&A tune for a while.

The imperative for companies to merge or acquire has been to maintain topline growth, especially as valuations are based on top-lines. The slowdown in general, and 9.11 in particular, saw companies struggling to sustain growth rates. Organic growth under these circumstances was not possible—it was inorganic growth, therefore, that emerged as the natural alternative. It was also a good time to buy, given the low valuations that most companies were getting.

Never mind the slowdown, software heavyweights like Wipro, Infosys, Satyam and HCL Technologies had been amassing huge cash reserves through public offerings and years of high-margin profits, most of which were lying idle. The slowdown proved to be a good starting point for these cash-rich players—they suddenly had the opportunity to snap deals at rock-bottom prices.

While bigger players demonstrated resilience during the tough period, it was the smaller players who bore the brunt of the slowdown. And this saw even smaller software players like Nucleus Software, with a turnover of Rs 62 crore, toy with the idea of acquisitions.

"Companies have merged either to fill up a gap in their product offerings, to ramp up presence, or to acquire skill-sets and competencies," observes Kapil Dev Singh, head for software and services research at IDC India. Finance and business process outsourcing are two sectors where fervent buying activity has taken place. Needless to say, these two segments have been driving growth during the slowdown. However, there are also instances like the TCS-CMC merger and the ICICI-Orion merger, where synergies were derived from competencies in other verticals.

Red-hot finance
With the slowdown in the telecom sector being the most severe, software companies were hit hard. Comparatively, the spending in the financial sector has been robust.

HCL Technologies was among the first players to leverage on this when it acquired a majority 51% stake in Deutsche Software (Deutsche Bank’s IT services subsidiary in India) in September 2001. HCL’s strategic move not only earned a captive customer in Deutsche Bank AG, but also ramped up its manpower and competency in the segment in a single stroke. Siemens Information Systems Ltd (SISL)—traditionally a strong telecom player—has also firmed up plans to acquire a financial software company shortly. The reason cited for this—to ramp up its product line and acquire a captive customer base.

Analyzing the reasons for the hectic M&A moves in the sector, Nasscom vice-president (research) Sunil Mehta says, "There are structural changes taking place in the global financial market, driven by regulatory and market forces. Universal banking has gained ground, with the emphasis being on retail banking, broking, wholesale broking and insurance. This has led to mergers and acquisitions in the sector, with huge requirements to integrate different legacy systems. This, in itself, presents a huge opportunity for software companies."

At the other end of the spectrum, established players like Polaris Software merged with Citigroup’s OrbiTech Solutions.

Here, the reasons were different—OrbiTech’s products are positioned for the high-end customer and Polaris’ offerings for the lower strata. The merger would enable the combined entity to offer a larger bouquet of products and cross-sell to the existing client base.

Even software giants in the financial sector, like Infosys Technologies, have been on the acquisition spree, snapping up IQ Financial Systems in the recent past. Although Infosys Technologies has a great brand presence in the overseas market, the acquisition is expected to further bolster its market penetration. With competition in the financial segment heating up, vendors are also taking recourse to M&A to either fill a gap in offering, or to increase their customer base in order to cross-sell.

BPO: Driving growth
Another area where a spurt of M&A activity is expected is the BPO-IT-enabled services (ITeS) space, given that the global market for BPO is currently pegged at $75 billion and is expected to cross $102 billion in the next five years. According to ICICI Securities, India can acquire a global ITeS marketshare of 13.1% on a price adjusted basis in financial year 2007, taking the country’s marketsize to $9 billion.

Indian BPO players can be segregated into four categories—MNC-owned captive software companies like those of GE Capital, Swiss Bank, HSBC, Standard Chartered, Amercian Express, Citibank, British Airways and AOL; second, VC-funded BPO entities like Daksh, iSeva, iEnergizer, Firstring, and the recently-acquired Customerasset and Spectramind; third, major consulting big guns like PriceWaterHouse Coopers, Convergys and eFunds, who have existing businesses in the US and are now shifting back office operations to India to take maximum advantage of existing talent; and fourth, Indian software companies that need to ramp up fast to get reasonable topline and bottomline growth. It is this fourth category, given the compulsion of software companies to maintain their blistering growth performance of yore, as also the need to focus on hot verticals, that will drive M&A in the BPO space.

And it is software companies are expected to continue to acquire more and more companies in the second category—VC-backed BPO start-ups. Although organic growth is inevitable, analysts predict a trend wherein BPO firms with good track records will be acquired by leading software and services companies. Apart from adding to the topline growth, software majors eye acquisitions as a tool to position themselves as end-to-end solutions providers. A case in point here is the high-profile acquisition of New Delhi-based Spectramind by Wipro Technologies for a whopping Rs 450 crore.

The acquisition helped Wipro ramp up quickly without the pain or lengthy process of having to nurture a project in its nascent stage. And the association with the Wipro brand could catapult Spectramind into another business league altogether.

Hot, hot, hot: Domestic and government markets

While finance and BPO may be today’s hot and glowing verticals, no software vendor can ignore the huge domestic market, particularly the government segment, which proved to be the only steady spender during the slowdown. And the merger that typifies the imperative here is the takeover of CMC by Tata Consultancy Services. While 14 other suitors in the fray opted out, TCS paid 40% more than the reserve price announced by the government when the company was put on the block. While industry speculated on whether the takeover made business sense for TCS or not, the company’s gains were clear—CMC had a huge presence in the Rs 9,500-crore domestic market, a space where TCS’ share was negligible. The deal, obviously, shores up about the only gap that TCS had.

CMC’s other stronghold was the government sector, which accounted for 34% of its domestic revenues. CMC is also the preferred vendor for public sector banks, and that accounts for 16% of the domestic IT market. CMC is by far the largest player in the Rs 450-crore maintenance and support market, with 70% marketsh-are. Another reason why CMC was an attractive buyout for the Tatas is the huge reservoir of intellectual property that CMC enjoys as a company, given its exposure to a large number of verticals.

Action time is now
Analysts expect to see more consolidation at this point in time as the economy begins to look up. "Smaller players who had been holding back due to poor valuation during the downturn will now be more open to buyout offers. Despite the economic gloom last year, the number of M&As was 15% less than in 2000," says Rohit Bhasin, partner in the corporate finance group of PriceWaterHouse Coopers.

Bhasin predicts more action in other vertical spaces as business picks up and companies spruce up their product lines. A recent example here would be ICICI buying out Mumbai-based Orion, which has an ERP product for the SME segment.

With the economy picking up, domestic SME companies are expected to increase spending in integrating disparate applications.

Even globally, Indian software companies are expected to increasingly resort to the M&A route to ramp up presence. NIIT Technologies has already been active on this front. During this year, NIIT has acquired US-based Osprey Systems and Data Executives International (DEI). While Osprey’s competency is in implementing full cycle SAP, DEI is focussed on the insurance and finance sector. The acquisitions are expected to expand NIIT’s hold in the US market.

"Well begun is only half done, particularly in a business strategy like M&A, fraught with challenges in the post-merger phase," cautions IDC India’s Kapil Dev Singh. Post-merger challenges include the ability to integrate the teams and processes of both companies into an acceptable cultural environment, synergizing the workflow and outlining a clear roadmap for existing products to allay customer fears.

Balaka Barua Aggrawal/CNS in New Delhi