The Shopping Binge

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