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.

Cash
Reserves Held by Software Companies in India
Company
Name
Year-Ending Cash & 
Bank Balance
Loans* Liquid Investments (in
MFs)
Total
Wipro 2-Mar 293.54 820.75 412.6 1526.89
Infosys
Technologies
2-Mar 772.22 254.74 0 1026.96
Satyam
Software Services
2-Mar 1098.34 40.06 0 1138.4
HCL
Technologies#
2-Jun 171.05 0 1115.63 1286.68
GTL 2-Mar 587.28 0 6.03 593.31
Mascot 2-Mar 40.67 0 91.33 132
Digital
Globalsoft
2-Mar 152.39 0 0 152.39
Mastek# 2-Jun 81.26 0 50.07 131.33
Hughes
Software
2-Mar 76.27 0 0 76.27
Note:
This list doesn’t include Tata Infotech & Silverline Technologies
(reports not published). All figures in Rs crore, as available in the
Annual Report. Loans are short-term deposits in non-subsidiary companies
and specifically mentioned in the Annual Report.
*Held
as deposits in non-subsidiary companies as mentioned in Annual Report
#Consolidated Revenues

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

Support Across the Spectrum
Why Do Companies Decide to Tie the Knot?
Fill up a gap in product offerings
Ramp up presence
Acquire skill-sets and competencies
Access markets in new geographies
Tap new verticals
Increase customer base in order to cross-sell

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

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