Cash-rich Indian IT firms likely to head for faster M&A activity

Citi report says TCS, Wipro most likely to buy; Mindtree, Genpact 'most desirable' targets

Indian IT services companies are likely to go for mergers and acquisitions (M&A) at a faster pace than before, with their growth rate expected to slow down owing to higher revenue base. According to a report by Citi Research, cash-rich IT services companies may go after larger deals as against small tuck-ins kind of acquisitions as some of them have been doing in the recent past.

Among the large Indian IT services companies, the brokerage firm said, it sees TCS and Wipro as the ‘most likely’ acquirers and Mindtree, Genpact, WNS, and EXL Service as the ‘most desirable acquisition candidates’.

“IT services firms globally could focus on improving capital allocation through such moves as M&A (moving beyond tuck-in deals), given their large and increasing cash piles,” the division of Citigroup Global Markets Inc said. “Our view is that as growth inevitably decelerates (and this is likely a multi-year process due to a near-term cyclical uptick), the companies in the sector could pay especially close attention to capital allocation, including both increased M&A and a greater return of capital to shareholders through dividends and buybacks.”

The top three Indian IT services companies have been sitting on huge cash piles, which are growing each quarter with healthy cash-flow generation. According to most analysts, these large companies and a few of their peers can comfortably fund a good-sized acquisition with the cash on hand and the available credit line.

As on December 31, 2013, India's second largest IT services company, Infosys has liquid assets (including cash and cash equivalents) at Rs 27,440 crore, while the third largest player Wipro held cash and cash equivalents of Rs 7,993.2 crore.

Terming it a 'strategic tool', Citi Research report said that the likely uptick in M&A activity in the sector could be because of 'financial factors' including low interest rates and 'structural factors' such as slower organic revenue growth due high base and uptick in demand for newer technologies. Besides, the company’s expansion into newer markets are also expected to spur M&As.

“Many of the available growth opportunities within IT services are not in traditional growth areas like datacenter outsourcing or ERP (enterprise resource planning) deployment. These growth opportunities stem from business transformation that clients are engaged in. Many clients are looking to accelerate their own growth by focusing on new channels, geographies and innovation, while at the same time widening their cost-control initiatives,” the report added.

Even as the top three IT services players have tapped the inorganic growth route in the past, most of these acquisitions have been small in size and more on the lines of the 'string of pearls' strategy.

The country's largest IT services company, Tata Consultancy Services has been one of the most active players in the M&A space, and has been (what analysts call) 'unafraid' to venture into large acquisitions. The only large acquisition that the Tata Group Company has made so far is that of Citigroup’s captive BPO, eServe, in 2008 for around $512 million. Besides, the Mumbai-based company has made some other tuck-in purchases like the France-based Alti SA in 2013.

Bangalore-based Infosys has also made some key acquisitions in the past, including the purchase of Switzerland-based Lodestone Management Consultants for around $345 million in September 2012.

Among the top three companies, Wipro has demonstrated a perfect implementation of a ‘string of pearls’ strategy with its multiple acquisitions. The latest acquisition the company made was that of US-based mortgage services company Opus Capital Market Consultants for $75 million (around Rs 465 crore) in December 2013.

Calling Bangalore-based mid-size IT services company Mindtree a 'desirable' acquisition target, Citi Research said, one of the reasons in favour of the company to be bought over is that its ownership is ‘relatively concentrated’ with three shareholders accounting for about 26% stake. Besides, the company is professionally run and appears to have good corporate governance practices, it added.

“Among mid-cap India-heritage IT services companies, Mindtree is perhaps the closest to larger peers in terms of its business mix – well diversified across verticals and service lines,” Citi Research said.

“While so far there have been no indications of a willingness to be acquired, we believe a shareholder-friendly proposal could be given consideration,” it added.