Coronavirus impact: Dip in valuation prompts IT firms to bet on buyouts

Tech firms with niche capabilities are on the radar of IT biggies

With valuations coming to a realistic level because of the coronavirus disease (Covid-19)-induced crisis, many IT services firms with sound balance sheets have started exploring the possibilities of acquiring companies operating in niche areas. According to sources in the know, strategy teams of many IT firms have sounded out investment bankers and analysts about opportunities that could be the right fit before conducting any formal due diligence.
 

Analysts are of the opinion that with enough cash reserves at hand, most IT firms are better placed to overcome the Covid-19 crisis. However, as revenue growth is likely to take a hit, a good acquisition could offset some losses in topline. “Global flight of capital to safety in a strengthening dollar environment would generally make investment in IT, KPO (knowledge process outsourcing) and BPM (business process management) firms an even more attractive proposition,” wrote Amit Singh, executive director (Enterprise Technology & Services) of Avendus Capital, in a recent note to investors.
 

According to investment banking firm, mergers and acquisitions (M&A) activity in the sector was trending down in March because of the unexpected disruption. While deals announced in the space stood at 226 in January, the number fell to 191 in February and 89 in March, the note said.
 

However, deals in technology services space were not impacted as much as the overall technology segment. M&As in the segment stood at 14 in January, rising to 28 in February, and was 17 in March.
 

“While the current unprecedented situation has shaken investor confidence, we expect technology outsourcing industry to be a net-gainer in the medium to long term,” Avendus Capital said. No wonder, companies such as Accenture, Infosys, Capgemini, Cognizant have closed acquisitions in March, despite the crisis.

In the past few years, most top and mid-tier IT services firms, including Infosys, Wipro, HCL Tech, and Tech Mahindra, have completed many acquisitions to build capabilities apart from supplementing revenue growth. “When the industry is likely to see a revenue growth in the range of -5 to +5 [per cent] in 2020, a good acquisition can in many ways offset losses from core business. 

At a time, when valuations are attractive, many IT firms have started exploring this option,” said Pareekh Jain, an IT outsourcing advisor & founder of Pareekh Consulting. While large-cap IT stocks have fallen by 27 per cent in March from their five-year high globally, market cap of mid-cap IT firms have dipped by 48 per cent.
 

Similarly, diversified BPM firms have seen an erosion of 54 per cent in market cap during the period, according to Avendus Capital. Such dips have made many firms operating in technology services space attractive for acquisition.