Mphasis on alpha returns: Why Blackstone finds Indian IT so attractive

The expansion of its stake in the mid-size IT services company is part of a trend of PE players betting big on the Indian IT sector

When Blackstone invested $2.8 billion to acquire a 26 per cent stake in 21-year-old Bengaluru-based IT services company Mphasis, this alone accounted for about 40 per cent of the $5.5 billion this PE giant invested in India in the first four months of 2021. That, as Amit Dixit, Senior Managing Director and Head of Private Equity--Asia, Blackstone, recently said represents a massive commitment by the PE player in the Indian IT sector in general and Mphasis, in which it already owns 56 per cent. Addressing analysts after the Mphasis announcement, Dixit said the company would be a 10-15 year investment story.

Why is IT, particularly Indian IT, so attractive for the New York-headquartered PE giant? Globally, the group has identified eight multi-decadal themes that span almost 650 Blackstone enterprises. “Some of them have been accelerated by Covid-19. Cloud migration is one of those eight themes,” Dixit said.

Certainly, the Indian IT sector has seen a demand surge led by cloud and digital computing with many service providers reporting their best-ever total contract value (TCVs). For instance, Tata Consultancy Services (TCS), India’s largest IT service provider, reported a total TCV of $9 billion for the Q4FY21, one of the highest reported, the company said. Similarly, Infosys, the second largest, reported that it signed large deals worth $2.1 billion.

Mphasis, which is ranked eighth, has also managed to close large deals; just as it closed the Q4FY21 numbers, the company signed one of the largest deals worth $250 million in the UK. For FY21, it reported a 51 per cent year-on-year jump in TCV of $1.1 billion. Nitin Rakesh, CEO, Mphasis, said FY21 has been one of the best years for the company with not a single quarter showing a dip, unlike some of its large competitors that saw client hesitancy impacting the first two quarters. With Blackstone recommitting its support, the company is looking to double its revenue from Blackstone portfolio firms, but it also intends to use this cash infusion for much larger acquisitions.

The biggest attraction of this sector is a natural hedge it provides for currency fluctuations. “You get your revenues in US dollars and part of your costs are in local currency. And as you know, the rupee has had a tendency to depreciate, it is about 2 to 2.5 per cent for the past 75 years. Wage inflation is a real issue. But that rupee depreciation helps you absorb the wage inflation. And that’s why you see the sector humming for more than 20 years. The natural hedge to currency provides, in a relatively asset-light model with low capital intensity, for very good free cash flow generation and good dividend distribution, and so on,” Dixit pointed out.  

This time, Blackstone is also bringing in strategic investors Abu Dhabi Investment Authority (ADIA), UC Investments and GIC into Mphasis. Reinvesting or upping its stake is not new. It has done something similar with business process outsourcing firm Intelenet. In 2007, Blackstone had invested $150 million to $160 million in Intelenet for a 67 per cent holding. In 2011, UK-based Serco acquired Intelenet for $634.2 million. In 2015, Blackstone re-acquired Intelenet from Serco again by paying $385 million, and sold it to France-headquartered Teleperformance for $1 billion in 2018. Blackstone made an internal rate of return of about 50 per cent, according to reports.

With Mphasis, it is assumed that Blackstone will continue on the board for 15 years. This, too, is part of a trend among large private equity players. Take the case of Genpact and WNS. PE player Warbug Pincus acquired a significant stake in WNS in 2002 for $40 million, and exited in 2013 via secondary sales. But it made huge returns. When it invested, WNS had revenue of $20 million; by 2013, it was $450 million. In 2006, the company listed on the New York Stock Exchange. Similarly, General Atlantic and Oak Hill invested around $500 million in Genpact for a 60 per cent holding in 2004. After reducing their stake to 40 per cent through secondary sales, they sold 30 per cent to Bain in 2013 for $1 billion.

One of General Atlantic’s early investments in the IT sector was Patni Computer Systems, which it exited after 10 years. “Historically, the investment thesis for PE in tech services when growth rates were stabilising was to bet on established scaled payers and drive margin expansion through operating efficiencies to optimise returns. The demand acceleration in the last few years and expectation that it will sustain has created more attractive return prospects for the investors. It’s a play for alpha returns as some of these funds have partially recovered their investment through dividend and buybacks,” explains Shivani Nagpaul, Transactions Partner (Tech), EY.

For Blackstone to have a controlling stake in Mphasis could also indicate how it intends to exit the company. Most PE players have struggled when it comes to exits in the IT sector. When companies mature and generate good cash, valuations soar. One example is Baring Asia’s investment in Hexaware. The PE player had been trying to sell its stake but whenever it tried doing so, the stock price would jump, making it hard to find new suitors. Finally, the company delisted itself.

Historically, PE players who have stayed for a longer time in a company have had to opt for secondary sales for at least the partial sale of their stake in the company. By taking a controlling stake in Mphasis, Blackstone is perhaps making sure its exit is not marred by delays.