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Capgemini Acquires IGATE to Power North American Ambitions | Sherpas in Blue Shirts

April 27, 2015

Today, Capgemini announced the merger agreement to acquire IGATE for $4.04 billion. IGATE is a US-listed technology and services company headquartered in New Jersey with US$1.27 billion in revenue in 2014. The sale of IGATE has been in the offing for a while after private equity company, Apax Partners, which financed most of IGATE’s US$1.2 billion acquisition of Patni Computer Systems in 2011, converted its debt into equity in November 2014 (becoming its largest shareholder) and also filed with the U.S. Securities and Exchange Commission to have the option to sell its stake. The combined group will have nearly US$13 billion in annual revenue and 177,000 people globally. Capgemini aims to realize revenue synergies of US$100-150 million (through cross-selling and account farming) and cost savings of US$75-105 million over the next three years. The deal’s size and cross-ranging implications make it one of the most significant transactions in the IT-BPO industry. Capgemini is paying a premium for its North American ambitions, over 3x revenue multiple. It outstrips other such deals in the marketplace, notable CGI-Logica (2012) and IGATE-Patni (2011), indicative of the scale and urgent imperative driving deal rationale.

Major acquisitions in the IT-BPO market (US$ million)

What works?

Prima facie it gives Capgemini a sizable foothold in the North American market, the biggest IT outsourcing market in the world. North America becomes a significant market for the combined entity, comprising nearly one-third of 2015 projected revenue, up from 20% for Capgemini earlier. Europe will still account for over half of the combined revenue. The North American region contributed nearly 80% to IGATE’s revenue in 2014, with marque clients such as GE and Royal Bank of Canada. This had increasingly become important for the company since its French-rival Atos bought Xerox’s North American ITO business late last year. That deal also made Atos the primary IT services provider to Xerox (~US$240 million annual revenue) and also have the right to first refusal on collaborative opportunities with Xerox.

It enhances Capgemini’s delivery presence in offshore/low-cost regions specifically India, where most of IGATE’s 33,000-strong workforce is based. Capgemini had earlier acquired Kanbay in 2006 with a focus on increasing India operations. It also bought Unilever’s India GIC – Unilever India Shared Services Ltd (UISSL) – in parts over 2006-2010. Around two-fifths of Capgemini’s global workforce of 144,000 employees is based in India, with the combined group having an offshore leverage of nearly 55% by the end of 2015, comprising over 90,000 people.

The move adds greater definition to the verticalization maneuvers Capgemini had been driving of late. IGATE’s strong BFSI client roster (CNA, Royal Bank of Canada, MetLife, UBS, Morgan Stanley), comprised over two-fifths of its revenue last year. Similar synergies are expected in manufacturing, healthcare, and retail sectors.

Capgemini’s functional spread stands to gain on account of IGATE’s mixture of IT and BPO services. Specifically, Capgemini has been looking to grow its ADM and BPO business, as enterprise clients exhibit a preference for integrated services stacks led by an expanding As-A-Service economy, combine infrastructure, application, and business process service needs. This is the driving force behind IGATE’s business model – ITOPS or Integrated Technology and Operations, which will help Capgemini position itself as a fully integrated service provider. The deal also holds Capgemini in good stead, bolstering its industrialization play. As the value proposition in the global services space moves beyond labor arbitrage, service providers are looking at non-linear IP-driven revenue sources through products, platforms, and solutions. IGATE has monetized the ITOPS value proposition through productized applications and platforms – IDMS (for BFS), IBAS (for TPA clients), and SIB (for retail customers) – which are distinct P&L-plays for the company. Capgemini is also likely to receive additional tax benefits from the deal, as it is carrying a large deferred tax asset in the U.S.

The uncertain

The adage “culture eats strategy for breakfast” couldn’t be truer for this merger. There is a stark cultural tension with a Europe-heritage firm struggling with offshoring trying to integrate an Indian IT service provider with a strong North American client roster. Plus all is not rosy with IGATE. One of its largest clients, Royal Bank of Canada, has been facing problems for its use of IGATE services while GE’s contribution to revenue has been falling. CEO Ashok Vemuri’s hire-for-growth plan witnessed a bump when Q4 2014 headcount actually fell by about 900 employees. IGATE registered an annual revenue growth of just 10% to $1.27 billion in 2014, lagging other IT peers. On the executive front, the merger means uncertainty for Ashok Vemuri, who left Infosys specifically to take over as CEO after Phaneesh Murthy left. His dream of staying a CEO might be curtailed, and he will be tempted to move on, as he wouldn’t want to occupy a role similar to what he held at Infosys, with even less leverage with the leadership. This potential void in leadership could pose a major hurdle for the integration process.

The road ahead

The move is indeed a bold one by Capgemini to catalyze growth, plug delivery/regional/vertical gaps, and streamline operations. IGATE is the right size for Capgemini to absorb – not too small so it does not have a tangible impact but not so big that to create an integration struggle. The sizable deal size could spur U.S. giants to action. Given Capgemini’s European legacy, other regional service providers could mull their options in a bid to expand their operational footprint. We have already seen recent activity in Europe with the Steria-Sopra merger last year. MNCs struggling for growth and looking at globalizing delivery could start thinking of mid-sized players as possible targets. Some of these players have growth issues, significant PE investments, scaling problems – all of which make a good rationale for a merger with a bigger player. On the other hand, the deal lacks some specific attributes when it comes to next-generation technology tenets such as cognitive computing, automation, digital, and analytics. Moreover, Capgemini will need to bridge the inherent disconnect between two different cultures, systems, processes, and people, to make this integration successful. The deal is certain to spark further consolidation and conversations, as service providers witness pricing pressures, evolving engagement models, and increasing anti-incumbency, in a bid to adapt to the As-A-Service construct.

Photo credit: Capgemini

Life in the Mid-Tier IT Services Log Jam | Sherpas in Blue Shirts

March 8, 2011

When Harvard Business School professor Michael Porter said, “Operational excellence may be at the heart of much of today’s business thinking, but it has little to do with what it takes to make a company truly successful,” he could easily have been speaking directly about and to the mid-tier IT service provider community.

Think about it. All 15-20 players in this US$100 million+/sub billion dollar revenue segment have gotten the basics of low costs and high productivity right. Not much differentiation there. In a space as crowded as the malls of Mumbai on a Saturday evening, the key to success lies in finding and strongly demonstrating a truly distinctive market position in terms of business mix, sales and account management capabilities, strategy and leadership. Let’s look at several examples for corroboration.

MindTree, with a three-year CAGR (2007-2010) of ~25 percent and EBITDA margins at 20 percent, has been doing well. Further, more than 50 percent of its revenues come from high margin and high growth non-ADM services such as product engineering. With recent IT infrastructure management service deal wins amounting to over US$70 million, MindTree is in the news for all the right reasons. Its strategic focus on building an engineering and R&D services business, and a leadership team that has largely remained consistent and reputed, have ensured it is one of the front-runners making a differentiating mark in this space.

In the same cluster, it is clear that Syntel is the biggie among the small guys. It is also one of the few companies to have seen steady growth through the turbulent 2008 – 2009 time period. It has had a three-year CAGR of 16 percent and EBITDA margins ranging between 25 and 30 percent. More than 60 percent of its revenue is in the BFSI sector, and ~25 percent comes from non-ADM segments; its successful joint venture with State Street Bank accounts for more than 20 percent of its revenue; and it has a consistent contribution at ~20 percent from American Express…these are only a few of the factors going right for Syntel. With a strategic focus on BFSI and healthcare, both high-growth, high opportunity verticals, it seems to be attacking the market in the right direction.

On the lower end of the spectrum is Headstrong, a privately held company, small even in size as compared to US$0.5 billion+ players like Syntel. A cursory skim through the company’s financials does not reveal anything incredible – growth bordering around 17 percent, and EBITDA margins in the range of 15-17 percent. However, the company does have some distinctive strengths. An active provider of IT services in the sell-side capital markets, it garners more than 70 percent of its revenue from this space. It is also foraying into business consulting, where most of its activity comes from Japan. With a capable leadership, Headstrong is a great example of a niche-focused company driving success.

The last one we’ll look at here is Hexaware, a company whose current financials are not very impressive. BFSI exposure of over 50 percent of revenue battered it during the chaotic times of 2008-2009. Yet that focus is likely to help it rebound as the markets recover driven by BFSI. Further, Hexaware’s considerable presence in enterprise services (~28 percent of revenue) and sizeable European focus (almost 30 percent of revenue) does make it a differentiated play in this market. However, its focus on eight areas may not be a very prudent strategy given its sub-US$300 million revenue base.

Clearly, these companies demonstrate the key ingredients of success through differentiation — a focus on high growth business segments like BFSI, healthcare and product engineering, consistent leadership, account management and mining capabilities, and delivery competence in terms of tools and domain knowledge.

However, given their sizes and the cluttered nature of the IT services sector, the industry is eagerly awaiting a game-changing move. Against the backdrop of the Patni-iGate merger, the market is abuzz with the big question, “What’s next in this space?” Is it a consolidation of complements following closely on the heels of Patni-iGate? Is it an acquisition of one or more of these companies by an Indian Tier-1 player? Revival of the markets, and the presence of maturing private equity investments in several of these firms, continue to fuel to these questions.

The rumor mills are making the rounds with news of assets in play on the deal street. This industry definitely seems to be heading toward some very interesting times.

iGATE’s Acquisition of Patni: A Lost Globalization Opportunity for Far East Providers | Sherpas in Blue Shirts

January 13, 2011

iGATE’s announced definitive agreement to acquire Patni is well-timed for investors, as Sensex (the Bombay Stock Exchange) is near an all time high of 20,000. Further, the acquisition propels the combined entity into the league of billion dollar IT services providers. While it does not create a fundamentally differentiated service provider or alter the Indian IT services landscape in a meaningful manner (please see our blog, “A Deeper Dive Analysis of iGATE’s Acquisition of Patni” and our Breaking Viewpoint, “iGATE Acquires Patni, Finally!”), the acquisition does represent a significant lost globalization opportunity for Far East providers.

As mentioned in a previous blog on NTT’s acquisition of Keane, “Japan at Your Service – A Keane Idea? “, the biggest challenge for the Far East majors, (e.g., the Japanese systems integrators, or SIers, and the Korean Chaebols, or business conglomerates), continues to be globalization of their services businesses (followed by building a robust annuity-based IT services business. )

Against this backdrop, Patni was a strong strategic play – close to $700 million in revenues, almost 80 percent of which comes from the U.S., more than 250 clients, and 15,000+ employees, including substantial presence in India and Mexico…all this provides a good U.S. business launching pad for a Far East provider. In addition, Patni’s strong BFSI play (30 percent from insurance, with all BFSI adding up to ~45 percent), and sizeable presence in manufacturing and retail (~30 percent) demonstrates credible presence in key verticals. And a services portfolio that includes ADM, enterprise applications and product engineering provides a good starting point in target verticals. In our view, Patni could have been a great asset for Far East providers to build presence in key markets with a large offshore capability to serve these segments. And combining this with a European-centric asset would have ensured a true global play for a Far East major acquirer.

Granted, a couple of the most notable Far East providers have aggressively pursued globalization via the M&A route. For example, with its acquisition of Keane, NTT Data made significant steps – onshore capabilities, clients and a strong offshore platform that complements other assets it picked up before that, including Intelligroup. Similarly, Hitachi’s recent acquisition of Sierra Consulting (~2400 employees across in India, and China-based delivery) strengthens its enterprise consulting and offshore capabilities, albeit on a much smaller scale than Patni.

While one might speculate that NTT Data saw Keane as a stronger fit than Patni, and Hitachi Consulting was looking for specific enterprise skills, in general Far East providers did indeed lose an opportunity to increase their global footprint when they passed on Patni, especially given that at a revenue multiple of just over two, Patni appears to be far less expensive compared to its larger peers, (Tier 1 Indian majors are in the six to eight range), and would have been less of a drain on near term financials.

The Far East players have a way to go to catch up in the requisite globalization game. M&A in IT services is a challenge, and perhaps they have not yet mastered the art of integrating complex services businesses, or the speed and agility required to execute such an acquisition. That said, lack of exposure to the developed market is a bottle-neck in how they build their global businesses and stay on top of service delivery innovation. And given the pace of change in the global services industry, there is little time for learning, and success will require an inorganic event to catalyze their globalization.

The Patni deal may open the floodgates of other Tier 2 and 3 Indian IT players cashing out in the face of growing challenges presented by market forces (flight to scale and quality, vendor rationalization). If/as this happens, Far East providers must respond accordingly, due diligence-based appropriately, and M&A masterfully in order to compete in the global services delivery market.

In an environment in which predators outnumber the prey by many times over, it is time for the Far East providers to press on the accelerator to drive globalization!

A Deeper Dive Analysis of iGATE’s Acquisition of Patni | Sherpas in Blue Shirts

January 12, 2011

The IT services industry has been abuzz since iGATE’s January 10, 2011 announcement of its definitive agreement to acquire Patni. And we, along with all those who felt they had at least two cents to share, chimed in with their initial reactions to the announcement (see our January 10, 2011 blog, “On and Off is Finally On…iGATE to Acquire Patni.” )

But to gain deeper dive insights into the acquisition, we tasked our research team to analyze the implications of the acquisition. Here goes:

The acquisition will help iGATE shed the “small provider” moniker and catapult it into the mainstream of the Indian IT service provider landscape. This is particularly important in an environment in which buyers want/need to rationalize their provider portfolio, and a threshold of US$1 billion in revenues is fast becoming table stakes for consideration in large deals. The increased scale, enhanced talent pool, client base, and breadth of capability should enable the combined entity to qualify for larger deals that were previously out of reach. Further, limited client overlap and a broader suite of industry experiences give the combined entity a renewed opportunity to capture additional volumes from existing clients, and the new financial partners (let’s talk Royal Bank of Canada and Apax Partners) could potentially help drive new business.

However, while the acquisition creates a more credible, scaled and potentially hungrier competitor, it does not create a fundamentally differentiated service provider or alter the pecking order in the Indian IT services landscape. Indeed, as depicted in the graphic below, the combined entity retains Patni’s original position behind MphasiS, per revenue reports as of the 12 months ended September 2010. Further, inexperience in large deal pursuits (which will be especially pronounced versus the larger and more sophisticated competition) and the distractions related to the complex integration could be inhibitors in kick-starting growth in the early years.

As it relates to the future of the Tier-2 Indian IT service provider landscape, the iGATE-Patni deal provides a glimpse (see graphic below.) Sustained growth in this segment lies in the ability to create a differentiated market focus that extends beyond the previous generalist approach adopted by most Indian service providers. If the two acquisitions in this segment (Hitachi Consulting acquired Sierra Atlantic on January 4) in just the first ten days of 2011 are anything to go by, we are witnessing the beginning of a consolidation wave that will sweep the Tier-2 IT services landscape in the near future.

For more details and analysis of the iGATE-Patni merger and the Indian IT services market, please see Everest Research Institute’s: “iGATE Acquires Patni, Finally!”

On and Off is Finally On…iGATE to Acquire Patni | Sherpas in Blue Shirts

January 10, 2011

After more than a year of “will it happen, and who will it be?” speculation, Patni Computers is finally being scooped up…by iGATE Corporation. On January 10, 2011, iGATE announced the signing of a definitive agreement to acquire up to an 83 percent stake in Patni. At a transaction value of US$1.22 billion, it is the largest acquisition in the Indian IT services market.

This acquisition bodes well for iGATE, Patni (which will continue to operate as an independently listed company) and the buyer market, which is increasingly questing for service provider portfolio rationalization, enhanced quality, risk mitigation (post the Satyam crisis) and larger service providers. But one of the biggest hurdles the new company must surmount from the starting line and consistently jump is presentation of competitive differentiation against global majors, Tier-1 and Tier-2 Indian service providers. For insights, please see our complimentary November 2010 report, “Survival of the Differentiated: The New Mantra of Success for Tier-2 Service Providers.”

While we’ll scrutinize this deal in detail in the next several days, its shape, flavor and underlying market and buyer drivers are largely in line with our Patni acquisition analysis, available in our free and downloadable report, “Patni: What if Ownership Changes are Afoot?”, published in December 2009.

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Tag: iGATE