Tag: mergers & acquisitions

Test It Out | Sherpas in Blue Shirts

A new week – a new market speculation. My favorite business paper, Business Standard, is hard at work again breaking technology M&A stories. This time the company in play is AppLabs, an independent software and application testing company. Reportedly, French IT services company Capgemini and U.S.-based CSC are looking to buy it.

Interestingly, AppLabs – which claims to be the world’s largest independent software testing and quality management company by testing professionals – itself grew through acquisitions. Founded in 2001, AppLabs has grown from a three-person outfit to its current size of ~2,500 employees, and has testing facilities in the United States, United Kingdom and India – its three key markets. AppLabs acquired KeyLabs in 2005 for US$7 million, IS Integration for US$37 million in 2006, and ValueMinds in 2010 for an undisclosed amount. The acquisitions gave it capability, geographic access, and IP and toolsets.

In terms of business mix, AppLabs’ is dominated by the hospitality industry.


Between 2004 and 2007, Sequoia Capital funnelled US$17 million into AppLabs to fund its growth, including acquisitions. While it is understandable that Sequoia Capital wants to exit its investment and that may have led AppLabs to find a suitor, the question that comes to mind is why Capgemini and CSC are interested at a valuation of 2.4x revenue (this seems very high, and may just be an asking price, and the acquirer may have a very good reason for doing this) for a ~US$110M top line.

Growth at any cost: Why are companies with close to US$30 billion in collective revenues interested in buying a small operation? My preliminary research shows Capgemini has a strong organic testing portfolio. Our hypothesis on testing as a service has been that third-party testing will grow as clients look for independent validation. There is certainly a case for having independent testing services companies with lower cost bases, compared to full services IT companies that employ high cost engineers and scientists. Unless, of course, these companies are buying growth wherever they find it. CSC grew its revenues less than 1 percent in FY11, while Capgemini grew at a relatively healthier ~4 percent in 2010. For both companies it may also be a buy versus build entry strategy into offshore testing.

Portfolio: AppLabs’ business portfolio shows a high share of business from hospitality and healthcare, two of the verticals with higher runways and growth potential. Companies will pay to be present in industries in which there is likely to be future growth

Testing as a wedge: One of the ways in which third-party testing services help diversified IT firms is by providing them with a lever to enter an account in which another competitor is strong in core services. This may be relevant for some of the India-heritage offshore majors looking to replace global incumbents in accounts. Which brings me to – where are the Wipro’s, Infosys’ and TCS’ of the world in this AppLabs game? Here is a look at the cash balance on their balance sheets as of June 30, 2011:

Balance Sheets1

1 Includes bank deposits and investments, as reported
2 Includes available for sale investments, as reported

With these kinds of cash balances, might one of the offshore majors want to buy AppLabs, thereby preventing Capgemini or CSC – and perhaps other globals that might potentially jump into the bidding fray – from gaining inorganic entry into the offshore testing market, and instead needing to build it themselves? Food for thought?

Cross-Shore M&A in the Healthcare Sector: Can You Make It Work Well? | Sherpas in Blue Shirts

On September 5, 2011, the Business Standard (one of the leading Indian business dailies) reported that offshore BPO player Firstsource was planning to sell U.S.-based MedAssist, a healthcare revenue cycle management-focused BPO provider it acquired in 2007 for US$330 million, at a reported premium valuation of more than 12x EBITDA. The idea behind the acquisition was to merge the payer business (Firstsource had multiple Fortune 100 health insurance clients) and the provider business (MedAssist’s main business) into one comprehensive organization.

In 2005, Apollo Health Street, formed in 1999 by Apollo Hospitals Enterprises, acquired U.S.-based BPO provider Zavata (a revenue cycle management firm) for US$170 million. According to the Financial Chronicle, some of Zavata’s key clients jumped ship after the acquisition. There have also been reports that Apollo Hospitals wants to exit non-core businesses including the BPO business. Apollo Hospitals tried to IPO Apollo Health Street in 2008, but the global economic crisis put an end to that.

The two above cases have several factors in common:

  • The acquisitions were focused on entering/building on the emerging healthcare services space
  • The acquisitions occurred in the heady days before the 2008 financial crisis, the onset of which likely contributed to derailing business growth plans to some extent
  • Client access was one of the value drivers behind the acquisitions that perhaps didn’t work out as well as was envisioned

So why is it difficult for offshore BPO providers to make acquisitions successful in the onshore healthcare space? There are certain services that simply don’t lend themselves to offshore delivery. Additionally, many healthcare industry-unique issues that relate to the execution and integration of acquired companies exist.

Think about some of these challenges:

  • Healthcare domain knowledge – in the examples above, the targets were onshore-based players with domain skills that were stronger than the acquirer. With that, the agenda was perhaps being driven by the target rather than the acquirer, which could have led to difficulties in driving synergies and adding value
  • Fragmented market – most healthcare-focused onshore BPOs are small players with limited scale, especially those serving the provider market. As the clients are not overly dependent on these suppliers, it makes it hard to leverage client access for cross-selling opportunities. (Note, the largest hospital chain in the United States is HCA with revenues of US$33 billion, while the rest are much smaller. For example, the third largest, HealthSouth, is 15 times smaller than HCA.)
  • Buyer preferences – Hospital chains are very sensitive to protection of patient data and are uncomfortable having sensitive data taken offshore. Most prefer to work with small onshore players and already have deep relationships with them.
  • Local understanding and social intimacy – Hospitals typically tend to build a networked community of people working around them. Most patients and service provider personnel are part of one large social network, making it difficult to take jobs offshore.
  • Offshoreability – Healthcare has generally lagged other industries in terms of adopting outsourcing and offshoring. The above-mentioned factors have further contributed to this.

We believe offshore providers must take into account two key considerations before considering acquisition of an onshore business:

  1. Access to clients: Understand the target’s client base, i.e., multiple small clients that rely heavily on it, or a few large ones that only depend on it to some extent. This will help determine leverage, access, and cross-sell opportunities.
  2. Ownership of business/rationale for acquisition: If the acquirer is entering a new business, the agenda will be driven by the target company’s management due to the acquirer’s lack of familiarity with the territory.

These two factors, in addition to others, will help drive the buy or goodbye decision.

The A to Z of Mortgage BPO – Accenture acquires Zenta | Sherpas in Blue Shirts

Earlier today Peter Bendor-Samuel, CEO of Everest Group, posted a blog about what Accenture’s acquisitions of Zenta and Duck Creek signal for the global services industry. My goal in this blog is to drill down into specific details around the Zenta acquisition. So, with that…

Accenture announced earlier this week that it had acquired Zenta, a provider of residential and commercial mortgage processing services in the United States. The announcement also cited the launch of Accenture Credit Services, which will consist of full service consulting, technology, and BPO capabilities for the commercial real estate, residential mortgage leasing, and automotive finance industries.

Given the abysmal state of the mortgage industry – especially residential – in the United States, this is an ideal time for a large BPO service provider with sufficient cash reserves and existing low-cost delivery model to build or expand its capabilities in the mortgage servicing space by taking advantage of attractive valuations, thereby making an investment in the future. (Cognizant did exactly this last month when it acquired CoreLogic’s India-based captive.)

Think about it. The mortgage industry is facing significant double whammy profitability issues, with costs rising due to higher fulfillment expenses and the need to manage increased and changing regulatory norms, and revenue dropping due to lower origination volume (purchasing volume). The nature of services itself has changed with loan modification volume rising significantly, while new mortgage initiations have reduced dramatically. And the increased regulatory oversight, resulting from regulations such as the Dodd-Frank Act and additional proposed changes, has created an air of uncertainty in the mortgage servicing industry. Against this backdrop, Accenture’s acquisition of Zenta was certainly smart and well-timed.

The acquisition was also smart, for a different reason. Within the banking, financial services, insurance (BFSI) BPO market, Accenture has a strong position in the insurance sector which accounts for 60 percent of its BFSI BPO revenue. However, it has a fairly modest scale of operations in banking BPO, and limited capability in industry-specific capital markets BPO. With this acquisition, Accenture gains Zenta’s strong voice and non-voice experience and capabilities in the mortgage services space, which it can then infuse with its own strong consulting and technology capabilities to establish what is essentially a one-stop-shop for the mortgage industry. The launch of Accenture Credit Services is a clear step in fulfilling this objective.

With Accenture making this move in the mortgage services space – as we had suggested it might in our BFSI BPO service provider profile compendium released earlier this year – what can we expect next? Will it make further investments in banking BPO around, say, credit cards? Or will it perhaps invest in capital markets BPO, which has been a gap in its overall BFSI offering? Can it develop the capabilities organically, or may another acquisition, either a captive or pure-play niche service provider similar to Zenta, be in its crosshairs?

Yes, it’s exciting times in the BFSI outsourcing space. Stay tuned for new developments!

Does Accenture’s Acquisition of Zenta and Duck Creek Signal Industry Maturation? | Sherpas in Blue Shirts

In the last several days, Accenture – a firm that has largely focused on organic growth strategies and avoided significant inorganic expansion activities – announced two acquisitions: Zenta, a U.S. mortgage processing firm, and Duck Creek, a provider of software solutions for the property and casualty insurance industry.

When Accenture does occasionally make acquisitions, it has followed a policy of buying tuck-in properties which allow it to build IP or enter new markets. Both of these acquisitions fit Accenture’s historical pattern by adding capability and IP which extend its transformational offerings. In this case, Accenture is adding an attractive mortgage processing platform from Zenta and important IP in the property and casualty arena from Duck Creek. Both of these additions more strongly position Accenture in attractive industries currently undergoing substantial transformation.

Taken together, these acquisitions may be heralding an increasingly acquisitive stance by Accenture, while at the same time demonstrating that at least some private equity firms are exiting the space. Historically, Accenture has been a value buyer, with these recent announcements appearing to fit that pattern. What’s unexpected is that the exiting PE firms are accepting modest valuations as compared to the high multiples often offered through a public offering.

The increased rate of inorganic activity from Accenture, combined with PE firms’ willingness to take reduced multiples, are consistent with a maturing market  in which  traditional powers adjust  their strategies to take advantage of and accommodate new realities.

What other changes do you see coming to the industry? Does this signal a new round of consolidation? Will Accenture divest Zenta’s commoditized services lines? If so, which firms will pick up those assets? Will less attractive valuations of properties slow the rate of investments into the space by PE firms?

Thumbs Up to Serco Acquiring Intelenet: Is 2011 BPO’s Year for Acquisitions? | Sherpas in Blue Shirts

Serco Group plc, a U.K.-based international services company with diverse interests in both the public and private sectors, yesterday signed an agreement to acquire Intelenet, a leading Indian BPO services company serving clients around the world and in the domestic Indian market, for up to £385 million (~US$635 million.)

This is the fourth big-ticket acquisition so far this year in the Indian ITes industry, following on the heels of iGATE-Patni, Genpact-Headstrong, and most recently EXL-OPI. I see two key forces driving this acquisition spree. First, and more relevant, is the need for service providers to expand scale and capabilities in an increasingly competitive market. Second is the potential attempt by private equity investors to exit their stakes in Indian ITes companies now that the valuations are attractive with the market bouncing back from the recession.

Serco’s acquisition of Intelenet is an outcome of both these factors in play simultaneously. On one hand, this move will add to Serco BPO’s scale and depth of capabilities, and provide access to attractive markets; and on the other hand, this marks a successful exit for Blackstone, which four years ago invested ~US$200 million to stage a management buy-out of Intelenet.

Interestingly, Serco’s entry into the Indian BPO market was through its acquisition of InfoVision towards the end of 2008, whereby it established Serco BPO. The acquisition of Intelenet marks a significant step change in its global capability and capacity in terms of:

  • Access to attractive markets –Intelenet has a strong customer base in the international markets and is a leader in the fast emerging domestic Indian BPO market. These markets are expected to grow at ~15 percent and ~20-25 percent per year, respectively. That a U.K.-based company has acquired BPO assets in India to target not only the international but also the domestic market underscores the growing importance of the domestic Indian BPO market. India has seen GDP increase by 7-8 percent per year over the last decade, with rising incomes driving demand from customers for services and increasing use of third parties to deliver them. In addition to this growth in the commercial BPO market, there is also emerging demand for process outsourcing within the Indian public services market.
  • Added scale and depth of capabilities – The combined BPO-related operations will have 40,000 employees (~32,000 coming from Intelenet) providing services across seven countries. While Serco BPO was previously a pure customer-centric BPO provider specializing in CRM support, the acquisition brings a wealth of expertise in a broad range of middle- and back-office services, including transactional, finance and accounting, and business transformation offerings. Serco will also benefit from Intelenet’s capabilities in the financial services, travel, and healthcare industries.

Intelenet’s scale and expertise, backed by Serco Group’s financial muscle, should create a formidable player in the third-party BPO space.

On a witty note, the year 2011 adds up to the number 4 (2+0+1+1=4) and we have already seen four major acquisitions this year. Will 2011 create history via more acquisitions, or will numerology play a spoilsport? Any guesses?

Expect Changes in the IT Security Landscape | Sherpas in Blue Shirts

The worldwide IT security market is already quite sizeable, exceeding US$25 billion. And all industry analysts are predicting 20-30 percent growth in the next three years. Multiple drivers will fuel this growth, including increasing complexity of IT solutions – which raises the level of challenges for supporting security – and much higher value assigned to proprietary information.

Yet, I believe the structural nature of demand will drive quite an important shift in customer buying preferences going forward. As large enterprise clients recover from the global economic crisis of 2008, they are increasing their emphasis on costs. And despite increased willingness to pay, IT security cost is not immune to this pressure. In order to avoid separate management costs associated with standalone IT security service agreements, enterprises prefer to bundle IT security support with either large IT outsourcing deals or existing telecommunications contracts, as the network is still perceived as the most security-exposed element of IT delivery. Moreover, large corporate clients prefer to deal with a single point of responsibility for actual IT delivery and corresponding security support, which eliminates any risk of finger pointing, and streamlines their governance activities.

So what are the implications of buyer preferences for the existing provider landscape? I believe they will be game-changers primarily for niche IT security service providers and traditional security software vendors. Under the threat of missing their portion of anticipated incremental demand, they will be actively seeking alternative distribution channels and experimenting with different forms of industry cooperation. Everest Group also expects to see increased M&A activity in the IT security industry as large, integrated IT suppliers will be seeking ways to further enhance their capabilities in efforts to capitalize on the rapid growth of this market.

So let’s check in one year from now on the state of the IT security industry, although there is no doubt that it will look different from what we see now.

How Will the IT/BPO Industry Leaderboard Change? | Sherpas in Blue Shirts

This past weekend, many people were glued to their televisions watching the 2011 Masters Golf Tournament at Augusta National. As the days rolled by, the leaderboard changed in some surprising ways – the young McIlroy slid a long way from Number 1 on Day 1; Tiger Woods finally showed his old spark and stayed steadily within the top 5 throughout the game; and Charl Schwartzel jumped into the front-runner spot to take the Green Jacket.

While we now know the Masters winner, there is significant speculation on the changes in the IT services leaderboard, both today and going forward. The market is rife with questions on where Wipro and Cognizant will end up this season. The discussion on C-level changes at Infosys made a leading Indian newspaper speculate on issues it may be facing, with TCS speeding on and Cognizant being on steroids and catching up quickly. The next day, analysts said TCS would continue to outpace the other TWITCH majors as the quarterly results season starts.

We will know the answers to these questions in the next few weeks, after all companies report their numbers. But the more important long-term question is, what else will change in that leaderboard? Will we see more M&As, new entrants, or exits? And fundamentally, what will the future structure of the IT services industry be, and who will the winners be?

In a recent meeting, a CEO of an IT services company made an interesting point about there being steps at the US$500 million, $1 billion, $5 billion, and $10 billion marks, and that it is progressively challenging to get to the next level. It was clear he was thinking that some, including those in the $2+ billion scale, will struggle to reach the next level, and some will stabilize in their current or adjacent level.

The TWITCH discussion is interesting, but then there are the mid-tier IT players. We are just past the first quarter of 2011, and already three (iGate, Patni, and Headstrong) no longer exist, at least not in their original form. From all we hear or understand, several more may go before the end of 2011.

Then there are continuous speculations about pure play BPO players being shopped about. The rumor that Cognizant will take out Genpact has been around for ages. EXL is up for some action, and the market is abuzz with other speculations. As one of my colleagues recently blogged – will the Indian pure play BPO companies survive in the same shape and form past 2011 or 2012?

Net, net, here is the big picture. Some large Tier 1 players are struggling, mid-sized IT is not necessarily the best place to be, and pure play BPO companies are a vanishing tribe.

All this raises more questions: What is the future structure of the global services industry? Will Accenture, IBM, Dell, the Japanese majors, TCS and probably a few others become the super majors by 2015 or 2020, and will the rest need to find their own places under the sun? What other categories and groups of service providers will exist, and what will their characteristics be, for example, regional specialists, vertical specialists, etc.?

Irrespective of how the industry evolves, consolidation will continue, and the M&A juggernaut will roll. This business generates cash, and doesn’t require a lot to sustain it…so companies will invest in buying capabilities, assets, businesses, and people in attempts to win top spots on the leaderboard.

We certainly are headed for some interesting months ahead. Is anyone betting on who the winners will be at the end of 2011?

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