In the last 18 months the markets took a deep dive and then recovered. Valuations in the Offshore Services industry yo-yoed, business prospects sank and then recovered. Yet amidst all this, the pace of acquisitions didn’t go up much. Apart from the Satyam acquisition by Tech Mahindra, deals have been small and infrequent.
The question is why? From the industry structure it would seem like the Offshore Services industry is ripe for consolidation. It has a few major companies that have scale, geographical and service breadth and brand names both in the market and the talent pool – companies like Infosys, TCS, Wipro, Genpact, Cognizant. And then you have companies distributed across the revenue spectrum. There are mid-sized companies, small companies and tiny companies. Shouldn’t the market be consolidating?
Not necessarily. First there is the timing issue. Valuations are back to being on the high side – which makes the buyer skittish. More importantly, growth is back. When the industry is growing, sellers don’t see a reason to sell. The companies that are growing don’t want to sell because they think they’ll get a better price next year.
But is growth evenly distributed in this recovery? It doesn’t seem so. I haven’t looked at the data, but my sense is that recovery of growth has been spotty for smaller companies. Which should mean that larger companies with a high P/E should be happy to bulk up with, but that isn’t happening.
I think the reason is the quality of revenue. Acquiring companies are looking at quality of revenue – acquisitions that bring them geographic penetration, domain expertise or a wider service footprint. And because these acquisitions are complementary the companies being acquired can be quite different from the acquiring company. Company culture, business operations, core skills may be different enough that the acquiring company is afraid of biting off too much. Which is why the acquisitions are small. “Pearls in a necklace” as Wipro has called it in the past.
But a scalar acquisition strategy – basically bulking up – can make a lot of financial sense. If you are a well managed company with a P/E that is higher than the industry, an active acquisition strategy can make sense.
First, if you can negotiate a price for the target that is somewhere at or below your P/E, you are already looking good.
Second, acquiring a company with a similar business, has fewer integration risks.
Third, this industry, even though it has low entry barriers, is a business of scale. Visibility, brand, lower sales costs and overheads – all come from scale.
I think the Satyam acquisition is going to be a big test case. If the merged operations of Tech Mahindra and Satyam are successful as a single company, it will prove that large acquisitions can work and can work financially, if the price is right. As growth in the industry slows down, especially for undifferentiated mid-size companies, acquisitions should pick up pace.
Basab , you are talking only about mergers between Indian outsourcers which doesnt bring any strategic synergies to complementing companies . Its the same talent pool , same revenue model , almost set of customers .So why would a company like Wipro/tcs/Infy try to merge with aouthr smaller player untill the smaller Indian player is doing something a la GOOGLE or really IP .
So while a Satyam-Mahindra was not a natural merger (not a love marriage) it was a arranged marriage by government still it will defintley succeed as they was funadmentally nothing wrong with the revenue stream of Satyam . Satyam has just moved from a family fiefdom to a better Corporate governance model .
"you are talking only about mergers between Indian outsourcers which doesnt bring any strategic synergies to complementing companies ."
Well, that was precisely the point I was making. I think it is time for acquisitions that just add bulk as opposed to bringing complementary value.
Natural Mergers in my opinion for following main reasons :-
1. If the company is a developing world company and doesnt have the know-how , technological prowess it takes over a smaller but Intellectual company abroad . Like Hero-honda , Maruti-suzuki etc .
2. If a bigger company feels that the smaller player has something new to offer which is attracting customers but which is not good for it own revenue , It takes over the smaller one and kills it . Ex – Oracle and Microsoft killing many green-shoot companies to kill competition.
3. Bigger company wants to gobble many small companies across geographies to build scale so that it can dominate and dictate terms . Like a Mittal steel , Time-Warner etc .
#3 is what this post is about.
Guess it's a little too early to say growth is back. I would say the aftershocks are yet to be felt (check out Greece and Spain that sputtered recently) . Also there's something else that's holding the acquirers back – fate of the dollar. Even now, a major portion of the revenues of outsourcing vendors come from the U.S clients that are rooted in an economy that's way too wobbly. Not quite the hour to loosen purse strings. In fact, it's better to wait it out to see which companies survive and then take a call whether to smother them in the market or to shake hands with them.
I think the broader point you are making is that stability is required for M&A activity to grow. I think the markets are as stable as they will be as are major economies that provide revenues to the offshore services industry.
You may have a point re exchange rates. The dollar rupee exchange rate has a big impact on earnings and if that fluctuates like it has in the last year, it makes for an unstable environment.
Basab, my point is that there is a huge consensus that is building up regarding the southward drift of the $$ during the medium to long term before U.S.economy gets back on its rails. In that case, it would be conceivable to buyout American companies that may come cheap (a beginning has already been made by buying out the captives back home) because of the favorable exchange rate. The bargain could be as much as 30-40% in terms of cost of acquisition. So instead of TCS buying out a Firstsource or Infotech enterprises, it could think of acquiring an Accenture or a Cognizant before the dollar gets back its strength. May be it would seem a wildcard deal now, but TISCO (65th in the world steel rankings) did acquire a Corus (5th in that index) and Tata Motors bought out Jaguar Landrover. So the mood is why sweat hurriedly over *string-of-pearls* (a la Wipro) when you can indeed angle for the big one.
Krishna – I won't argue whether the $ is headed down in the medium term or not. But if there was broad consensus on the dollar being overvalued, shouldn't it have been going down?
We may not have a shared view of where the dollar rupee is headed, but what we can say is that Indian companies have opportunities at both ends. If the dollar is strong, their earnings are strong and their valuations are better. If the dollar is weak, targets become cheaper. In both cases it helps if the stock market is firm which it has been.
But all said and done, TCS acquiring Accenture is a non-starter – a disaster, a shipwreck in the making. Why? That's a full post by itself.
Basab, You could use some data. Take a look at the US public debt clock that reads $12.35 trillion and counting at the rate of $ 3.85 billion per day, loading each of its 308 million citizen with $ 40 K on an average. At this rate as <http://gregpytel.blogspot.com/2009/04/us-way-out…. Pytel says, the US borrow and spend solution is akin to an insolvent person who keeps on borrowing, as long as there is a “silly” lender out there. Obviously he has no intention to repay (not that he can, not with a China around) and when push comes to shove, declare a bankruptcy, write off the entire debt and start its financial life anew. I don't want to be an alarmist, but for the <http://www.commodityonline.com/news/History-of-co… of the collapsed dollar that can repeat itself, so long as it stays a recorded event from the past that a vexed Tim Geithner or his successor can turn to !
Basab, You could use some data. Take a look at the US public debt clock that reads $12.35 trillion and counting at the rate of $ 3.85 billion per day, loading each of its 308 million citizen with $ 40 K on an average. At this rate as Greg Pytellsays, the US borrow and spend solution is akin to an insolvent person who keeps on borrowing, as long as there is a silly lender out there. Obviously he has no intention to repay (not that he can, not with a China around) and when push comes to shove, declare a bankruptcy, write off the entire debt and start its financial life anew. I don't want to be an alarmist, but for the history of the collapsed dollar that can repeat itself, so long as it stays a recorded event from the past that a vexed Tim Geithner or his successor most likely turn to !
I guess one of the common reasons for M&A (to add bulk) is to achieve economies of scale. Indian IT outsourcing is services business. In services industry, (compared to manufacturing industry) the economies of scale flatten out relatively fast. The profit/revenue per employee for a 10,000 employee company may not necessarily be better than a company with 5000 employees. After all its all about humans, not machines.
So a large company (Infy,Wipro etc) doesn't gain much by acquiring a smaller size company. Their own brand name is already so powerful, that they don't need much help in that department.
Centuries ago India gave ZERO to the western world , and since histroy repeats itself its again time we give ZERO again to the western world .
In my prediction Indian companies can literally acquire any company in the world in next 4-5 years and make them Zero – Atleast the inflated egos will be reduced to zero :-))