Horses for Sources has a post on the rumored merger discussions between Cognizant and Genpact. Financial Express reported on it first. I disagree with the premise of the post and wrote a long comment which for some reason did not post to the blog. So I am reproducing it here at the end of the post. (Note to self: always write long comments in a notepad before you post them.)
First let’s look at what could be the rationale for an acquisition in the Offshore industry. To my mind there are four models that justify an acquisition. They are not mutually exclusive and most acquisitions may be classified under multiple models.
1. Acquiring Offshore Capability
The legacy model of IT Services and BPO is no longer viable. Whatever remains is crumbling under the weight of offshore economics. It has taken over a decade to do so, but most of the major players – IBM, Accenture, Cap Gemini, Unisys – have all set up, with varying degrees of success, India and other low cost country capabilities. On the way, some of them took the opportunity to acquire an Indian company. IBM acquired Daksh and EDS acquired Mphasis. I see acquisitions in this model continuing as promoters in smaller Indian companies becoming more willing to deal.
2. Market Footprint expansion – Geo, Vertical
These will typically be small, tuck-in acquisitions. You could be buying a point presence in a geo or a vertical where you see potential but don’t have a foothold. Infosys’s acquisition of Expert Systems in Australia would be in this category.
3. Service/Solution expansion
TCS’s acquisition of Citi Global Services gave them a solid capability in BPO in Financial Services. HCL’s Axon acquisition would be in this category as well.
4. Scalar expansion
Acquiring a company similar in most respects to your company would fall under this category. Tech Mahindra’s acquisition of Satyam and Caritor’s acquisition of Keane would be called scalar acquisitions. I call them scalar, because the rationale behind them is to scale the company. I believe that there hasn’t been enough of this kind of consolidation and that this is coming soon to the industry. My earlier post gives the reasons why.
One model that is conceivable but I don’t hold out much hope for is where an Indian services company acquires a major consulting led company. I just think the integration is too tricky and the risk of flight of talent is very real. HCL Axon approaches this model, but Axon while reasonably large was a very focused SAP consulting and services company and SAP was never HCL’s strong suit. So they can effectively carry on doing what each of them was doing pre-merger and avoid any integration whatsoever.
This may look like the same combination as 1) above, but it is not. If a major global player acquires a mid-sized Indian company they will operate it purely for offshore capability. All market based roles and leadership roles in the company will be retained by the acquirer. But when an Indian services company acquires a consulting company, it is not clear who will lead and who will follow. And that is what will lead to trouble.
Onwards to the possibility of a Cognizant-Genpact combination. Why might this be a very good combination? Here are my reasons:
The businesses are very complementary. Genpact is less than 15% IT Services. Cognizant is 5% BPO. The lack of overlap means a few things, all of them major factors:
- In one stroke Cognizant as the acquirer becomes one of the largest and most sophisticated BPO service providers. In addition to already being a large high-growth IT Service providers.
- One of the worries in Services acquisitions is that you will end up offering the same services at the same clients at different rates and then the client will move all services to the lower of the two rates. That overlap is going to be minimal in this case.
- The senior teams of both companies will find homes in the combined company. In the medium term they should not have to merge leadership of business units.
Horses for Sources (HfS) says that the BPO culture is quite different from the IT Services culture and that will not bode well for a merger. I can’t see why they would think this. Both companies have a dynamic, growth-oriented culture and have professional management.
HfS thinks that Indian companies have used cash for acquisitions and Cognizant doesn’t have enough cash to acquire Genpact. Indian companies have used cash so far for acquisitions because they have enough cash – actually more cash than they know what to do with. This cash expands the balance sheet and lowers investors’ return on capital. Companies like Infosys have done several special dividends to reduce cash. Nobody in their right minds would use stock to acquire when they have that much cash sitting around.
Does that mean that they won’t use stock when they have to? Absolutely not. I don’t think Genpact’s investors would have any problem accepting CTSH stock.
Also, on a related matter, both Genpact and Cognizant are listed in the US with no float in India. This makes things easier. Acquiring a company 100% in India is a little messier, procedurally.
The fact that GE is 40% of Genpact’s revenue is known and will be priced in to the acquisition price, post due diligence.
The rumor may or may not be true and even if it is true, the deal may or may not happen. But on the face of it, it makes sense. The combined company will be on target to be the second largest in the Offshore industry after TCS within less than a year based upon projected growth rates. And in this industry size matters.