Is Infosys Preparing For Its Maiden Blockbuster Deal?

By Boby Kurian

  • 04 May 2010

India’s technology bellwether Infosys Technologies, with a reserve cash pile of $3.5-billion and a conservative approach towards M&As, is working on significant overseas acquisitions priced at around $500 million.

This time, speculation points to India's tech poster boy working on two possible buyouts, each of which is "about one-tenth its own size" in acquisition cost. The destination could be continental Europe, possibly France or Germany, where Infosys has mined hard in the last two years. An Infosys spokesperson said, “we do not comment on speculation” in response to a VCCircle mail.

In recent weeks, BNP Paribas Securities analyst Abhiram Eleswarapu wrote, in his report, that Infy's move to skip a special dividend suggested that the company may be working on a fairly large acquisition. "A lack of special dividend in FY10 given over $3.5 billion of cash on the balance sheet surprises us. In our view, it signals a reasonably large acquisition in the near term," he said, in his note, after Infosys declared its latest set of quarterly numbers last month. There are others who back this argument after being disappointed on the special dividends, which were doled out in FY08 and FY06.


"A few generic assets with some consulting revenue have been highly recommended, especially since the US tech spending slackened during the economic slowdown," said one investment banking source, who did not wish to be quoted. Notwithstanding the challenges, which include the conservative opposition to offshoring and heavily unionised employees, Indian firms have been actively pursuing acquisition opportunities to crack a stable and matured European IT market with some largest clients outside North America.

"It is still a difficult market even though the negatives are too obvious by now. But IBM and Accenture have been running profitable operations in central European markets like France. The key question is how they (Infosys) can get to 20% margin in three-four years post acquisition," said a source who has worked with Infosys on one of the earlier transactions.     

A Business Line report on Tuesday said, Infosys was committing $100 million to expand in Europe organically, which underscores the significance attached to that geography.


The second source argued that the current Infosys CEO Kris Gopalakrishnan has surprised many - as in the case of his active backing to the $58-million McCamish Systems acquisition - with his intent to follow a serious inorganic growth strategy. Global IT valuations have been recovering even as the deal-making flow opens up. On Monday, Reuters reported that Warburg Pincus along with a fellow private equity may be snapping up IDC for $3.1 billion. Indian tech firms, looking for inorganic growth, may still have a six-month window to effect buyouts without over-paying.

With valuations stabilizing, more American assets are hitting the deal table, which would throw up interesting opportunities in the Indo-US corridor for the acquisitive tech firms.

Infy's first acquisition of a consulting business, Expert Information Services, in Australia, nearly seven years ago, saw the Indian company more than double its margins to over 25% in 3-5 years. "Of course, it was a smaller acquisition and Down Under is easier compared to continental Europe. Infy must work on lower margins in the first three years to get ahead with deal-making in Europe. And the management challenge will be to bring up the margins thereafter, while factoring in not more than 25% offshoring potential," explained an analyst tracking the tech sector, and Infosys in particular.     


However, Harit Shah, IT and telecom research analyst at Karvy, says, “Indian IT firms are more likely to go in for smaller-sized acquisitions. Big-sized acquisitions by Indian IT firms will come with huge operational challenges on integration which occupy management bandwidth. I expect Indian firms like Infosys to continue to be selective and conservative. More than a pressing need to close the revenue gap between Indian IT players and global biggies, there is a need to fill global capability and consulting gaps.”

The Bangalore-headquartered IT services giant, like some of its other domestic peers, has been cautious on acquisitions that are margin dilutive. Firms such as Infosys have worked on margins that are as high as 30% historically but will have live with a new reality if they are to script big-sized acquisitions, which is the only way to reduce the revenue gap with global biggies like Accenture.

Infy's religiosity towards margins is what keeps its share price stay clear of the defensive cycle that played out on the IT sector in recent quarters. With $5 billion revenue, Infy's mcap stands at about $36 billion. Accenture with $23 billion revenue shows up with $31 billion in mcap. Infy's EBIT margin continues to play at 30%, while that of Accenture at just over 13%.


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