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IT’s New Pecking Order: Tech Mahindra Gets Into Big League

13 April, 2009

Tech Mahindra becomes the fourth largest IT firm with its successful bid for acquiring 31% in Satyam Computer Services (to be followed by an open offer to acquire another 20%). While on the one hand it would replace Satyam (based on the cooked accounts as of December 2008), which was placed at the no:4 behind TCS, Infosys and Wipr , Tech Mahindra will overtake HCL Tech to move up the charts amongst Indian IT firms.

Size Matrix

With an anticipated Rs 8,000 crore annual revenues for Satyam and around Rs 4,500 crore of Tech Mahindra (FY09) the two as a combined force would have a revenue rate of close to Rs 12,500 crore ($2.5 billion) with profits upwards of $250 million.

For Tech Mahindra, the deal means entering the big league through diversification of business. Even though, its dependence on BT as a business has come down overtime, it is still seen as largely telecom heavy in expertise. With Satyam in its fold, Tech Mahindra becomes a well diversified IT services firm with a strong presence in SAP in which Satyam has a dominance.

For many sectoral analysts, L&T would have been a better fit for Satyam as it would have brought engineering skills to the fore which could have helped, specially in attracting manufacturing clients. Moreover, L&T also has understanding in the SAP area which could have brought added synergies. To some extent this issue gets mitigated by the fact that Mahindras also have a strong manufacturing presence and can bring some technical knowledge of auto sector for instance to Satyam.

Challenges

But as the highest bidder, Tech Mahindra is taking a gamble to move to the bigger league. One issue it would face would be of managing an employee base which would be three times its existing workforce of around 25,000 people.

At the same time Tech Mahindra would now have to try and retain key talent in the firm (and contracts) so that they don’t just end up with a shell firm. There have been various reports of some leadership talent trying to break off with their own client base to other firms. To add to the daunting task for Tech M to integrate smoothly, there are other challenges including Upaid impending case against Satyam, US class action suits and Raju’s confession of Rs 12.3 bn of funds arranged by him to fund Satyam’s activities.

Another problem would be raising funds for the transaction, given bleak securities market and tight credit position for debt. Tech Mahindra had cash worth $110 million (around Rs 550 crore) as of December 2008. In March, Fitch Ratings withdrew Tech Mahindra’s debt rating, due to uncertainties surrounding the bid. Fitch had also highlighted that any debt-led acquisition would act as a negative trigger for the company.

The biggest issue however would be the extent of lawsuits facing Satyam including the class action suits in the US. Although, the valuation would have factored in the likely liabilities arising out of such legal issues, they remain to pose a question mark for Tech Mahindra.

 

Funding The Deal

The next question before Tech Mahindra would be how to finance the deal. The firm had reserves and surplus of Rs 1,631 crore as of December 2008, which will not be sufficient to bankroll the transaction. Earlier reports had suggested the firm is considering bringing in a private equity investor to the SPV which will be floated to route the transaction. One of the obvious investors could be Kotak Mahindra Group which is also engaged in private equity business.

Another option is where Mahindras bring in part of the fund required through one of their privately held investment firms, though this would be difficult given the flagship firm M&M facing slowdown in the auto industry. This would in turn have tied the hands of the promoters to bring in fresh funds to the table.

According to a Mumbai based broking firm, Tech Mahindra which had cash of $100million at the end of 3FQ09 and will have to take debt on its books to fund the acquisition. For 51% stake ( including 31% preferential allotment and 20% open offer at Rs 58, Tech Mahindra would have to shell out Rs 28,870 million. Nearly US$575m of cash is needed versus $110m that Tech Mahindra has as of now. Tech Mahindra is required to deposit in escrow account the total funds necessary to conssumate the public offer by 21 April, otherwise the next highest bidder will be considered the highest bidder.


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IT’s New Pecking Order: Tech Mahindra Gets Into Big League

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