Are acquisition strategies of IT bellwethers right?

Updated: Sep 22, 2011, 14:33 PM IST

India Inc is no stranger to big ticket takeovers. Tata Steel acquired Corus in a deal worth US USD 7.6 bn. Aditya Birla Group`s Hindalco acquired the Canada based firm Novalis in an all-cash transaction for USUSD 6 bn. And not to forget Tata Motors which acquired Britain`s most famous automobile manufacturers, Jaguar and Land Rover, in a US USD2.3 billion deal. There are several others big acquisition deals by other business houses in India as well. Now pause for a moment and think about our Indian software majors. Have you ever heard of similar big acquisitions by our IT bellwethers Tata Consultancy Services and Infosys? Your answer would be "No". Why it is so?

Let us first spend a minute on what an acquisition is. An acquisition is the purchase of one business or company by another company or other business entity. There are various purposes of an acquisition such as to achieve greater economy of scale, to increase market share, to have taxation advantage, to create synergies between operations of two entities or to form a vertical integration. Sometime it is also done for diversification or just to expand the business house`s footprint.

Now getting back to the question raised earlier, there could be various reasons. It may be the lack of right opportunities in the software sector. Companies like Tata Motors, Tata Steel, Hindalco could visualize the synergy because of the nature of the businesses they were in. However, in IT sector, getting that kind of synergy is relatively difficult as they generally tend to cater to different verticals which are again addressed differently by different companies. Therefore finding that one perfect fit is a challenge for the companies.

Having said that, it is not that the IT companies have not made any acquisition at all. Companies have acquired others but none has been as big as the ones seen in the other sectors. Let us see how the acquisitions or the lack of it have impacted the companies` revenues and profitability.

Revenue Growth Rate of Indian IT companies

Company FY2006 FY2007 FY2008 FY2009 FY2010 FY2011
Infosys 33.5% 45.9% 20.1% 30.0% 4.8% 20.9%
TCS 36.1% 40.9% 21.1% 23.0% 8.0% 24.3%
Wipro 29.9% 41.5% 33.2% 28.6% 5.9% 14.1%
HCL Technologies 36.4% 32.7% 24.6% 35.3% 18.6% 26.2%
Mindtree 82.1% 31.5% 25.3% 67.3% 4.7% 16.4%
3i Infotech 44.5% 56.8% 83.9% 89.6% 7.1% 5.0%
Tech Mahindra 31.4% 135.7% 28.6% 18.5% 3.6% 11.1%

Net Profit Growth Rate of Indian IT companies

Company FY2006 FY2007 FY2008 FY2009 FY2010 FY2011
Infosys 30.0% 56.9% 20.8% 28.5% 4.6% 9.1%
TCS 50.1% 42.7% 18.8% 4.6% 33.2% 29.5%
Wipro 27.0% 42.3% 11.6% 18.8% 18.7% 14.3%
HCL Technologies 11.6% 90.9% -15.8% 18.8% -4.6% 29.9%
Mindtree 221.1% 66.1% 14.7% -49.4% 310.8% -52.7%
3i Infotech 79.6% 94.3% 80.0% 43.0% 4.1% -3.2%
Tech Mahindra 129.9% -62.8% 276.6% 207.5% -31.0% -8.0%

As seen above, the top three companies Infosys, TCS and Wipro witnessed consistent growth in their revenues as well as net profits. And they have done this with very small or no acquisitions at all. However, other firms though registered consistent growth at the topline level; they failed to see similar movements at the net level. The one important reason for this is while top three firms grew mostly organically, while other firms did several acquisitions for getting those growth numbers. This may suggest that acquisitions do not fetch good results at least for the IT companies. If we delve deeper we see this has actually been the case for some of the companies.

In 2009, Tech Mahindra acquired the operations of erstwhile Satyam. The company had stated that it would look to merge the operations with itself at some point of time. However, there is still no clarity with regards to the merger details or timeline due to various regulatory roadblocks. As a result, performance of Tech Mahindra suffered as well.

Another example, 3i Infotech had done various acquisitions in Banking, Financial Services and Insurance (BFSI) space such as J&B Software in November 2007, Regulus Group in May 2008 and JP Morgan Chase`s retail check processing division in June 2009. The company had to incur restructuring costs towards the integration of these units to form a Global Billing & Payments unit. Interestingly these payments ended up as a bad investment for the company. It increased interest burden of the company and adversely impacted company`s cash-flows and. What is more, the company had to sell these units due to lower-than-expected performance and bleak future prospects of the same.

On the other hand, companies like TCS and Infosys have not gone all out to acquire operations of others. As a matter of fact, in light of the above, we can definitely congratulate the high quality management of the top firms for managing the company`s cash well and not squandering away the money in meaningless acquisitions. While many experts have criticized Infosys for not being aggressive because of not pursuing acquisitions very actively. However, the management of the company believes that they are not in the business of buying revenues. Hence, they always refrained from high priced or misfit acquisitions. For those experts who find Infosys not very aggressive, we can say only this much that they need to look all the big campuses the company is setting up across the country as well as outside the country, that too ahead of time. Being aggressive does not mean only acquisitions.

All this does not mean that these companies do not have any acquisition strategy or they are averse of acquisitions. However, they have set stringent criteria which they feel can help create synergy and better value for the shareholders. For example, Wipro has recently acquired the IT related Oil & Gas business of Science Applications International Corp (SAIC). This acquisition is very strategic to the company. It would enhance Wipro`s domain capabilities in the upstream area and make it an end-to-end service provider in the Oil & Gas space. Looking at the emerging opportunities in the healthcare space, Infosys is eyeing to buy Thomson Reuters Corp. (TRI)`s health-care business and is the frontrunner for the same. These companies are just waiting for the right opportunities at the right valuation. Which we believe is the right strategy.

To conclude, just because you have the cash balance does not mean that you acquire anything and everything. Particularly in case of a company where the wealth of many is at stake. After all it is shareholder`s wealth put under the faith of the management. Therefore the management is obliged to ensure the best use of the resources entrusted to them. In that regards, we appreciate IT major for not destroying the shareholder`s wealth in making meaningless acquisitions. Investors too must keep this in their minds the next time they read an acquisition related story. Delving deeper may throw out the fact that the acquisition is really not worth the effort or the money that it demands.

Courtesy: Equitymaster

By continuing to use the site, you agree to the use of cookies. You can find out more by clicking this link