Michael Parent
IT Services M&A Requires Strong Mutual Interest in Addition to Complementary Business Models
Over the holiday weekend, The Hindustan Times of India reported that Wipro was “likely” to place a bid for the Paris-based global consulting firm Capgemini. I stand ready to be corrected if this deal comes to fruition or if a bid is actually made. But in reading the coverage from India and France, I felt like I had watched this play before: back in December 2001 the Times of India announced that Wipro had “decided to acquire” the US-based telecom consulting firm, The Management Network Group (NasdaqGM: TMNG). At that time, other than the Indian press, no one seemed to know anything about this deal, and the silence which followed the “announcement,” was affirming — there was no real deal here. TMNG remains publicly-traded and independent today.
We are a long way from 2001, and the ability of offshore IT services firms to execute on cross-border M&A transactions is assured. One need only look at Wipro’s $600 million acquisition of Infocrossing, Caritor’s combination with Keane , and Patni’s acquisition of Taratec for proof, if any is needed. But I have serious doubts about the viability and reality of a Wipro/Capgemini deal. To begin with, Wipro is going to need to muster considerable cash for this transaction. As of September 30, 2007, Wipro had $1.1 billion in cash and ST Investments, well short of what would likely be demanded by Capgemini shareholders in a transaction for a company with a market cap of about $9 billion last week — even after taking in to account Cap’s $660 million in net cash. There is no arguing that Wipro’s market cap is almost double that of Cap and that a stock swap is theoretically possible. But this gets to the crux of my thesis on why this deal is nonsensical. The offshore IT services vendors, including Wipro, have achieved incredible stock market valuations through a rare combination of high growth, high profitability, and recurring revenue models with great forward cash flow visibility. A combination with a player the size of Cap would completely change Wipro’s business model, and move it away from its traditional peers. These are possible reasons why the Infosys bid for Capgemini rumored earlier this year never materialized.
Cap is a very large fish for Wipro to swallow. While it would move Wipro up the value chain into higher-end business consulting and move Wipro physically closer to its clients, it would also drive down Wipro’s margins, slow its growth rate, pose cross-cultural personnel turnover risks, and ultimately undermine its stock market valuations. It would face daunting French regulatory scrutiny, not to mention potential government intervention if French public reaction is loud. It certainly could not be executed in a hostile environment, a point underscored by Philippe Grangeon, a member of Capgemini’s executive committee, in his quote last Monday: “…we affirm our conviction that any hostile takeover in this sector is doomed to fail.”
Setting aside growth rates, margins, and business models, Grangeon’s comment is true for almost all IT services M&A transactions. It is hard to imagine a hostile acquisition of a business in which employee talent and time are the primary operating assets. Even in the friendliest IT services M&A transactions, there is usually hand-wringing and negotiating about the retention of staff at all levels, which could never be the case in an unwelcome transaction. As a multinational organization, Cap understands this. It has executed on many successful international transactions which otherwise would have failed in a hostile setting. In 2007, Cap made a $1.25 billion bet that it could favorably navigate multi-shore waters again through its friendly acquisition of Kanbay International. A similarly friendly approach is underway between Keane and Caritor, which are forging a transformative combination that would have looked very unlikely just a few years ago.
If Capgemini and Wipro had the strongest mutual desire to effect such a combination of their businesses, it would still be a very complex undertaking. That mutual desire seems not to be the case based on Capgemini’s initial negative reactions to the rumors, but the Indian press loves this sort of speculation. If I were standing in Wipro’s shoes, I would take a serious pause to contemplate why I would want to radically jettison my business model and leave my peer group, to join the ranks of the slow growth IT consulting behemoths. I don’t see the value creation in that. But I stand ready to be corrected…
