Indian IT firms take M&A route to tap top talent, boost capabilities

The buzzword for Indian IT service providers these days is M&A. The mergers and acquisitions are primarily intended to build capacities around Cloud computing, cybersecurity, and application transformation, as software service exporters scamper to meet client demand, particularly following the Covid-19 pandemic.

Most of these M&As are driven by an urge to strengthen their presence at the deal table, although absolute deal sizes are trending lower overall. As clients focus on end-to-end transformation solutions, the more capabilities that a system integrator can offer, the more it will be able to tap a larger share of the client’s business.

“When you have scale, you get invited to bigger parties. When you’re a particular size, you’re not invited,” SN Subrahmanyan, the chief executive and managing director of Larsen and Toubro, said recently, explaining why group companies Larsen and Toubro Infotech (LTI) and Mindtree announced merger plans earlier this month to form an entity with a combined revenue of about $3.5 billion.

The LTI-Mindtree merger, the largest in the Indian IT services ecosystem in recent history, is only the first such and M&As will increase markedly in the coming months as valuations plummet and the need for talent reaches unprecedented levels, analysts said.

Acquisitions are also certain to hit top gear in the coming years as demand for technologies like Industry 4.0 and Edge computing increases, they added.

No more conservative

Indian IT companies have always been known for their conservative approach to M&As, as opposed to global peers such as Accenture and Capgemini.

“Indian companies mostly acquire niche consulting skills around key technology areas when they look for acquisitions. In several cases, the acquisitions are part of a larger outsourcing deal that involves rebadging the customer’s IT staff,” said Hansa Iyengar, principal analyst at technology research firm Omdia.

However, in the past 5-6 years, the top IT services providers have taken a slightly different route to M&As. HCL Technologies, for instance, has chosen a product play, while Infosys has adopted a design and consulting approach. TCS, which is relatively acquisition shy, has preferred to build capabilities in-house, while Cognizant has been acquisition-heavy, she pointed out. “Indian vendors are historically cash-rich, and I expect to see M&As continue in the coming year as we expect spending to pick up towards the end of 2022 and early 2023,” Iyengar added. Wipro, one of the top five Indian IT service providers, has announced 12 acquisitions since Thierry Delaporte took over as CEO in July 2020.

“We will never do very small acquisitions, because in the services sector, it doesn’t make sense,” Wipro’s chief financial officer Jatin Dalal told ET recently. Analysts believe Wipro’s bullish approach to acquisitions – though much-needed – may end up hurting margins. “We believe acquisitions are necessary to plug the gaps in capabilities and expand into newer areas, but large acquisitions or too many acquisitions can drain margin profile, drag RoIC (Return on Invested Capital) and dilute earnings,” ICICI Securities said in a recent report. Wipro’s acquisition of London-based technology consultant Capco for $1.5 billion in 2020 and SAP consulting firm Rizing for $540 million earlier this year are seen as significant capacity builders for the company, though they were expensive.

TCS, India’s largest IT services provider by revenue, has largely turned to acquisitions to enter new markets. The acquisition of Germany’s Postbank in 2020 gave TCS a solid footing in the German retail banking market while bringing more than 1,500 employees into the organisation as part of an existing client deal.

“Vertical solution-wise, productwise, we have always done that (acquisitions) but the place where we have executed most is geographical market access…because the nuances are more well pronounced,” said TCS chief executive Rajesh Gopinathan. “Typically, we’ve entered new markets through an acquisition or a JV and then the JV folding in; that has continued to be our preferred one (M&A route).”

HCL Technologies, which said during its fourth-quarter results that it does not have major acquisition plans for FY23, has since reported two tuck-in ones. Similarly, Tech Mahindra - after committing over $955 million (around Rs 7,353 crore) to acquire 10 companies - has said that it would be less acquisitive in the new fiscal year.

“HCL and Tech Mahindra both have significant work to do in integrating their assets and, at best, we will only see small tuck-in acquisitions from them. However, other firms are clearly still in the market,” said Peter BendorSamuel, the chief executive of analyst and advisory firm Everest group.

The market for acquisitions remains robust and private equity firms will continue making efforts to acquire service assets as well, he said.

Meanwhile, global peers like Capgemini and Accenture are also expected to stride forward in M&As, Bendor-Samuel said. For IT service providers, acquisition of niche players could be a hit-and-miss affair depending on which way the market turns. In fiscal year 2019 (FY19) Indian tech majors reported a small jump in the number of acquisitions, led by a string of buyouts across digital capabilities. It was only in FY22 that these companies -- like the W12 acquisition by TCS and Wongdoody of Infosys -- started generating significant traction across their design and metaverse-related solutions, chiefly led by the digital transformation boom, said analysts.

On the block

Talent is a big driver for acquisitions, apart from Intellectual Property (IP), market and client access, analysts said. “The attitude towards acquisitions is now becoming two-fold – to add capability, and to bolster access to talent resources in light of the massive attrition (rate),” said Phil Fersht, chief executive of HfS Research.

For example, Wipro acquired Rizing to add significant strength to its onshore SAP consulting expertise and Infosys acquired Oddity to deepen its digital capabilities in Germany.

“In addition, the LTI-Mindtree decision to (finally) merge is very much driven by consolidating people-scale and becoming a viable competitor to the Tier 1 service providers,” Fersht said. In the ongoing fiscal year, service providers will focus on acquisitions that plug immediate gaps in “bread and butter” areas like ERP implementations and cloud deployments, as well as in sectors where talent is scarce, such as cybersecurity and hybrid cloud, Fersht added.

Industry-specific domains, such as healthcare analytics, fintech and antifraud, energy/sustainability technologies and supply chain, could also be on the radar for M&As. Cloud, cybersecurity and application transformation will be the key focus areas, while demand for technologies like Industry 4.0 and Edge computing is also expected to drive acquisitions going forward, said Harish Krishnakumar, senior market analyst, IT services, IDC India.

Acquisition of a captive delivery centre adds an average 1,000-2,000 employees, whereas the acquisition of a small technology-specific service provider usually adds between 50 and 500 employees to a company’s talent pool.

“Acquisition of service providers with strong capabilities in financial solutions will continue as BFSI (banking, financial services and insurance) is the largest revenue contributor for Indian tier-I IT service providers, along with verticals like manufacturing and telecom,” Krishnakumar said.

Close to home

Nearly all these acquisitions are of companies based in top client locations. They are rarely homegrown solution providers from the rich pool of product and software companies in the country. The acquisitions are in consulting and, particularly, they are picking up firms in the domestic markets in the US, UK, EU and Australia - all driven by acquiring talent. The acquisitions in engineering are also likewise driven by this motive,” said Bendor-Samuel of Everest group.

HCL Tech’s recent acquisition of Bengaluru-based Quest Informatics was an exception to this rule, but Quest has a global client base, which made it an attractive buy, analysts said.

“Indian SaaS (Software as a Service) firms will become more attractive to Indian service providers as valuations plummet. However, this will largely be where there are strong SaaS support businesses that can be easily ingested, as opposed to technology acquisitions,” said Fersht of HfS Research.

Since the work culture at service providers is widely different from product companies, IT firms are generally hesitant to acquire such companies, especially because retaining talent can become a pain point. Iyengar of Omdia believes that with acquisitions being largely skills-led, having an Indian employee base does not offer these providers any specific labour arbitrage benefits.

“Higher headcount does not translate into success and, moreover, labour arbitrage lost its sheen several years ago; the emphasis is on augmenting human resources with tools and automation to generate maximum revenue per employee,” she said.

Any acquisition, she added, would be fuelled by the solution stack, customer base, skill sets, and geographic reach that fill existing gaps or augment existing capabilities rather than where they are located or how many people are added.

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