Leverage and Opportunity for India Based Firms
While the Mergers & Acquisitions market is slow in the U.S., it seems to be on the rise for Indian companies doing business in the U.S. Private equity, including venture capital, has flowed freely into India-based IT firms, citing stability of the Indian political and financial system, an improved legal and regulatory structure, an efficient system of organization and distribution, and a blue-chip international clientele. Many India-based firms have raised capital through ADRs or GDRs. Many of these IT firms have adopted a strategy of expansion. This strategy allows for market growth of the buyer through acquisition, and leverages complementary strengths of the target firm, including sales, marketing, products and competitive positioning.
Socio-Political & Economic Initiatives in India
A combination of factors and initiatives over the last decade have built favorable conditions and an enabling infrastructure that is conducive to such expansion strategies by Indian firms. Government- backed reforms and business leaders' entrepreneurial zeal has rendered the information technology industry in India one of the most competitive in the world, just by being extremely efficient, cost effective, and high-quality. While U.S.-based companies went on an acquisition spree during the last few years, paid multiple times higher price for each acquisition, and are now teetering with operational challenges and financial drain, India-based companies have been expanding and prospering.
Opportunistic Move
HCL's latest acquisition of Gulf Computers is a good example and points towards the government, education, and healthcare industries as attractive sectors. Infused with billions in federal funding, this sector is worth consideration for India-based firms that are looking to increase their market share by leveraging the target firm's sales and marketing infrastructure. India-based firms have the cost basis as significant leverage. The expansion strategy through acquisitions makes more sense in an environment where an acquirer has an under-utilized capacity or has the capability to quickly expand the supporting backend infrastructure and the labor pool in the face of expanded market share and increased demand and aggressive growth. Government, education, and healthcare sectors—virgin territory for India based firms—are being considered as an alternative to continue robust revenue growth, utilize the consulting capacity, and cut the associated overhead cost.
Industry Dynamics & Growth Options
Federal and State agencies mandate bidding through contracting vehicles. It can take anywhere from one to three years to get onto those vehicles. While awarding these long-term contracts, these agencies give consideration to past government contracting experience. More recently, agencies have asked for packaged software skills and outsourcing capabilities in their request for proposals, something not widely offered by existing IT vendors catering to this sector. An acquisition-based strategy can give the buyer immediate access to seller's contracting vehicles and a history of experience with well-funded agencies. IT consulting firms who don't have a significant presence in this sector—whether based out of India such as Wipro or based in the US such as Cap Gemini E&Y—have two options to consider: organic growth or acquisitions. The first option is to penetrate and grow in this sector organically at the expense of time, without radically replacing the shortfall in revenues. The other option is to acquire companies already active in the sector and leverage the seller's investment of years of time and effort.
Long-Term Vision
Indian multinationals have been at the forefront of a strategic expansion strategy through well-placed joint ventures and acquisitions. The acquisitions have allowed these firms to utilize excess capacity and gain an early lead on competitors in the government marketplace by garnering a number of commercial clients. An earn-out option to the existing principals of sell-side firms has helped create an environment of mutual cooperation and continuity and greater rewards with minimum risk, enabling a win-win situation for all firms.
Small and Mid-Size Government Contractors
There are several firms within the $20 to $250 million-revenue range that are faced with limited expansion options and are considering an exit strategy for any number of reasons. Some of these companies were founded by baby boomers on the verge of retirement; some are short on the type of skills and IT services being demanded by the agencies and have exhausted resources to expand; some are in search for the right alignment partner; some are feeling the mounting competitive pressure among the larger consolidated firms; while other promoters are looking for a different type of challenge.
The valuations of these firms are at their peak, but for a limited time only. While the IPO market is almost shut to commercial sector firms, a record number of IT consulting firms catering to the government sector have gone public in the last few months. These are the times when some of the smaller firms should be looking at laying out an exit plan either by becoming part of a bigger organization or by pursuing a roll-up strategy for growth. Either way, the window of opportunity is small and firms that have the foresight and strength to execute will survive the current consolidation.
Time is of the Essence
Time is of essence, for firms both on the buying and selling sides. Once the government sector is penetrated by foreign-based IT firms-including firms based out of India-it will lead to cost-cutting and cut-throat competition. Armed with SEI/CMM level 5 quality consultants, these and other cost efficient firms are sure to wipe out those that looked to the government sector as a market where there was room for everyone to co-exist and grow organically. Once the agencies move to project-based contracts instead of body-shop based ones, many small-size firms will suffer. And once the industry alignment and consolidation are in shape, many mid-size firms will have to defend the mounting competitive pressure from the larger and more skilled consolidated firms.
Ajay Srivastava is a Director with Newbury Piret & Co., an investment banking and venture firm with interests in M&A, private equity, joint ventures, and advisory services. Prior to Newbury, Srivastava held several senior positions at KPMG and PWC. Srivastava holds an MS and an MBA from the Smith Business School at UMD, College Park and is a CPA. He can be reached at ajay@newburypiret.com
