Mid-size IT companies on course for consolidation

Monday, 26 April 2010, 15:53 IST
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Bangalore: When MindTree a mid-size information technology (IT) Services Company acquired Aztecsoft in May 2008, many thought this would indicate a trend in Indian IT, in terms of consolidation of small and mid-sized firms to allow them to viably compete with bigger ones. The global recession, however, played spoilsport. It affected the appetite of prospective buyers due to sluggish demand for IT services and products. More, the acquisition targets were also conscious that they would get a raw deal if they put themselves up for sale, as reported by Bibhu Ranjan Mishra of Business Standard. The jinx, it appears, has broken. Consider these examples. MphasiS, a subsidiary of HP in India, recently acquiring Fortify Infrastructure Services, a provider of offshore based Remote IT Operations and Management (ROM) services with a sizeable presence in Pune. In February this year, network security and management company Blue Coat Systems acquired 100 per cent stake in S7 Software Solutions, a Bangalore-based company started about six years earlier by a team of seven software professionals. Going by industry sources and analysts, the next one year is expected to see a spate of mergers and acquisitions (M&A) in IT and ITeS (IT-enabled services) in India. "We are seeing a lot of acquisition activity happening all over the place. There are large numbers of active discussions happening right now. Whether these will close this quarter or next quarter depends on a lot of other things. But, consolidation has begun in this market place," says Amit Singh, Executive Director and Head of Technology Practice of investment banking firm Avendus Capital. Post the recession, with the job market picking up, smaller and mid-sized companies are finding it challenging to attract talent. Besides, many in their early phase of growth are finding it difficult to attract investments, a challenge to their long-term sustainability. Former Wipro COO A L Rao, now providing mentorship to a host of technology start-ups post his retirement from the company almost a year earlier, says attracting the right kind of talents has become a real challenge for smaller companies. "There is a real crunch of people with 3-6 years of experience, as companies in their early stage of growth cannot really survive by banking upon freshers. Only financially sound companies are able to attract them." According to Venture Intelligence, a research service focused on Private Equity and M&A activity, M&A transactions worth $155 million were concluded among small and medium enterprises during the first two months of 2010. This is an increase of 66 per cent over the corresponding period last year. M&A in IT services is bound to increase. More, there is not much headroom for growth for small IT firms, who lack the ability in establishing themselves in niche areas like business intelligence, healthcare, remote infrastructure management, financial sector or procurement outsourcing. Because of their nature of business, these smaller players who lack innovations are finding it difficult to attract investment and scale up further. "VCs used to invest in IT services substantially, may be two years back. But, that has come down quite substantially in the last two years. So, an SME getting venture or equity financing is no longer easy. And, if you are a generalist, things are far more difficult," opines Arun Natarajan, Founder and CEO of Venture Intelligence. But if you are a specialist, providing services in areas like healthcare or banking, then that kind of specialisation has a far better chance of attracting venture capitalists, he adds. Agrees, Sudhir Sethi, founder-chairman and MD of IDG Ventures India, "Many of the companies we have seen are lacking in innovation and lacking in services. This is the reason why they are not able to attract investment to scale up." According to data from Venture Intelligence, only three "generic" IT services companies (i.e. which focus on more than 1/2 verticals) Trianz, - Ontrack Systems and Infinite Computer Solutions - have raised VC funding, worth $27 million, since 2004. During the same period, there were a total of 38 VC investments into specialist IT services companies who raised $259 million. Analysts opine that generic IT service companies and smaller companies would find the going quite tough. Many of the generic IT services providers will try to get into offering specialist services, to establish themselves in a niche segment. Those who failed to do so in terms of achieving sustainable growth and profitability will eventually be acquired by bigger players or get merged with similar or bigger players.