Over the next few years, investments in IT-services and Business Process Outsourcing (BPO) companies will continue to dominate Private Equity (PE) deals globally. Either directly or indirectly through its portfolio companies, PE firms will widen the geographical scope of their search for investment in this sector. At the same time, in India, the leader in the IT and BPO space, such an investment is likely to be at an all-time high.
As per Grant Thornton, in July and Aug. ’07 alone, telecom-, IT- and BPO-related investments accounted for over 63 percent of the total PE investments in India. Of these, approximately 13 percent or $0.54 billion represented investments in the IT and BPO sector. In fact, there has been a steady increase in the size and complexity of some of these investments — for example, the $29 billion leveraged buyout of First Data by KKR, and a similar transaction in GMAC by Cerberus. Such M&A and PE deals are not restricted to India, or to the U.S.A, alone. Recently, Fuji Xerox Australia bought the BPO division of KAZ, the IT-services arm of Telstra for an undisclosed but large sum. Similar deals have taken place in Europe (e.g., investment made by Oakhill in Vertex).
SWITCH: Leading the Way
While it is always difficult to predict specifics, we would closely monitor the SWITCH (Satyam, Wipro, Infosys, TCS, Cognizant and HCL) companies in India. As per Gartner, SWITCH companies accounted for 1.9 percent of the $672 billion IT-services market in 2006 as compared to 0.5 percent of the $554 billion market in 2001.
The average growth rate of these companies was 42.4 percent in 2006, which compares very well with that of IBM (4.3 percent). In terms of market share, too, the Indian companies are steadily climbing. IBM leads the IT-services market with a 7.2 percent share, followed by EDS (3.2 percent share), Fujitsu (2.7 percent), Accenture (2.6 percent) and HP (2.4 percent). SWITCH companies are likely to climb from current rankings: TCS with a 0.6 percent share (ranked 35th in 2007), Infosys with 0.4 percent share (ranked 43rd) and Wipro (ranked 49th) with a 0.3 percent share, according to Gartner.
With $38 billion worth of deals coming up for renewal in North America over the next two years in multiple infrastructure-management contracts, these market shares could see some changes as the SWITCH companies increasingly get included in the bidding process.
Rising Indian rupee and wage inflation will see several small and mid-sized providers in India being acquired by companies backed by PE funds
To offset the dollar depreciation and be closer to the European market, large Indian companies will invest in provider companies with specific domain knowledge in Europe
PE companies’ proportion of investment is likely to be more in India than in other outsourcing provider destinations such as China, Latin America or East Europe.
In addition to the SWITCH companies, we need to watch out for niche focused IT-services players such as Hexaware, KPIT and Infotech Enterprises. These companies have leveraged specific niches to create attractive business propositions.
On the BPO side, companies such as Genpact and IBM Daksh have similar value propositions to offer their customers.
PE players and their portfolio companies will look for niche opportunities in the knowledge-process outsourcing space — legal processes, analytics, research, financial modeling, etc. Moreover, industries such as media, advertising and education that have until now outsourced very little will outsource IT and BPO solutions, presenting an opportunity for investment. For example, Quattro Risk Management incubated by Quatrro, which itself is funded by Olympus Capital.
The challenge of operating captives and the benefits accrued by sharing services with clients broadly will result in captives converting into third-party providers. Some of these conversions will be through PE players while others will be through M&As. MNCs such as Aviva, Dell, HP, ABN, Citigroup and Standard Chartered are likely to spin off their captives and unlock value using PE firms or other inorganic exit strategies. Some recent examples of captive carveouts have been E-serve being spun off by Citigroup with PE firms as potential acquirers, and the Philips captive BPO in the Czech Republic getting acquired by Infosys BPO.
SWITCH companies and other mid-cap IT and BPO firms in India have sufficient liquidity or access to sufficient PE funds, to look for global acquisition targets. They will take the acquisition route to enter new markets and new segments, and be closer to their customers — for example, the potential buyout of Sage and Atos Origin by Infosys. Targets for acquisition are also likely to be small and medium companies that may not be able to deal effectively with the appreciating rupee and the supply side challenges.
Other recent examples are Wipro acquiring Infocrossing to establish a strong presence in the infrastructure business, and acquisitions made by 3iInfotech to enter new geographies in Kazakhstan, Middle East and Malaysia.
Moreover, Accenture, IBM, HP, EDS, Fujitsu and Oracle on the IT side, and Euronet, IBM, EDS and First Data on the BPO side will continue to expand their presence in India. They will look at PE-funded smaller firms as their targets.
There will likely be an increase in capital-market activities related to third-party IT and BPO companies in the light of the high valuations of the recently concluded IPOs in the Indian and the European and American markets. Some of the investments made in between 2000 and 2005 will slowly begin to see exits through IPOs, stake sales and M&As.
The market will remain very active in this dynamic sector in India and globally. Expect many new developments in the next few years, including continued PE interest and growth among well-managed and well-funded players.
Sunish has extensive experience as an investor, board member and strategic advisor to companies in the IT and BPO industry. He has also worked at McKinsey, where he co-authored the NASSCOM-McKinsey reports. Kaushik works with General Atlantic’s portfolio companies to identify opportunities for process improvement, re-engineering and globalization.