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Software Co.ís: Time to go shopping? - Views on News from Equitymaster
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  • Mar 7, 2001

    Software Co.ís: Time to go shopping?

    With global tech valuations melting, is it the right time to buy for Indian software giants? But first let us answer the question why in the first place should companies like Infy and Wipro go for acquisitions?

    The answer to this lies in two reasons primarily. Firstly, to move up the value chain and secondly to increase the client base. By acquiring US based companies the Indian companies would be looking to add expertise that does not exist in house or to enhance the expertise. Also, these companies (the US based) would have an existing client base. The Indian companies would be hoping to convert on these accounts. A precedent is the merger between BFL and Mphasis. After the merger the loss making BFL, that is now Mphasis BFL, is doing a sure and steady turnaround.

    The top rung software companies Infy, Wipro, HCL Technologies would like to move up the software value chain by adding e-consulting to their business portfolio. The strategic advantages are that not only will the companies command higher operating margins but they will also be able to provide end to end solutions. There is a visible effort on the part of these companies to shed the image of being merely job workers. Therefore, e-consulting firms like Scient, Sapient and Keane could be top picks for the Indian companies. The second type of companies that Indian acquirers could be eyeing would be proprietary technology companies.

    The acquirers No of ADRs (m) 52 Week high (US$) Mkt Cap at 52 week high (US$ m) Current price (US$) Current market cap (US$ m) % Loss in Mkt cap
    Infosys 132 375 49,616 73 9,568 81%
    Wipro 232 68 15,905 47 10,806 32%
    The targets
    Scient 74 134 9,920 3 194 98%
    Keane 69 30 2,081 15 1,032 50%
    Sapient 121 75 9,042 11 1,365 85%
    Viant 48 45 2,163 3 144 93%

    The hurdle to this route of inorganic growth for the Indian companies was the ceiling of US$ 10 m or ten times export earnings (whichever is lower) for acquisitions abroad. The finance minister has increased this limit to US$ 100 m or ten times the export earnings (whichever is higher). With the cap now being removed the Indian companies can acquire companies that fit their strategy. Another piece of change in the legislation, which has extended the tax exemption under 10A/10B to software companies even if there is a change in the management, will help fuel local M&A (merger and acquisitions) activities that were previously not so convenient. Earlier any change in ownership would immediately have brought the companies under the tax net.

    Exports as a % total revenues FY01E (US$ m) Exports (US$ m) 10 times export figure (US$ m)
    Wipro 48% 689 331 3,308
    Infosys 99% 379 376 3,757
    Satyam 98% 240 235 2,355
    Hughes 100% 43 43 427
    Visualsoft 100% 29 29 292

    In its vision 4 by 4 (Size of US $ 4 bn by 2004) Wipro has targeted inorganic growth (growth by acquisitions) of the size of US$ 1.7 bn. To maintain the splendid growth rates the companies have shown in the past the inorganic route is not an option but an eventuality. With the government doing its part, now its time for the companies to make the next move.

    More critical than these facts is the point that the time is perhaps one of the best to buy till at least a few days ago. The valuations at NASDAQ are at their lowest. The Indian software companies are loaded with excess cash. The only way they utilize this currently is through investments. But with the companies operating at 30% plus operating margins, sizeable investments would prune the operating margins of the companies, as the returns are not so high.

    The time and environment seems just right for the Indian software majors to go shopping and the best part is they can start right here at home.



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