Making an acquisition is like falling in love; you can’t say when or how it will happen." No, this is not a dialogue from the usual sugar candy teenybopper romances churned out in regular frequency by Bollywood. Nor does the statement come from a corporate maverick or any Young Turk out to create an image for himself. It comes from one of the most revered names in India IT Inc.—N R Narayana Murthy, the chief mentor of software bellwether Infosys.

Murthy was addressing a press conference in Bangalore to announce Infy’s Rs 105.3 crore acquisition of Australia-based telecom software company, Expert Information Services.

That Murthy has officially attended a press conference on an Infy forum after a hiatus of more than a year is significant as it perhaps implies the importance Infosys is attaching to this acquisition. In fact, along with Infosys a host of other acquisitions made by Indian software companies in calendar year 2003 has revived hopes that after a dull 2002, inorganic growth through the M&A route is again becoming fashionable for the Indian software industry. Of course, there is the ‘other side’. The flip side being that, proponents feel, going by the acquisitions made this year, it would be premature to call M&A as a reviving trend.

"Anyway, even though M&A activities have seen a resurgence, it is unlikely to match the euphoria witnessed in 2001," says Parmod Bhalla, CMD, Blue Star Infotech, a strong proponent of this group.

Numbers might support Bhalla’s views, if the IT industry is taken in isolation. While in 2001, there were more than 30 acquisitions by Indian IT companies, the number barely crossed 20 in 2003. However, add the hyper-active BPO segment, the trend is clear. M&A is happening. And the figure well crosses over 40 and almost 50% of the acquisitions came from the BPO segment. Manish Modi, CEO, Datamatics Technologies Ltd., feels apart from the numbers, the quality of the deals are much better. "Some of the companies who made acquisitions in 2001, barely themselves survive today." Besides, another current trend unlike 2001 is that companies are looking at acquisition of an entire company, not merely an individual division. Plus, there are lot of activities happening in the BPO domain, which promises to play a significant role in the M&A market in future

Software Takes the Lead...
Though Infy’s acquisition of Expert was the most significant deal in 2003, it was by no means the only one of the year. In fact, its close competitor Wipro was also quite active on this front. While Wipro had already acquired the energy practice of Boston-based tech consultant American Management Systems Inc for $24 million in 2002, in May 2003 it bought NerveWire Inc, a financial consultant in the US for $19 million. Even before Wipro, the M&A activities were kick-started in the year by NIIT which acquired CognitiveArts, a leader in the US in designing experience-driven e-learning and knowledge solutions for large corporations. (See box)

That M&A activities are no longer restricted to only the biggies becomes clear from not only Tooltech’s acquisition of Tecodesign, from Bangalore-based Crane Software’s acquisition of AISN Software’s range of visualization software products, TableCurve 2D, Table Curve 3D and PeakFit (for a valuation of $1.8 million over three years) and SYSTAT, an award winning well-recognized statistical software product, from SPSS Science, subsidiary of SPSS Inc. for $ 2.3 million.

Other than Wipro, both NIIT and Cognizant carried off from where they had left behind in 2002. Even in such a dull year, NIIT made four acquisitions—Osprey Systems, custom development business of Click2learn and Data Executive International of the US and AD Solutions of Germany. On the other hand, Cognizant had acquired certain assets of United Healthcare of Ireland (70 people) for $3million as well as Silverline’s customer relationship with American Express Travel Related Services (200 people in India and 100 people in the US) for $10million.

However, it was not only Indian companies that were being acquired, software services players also picked up available Indian companies.

BPO Follows
The BPO area has also been particularly active on the M&A front. However, here the dynamics might be slightly different from the software services sector in that, while for software this is the second phase of acquisitions, for BPO this is just the beginning.

India’s BPO business is entering a new phase with several Indian companies acquiring small to medium size businesses in the US in 2003. Other than reflecting the growing ease with which Indian companies are acquiring businesses outside India, the new trend marks a milestone in the development of the Indian BPO sector, which is now growing faster than software services. Essar, Datamatics, Godrej and Intelenet, jointly owned by TCS and HDFC, form a growing list of Indian companies that have in the last few months acquired BPO businesses overseas in the footsteps of HCL Technologies which pioneered the process by buying a BPO company in Northern Ireland two years ago. The foreign acquisitions are a departure from the trend so far of foreign and Indian companies setting up operations in India to take advantage of the cheap and abundant supply of skilled workers in India.

Essar acquired a 40% stake in the Aegis Communications group, a $150 million listed company in which Deutsche Bank also has a 40% stake. Aegis has 11 centers across the US, with around 5000 seats.

Searching for Synergy
In fact, this synergistic problem poses the biggest challenge behind a successful acquisition. If Narayana Murthy compares making an acquisition to falling in love, the most crucial point is once the marriage happens if and when can it be consummated. In most cases, once this consummation does not happen, the relation can end in an acrimonious divorce. The worrying point behind these flurry of acquisitions in 2003 is that the situation has been more like a fairytale romance; once the deals are through, the current situation is more like a feel-good honeymoon. But next year can gradually see the conjugal disparity which might push the relation towards eventual separation.

Though an acquisition strategy makes a lot of sense on paper, the challenges and risks associated with large mergers are quite high. And the "make or break" characteristic in large-scale acquisitions is something which investors will have to bear in mind as consolidation in IT services gathers momentum.

While in Infy and Wipro’s case, the M&A strategies have been designed in line with their global ambitions to emerge as leaders in the consulting space, even the other acquisitions were targeted by the other companies at increasing their bottomlines. The SuperSolutions acquisition greatly strengthens i-flex, product portfolio and would help accelerate its penetration into the US market. i-flex can coverage SuperSolution’s top-tier American clients such as Harley Davidson Financial Services Inc, Mitsubishi Motors Credit and Hyundai Motor Finance to increase its market short in US market. Asserts Rajesh Hukku, chairman and managing director of i-flex, "By opening up the consumer finance market segment for us, SuperSolutions will create another growth engine for the company. This is the first step in the execution of our inorganic growth strategy."

The acquisition of Tenet is expected to enhance Hughes’ focus in Japan, where the former has a strong presence. Tenet, with 95 employees, is focussed on providing solutions in areas of 3G, IP, broadband, telecom both wireline and wireless and emerging areas of mobile applications.

Manoranjan Mohapatra, executive vice president and chief operating officer, Hughes Software Systems, commenting on this acquisition, says "Hughes chose the inorganic path for developing deeper understanding of the Japanese market and enabling us with several key customer contacts. The Quintant acquisition provides iGate about Rs 68 crore in assets, including Rs 60 crore in cash, domain expertise in banking, insurance and financial verticals, the management team and proprietary process tools and frameworks, among others. iGate global chairman Sunil Wadhwani felt that the move would augment the company’s domain expertise and strengthen its presence in the financial services segment.

The acquisition of Infopulse, which has about 100 employees, will enable Cognizant to better serve customers in the Benelux region with additional local client partners, industry expertise and local language capability.

Says Kumar Mahadeva, chairman and CEO of Cognizant, "Customers in banking and financial services have been among the first European companies to adopt a large-scale offshore strategy, and Infopulse helps Cognizant strengthen its position in this vertical." According to N K Patni, chairman and CEO of Patni, the acquisition of Reference "will bring together the expertise of The Reference with Patni’s ability to take the costs out." While GE and AIG had come to India for "horizontals", Patni was keen to exhibit its "verticals" skills. "The acquisition is aimed at consolidating Patni’s vertical skills" he says.

Tooltech director Atul Khanna believes that the move to acquire Tecodesign was part of the company’s vision to establish an expansive R&D base across Europe. "Acquisition of Tecodesign is a significant step forward towards realizing my dream of building a knowledge-corridor between the two," Khanna says.

Finding a Cool Niche
Going for global acquisitions can be a safety measure even during times when the going gets much tougher. While the 2003 acquisitions could be attributed to more optimistic sentiments in the market, the acquisition spree by Wipro, Cognizant and NIIT in 2002 proves this point. The policy to beat depression blues for smart IT companies, especially when big-ticket buyouts are elusive and there is tremendous pressure on the toplines, seems to be to go for "niche" acquisitions. Niche buys usually refer to acquisition of the assets of a customer or of a competitor. In some ways all these three companies have deftly dealt this card to beat lack of opportunities for inorganic growth. Though such moves are seen as highly opportunistic and unplanned, it at least shows the way the industry needs to move when the Big Bang deals are not forthcoming.

While acquisitions of customer assets are common in the US among large players such as IBM Global Services, EDS and CSC, it was the first time that companies such as Wipro and Cognizant that leveraged the offshore model did it in 2002 and continued in 2003.

Cognizant was one of the first companies, which set the trend by acquiring the assets of United Healthcare Ireland Group, a subsidiary of United Health Group. The move helped Cognizant start its near-shore software development center in Ireland and cater to clients in Europe. The strategy behind the acquisition—Cognizant will have a global footprint and also re-in force its multi-cultural identity. Cognizant is a US-based company headquartered out of New Jersey and operates out of development centers in India.

Almost immediately, Wipro announced that it had struck a deal to acquire the resources of Ericsson’s India R&D centers in Bangalore, Hyderabad and Delhi. The strategy behind the move—Wipro will be able to deepen its numero uno status in R&D outsourcing and also at the same time expand the number of its development centers. In both cases Ericsson and United Healthcare were customers of Wipro and Cognizant and they also netted 70 and 250 highly skilled software personnel respectively in the bargain.

While Indian software companies have not yet made the much promised acquisitions of consultancy firms or boutique consultancies, acquisitions like these, opportunistic and not replicable as a business model, does indicate the novelty with which acquisitions are done. Both acquisitions also indicate the global footprint that Cognizant and Wipro are charting out for themselves and reinforces the global delivery model and industry practices that they are establishing. Moves such as these also ensure that companies like Wipro and Cognizant are also able to cross sell more from their bouquet of software services to the clients that such acquisitions bring with them. In a depressed market, where billing prices increases are out of question and bulk discounts are in and the only way to ensure growth is through volumes, novel acquisitions and these go a long way in helping Indian software companies boost their top-lines as well as get more customers in.

Is the Hoopla Premature?
However, all the deals signed in 2003 might not suggest a trend in the software services or even in BPOs. This becomes evident from the Infosys example. The company sifted through 135 candidates over the past four-and-half years to find the right match. Though the company has been sitting on $470 million in cash and equivalents (including investments in liquid mutual units) in its balance-sheet, less than 5% of it is to be used for the acquisition. Finding the ‘right fit’ and financial prudence will continue to dictate the future acquisition strategy of most companies including Infosys.

Second, it cannot be said that competitive pressures were at play driving Infosys to make this deal. Wipro, its closest competitor, had announced four acquisitions—two each at home and abroad over the past 12-15 months. The last deal by Wipro involving Nervewire Inc was put through in April. Moreover, the size of the Infosys deal at $22.9 million (relative to $18.7 million Wipro-Nervewire deal or $11.5 million of i-flex solutions) is fairly small. This may hardly change the competitive dynamics for frontline companies such as Satyam Computers and HCL Technologies to press the panic button on the strategic front. The only signal that Infosys has sent out is that it will not be averse to acquisitions when the company offering the right match at the right price comes along. The same is again true of most software and BPO companies. For every deal in both software and BPO there has to be a willing buyer and a seller and in this case the valuations of the acquisitions are attractive and low. For US based small to medium companies it is an opportunity to exit, as margins are squeezed and there is no "light at the end of the tunnel". Indian companies, on the other hand can bring back a part of the operations to India, make a 50% saving on cost of those operations and thus improve profitability.

However, especially in the BPO sector, there is a need for big corporates to be behind the acquisitions as BPO is a capital intensive business. Besides, customers who are shifting key operations need to be satisfied both about the financial strength of the supplier and also his ability to offer proper business processes. So, along with acquiring a ready revenue stream and customers, the new BPO player is also securing the business processes that the BPO operation has picked up by doing the client’s work. The numerous pros and cons make one thing clear: though an acquisition strategy makes a lot of sense on paper, the challenges and risks associated with large mergers are high. And the "make or break" characteristic is something which investors will have to bear in mind as consolidation in IT services and BPO gathers pace. And since no foolproof formula has been evolved for managing the integration, a cautious approach to M&A will remain the norm.

Rajnesh De in Mumbai

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