3Cs driving M&A deals by Indian Companies in IT Consulting & Services

The Year 2000 was a real turning point in evolution of  Indian IT industry on a global scale. By offering the world a fix for Y2K Millennium bug, Indian IT services companies established their credentials beyond  being just “body shops”. Since then, Indian IT services market has continued to grow their business all across the globe. Their contribution was  less than 1.5% of India’s GDP in 2000 and is now over 7.5% of India’s GDP and it has gained  over 55% market share in global services outsourcing. Covid-19 pandemic can probably be one more of such decennial opportunity which can trigger another growth wave for the industry.

The pandemic has forced enterprises in finding an optimal way of continuing to do business; and going digital seems to be the only option forcing the enterprises to a digital transformation. Such largescale digital transformation would require better software and a workforce to build, implement and maintain them. Enterprises have option of developing internal capabilities to execute digital transformation, however IT outsourcing is considered a proven and better strategy. IT outsourcing helps enterprises focus on customer and innovation while transferring the responsibility of technology to better equipped IT professionals and consultants. Further pace of change of technologies is so rapid that it’s not feasible for most enterprises to build internal capabilities.

Work from Home (WFH), a concept which was hardly in practice earlier has now become the new norm. There are two important changes which WFH has brought – first, after successfully witnessing productive work from employees working from home, enterprises are more confident about efficacy of outsourcing. Earlier, enterprises which were only outsourcing their non-critical work are now more open to outsourcing even critical aspects of their business, including product development. Secondly WFH has paved way for a global workforce and opened talent pools for the resource-starved IT industry.  Here too, Indian IT services are better placed in leveraging these talent pools.

The impact is quite visible from recent contract wins by tier-1 IT services firms from India. Infosys recently won $3.2 billion contract in December from Daimler for their massive infrastructure overhaul and migration to hybrid cloud. In July, they got similar contract of $1.5bn from Vanguard. Wipro bagged over 5 large contracts post-Covid from Olympus, Thoughtspot, Fortum, Verifone and Metro AG. TCS has also announced large contracts from Deutsche Bank and Prudential Financial this November. This is true for other small to mid IT services firms as well, like Mindtree. Such mega deals are now being closed over the calls, without any physical meetings clearly emphasizing the confidence on Indian IT services ecosystem.

This demand expansion has also, on the other hand, put a pressure on Indian IT services firms. Talent and skilled workforce are the feedstock required by these companies to sustain growth. Further, constantly changing technology requires them to upskill and build the relevant capabilities. And hence many IT services companies have focused on inorganic growth last few years and the three Cs driving the M&A activity are – Cloud, Capabilities and Clients.

Cloud, Capabilities and Clients are the three Cs driving M&A activity

According to Gartner, worldwide IT spend is expected to be around $3.8 billion in 2021. There is not only a significant jump in budget allocation on IT by many primary sectors like healthcare and education but also, proportion of IT spending that is being allocated to cloud is expected to accelerate. Organizations are increasingly using cloud services for new digital business initiatives or to replace existing systems, so it is quite evident that cloud is getting a preference over traditional IT solutions. Large IT services companies, have lately, acquired implementation partners and vendors of large cloud vendors like Salesforce, Servicenow, Oracle, AWS, MS Azure and others. The driver has been to acquire talent and build cloud capabilities. Similarly, they have acquired vendors providing niche technology services like analytics, IOT, RPA, digital manufacturing, AR/VR, blockchain, etc with the motive to augment capabilities and service offerings. Also, some acquisitions were driven by need to acquire new clients, while few were driven by client requirement to offer combination of onshore, nearshore and offshore service offering.

In last three years, Indian IT services firms have done around 40 acquisitions. This includes 12 by Wipro group, 10 by Tech Mahindra and 8 by Infosys; and almost all driven by the 3Cs. Europe and US seem to be the hunting ground for these companies. Going forward, from the deal perspective, it is expected that number of deals will continue as Indian companies continue exploring inorganic way for ramping revenue and penetrating new markets while they are well supported by the cash surplus and rich public market valuations. Top Indian IT companies are being traded at a premium valuation of c.4x revenue multiple as compared to other global companies which are at around 2x revenue multiple, which provides a good currency to pay premium for acquisitions

We at IMAP India have a strong conviction that Indian IT services would continue leveraging their position in the outsourcing market and would move ahead in the value chain through inorganic way.