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Acquisitions: Earn out deals rising

By Sanjay Krishnan in Mumbai
Last updated on: April 22, 2005 17:37 IST
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It is an acquisition trend that is quickly catching on. Making it popular in India have been a clutch of software companies.

The trend? 'Earn-out' deals or the earn-out opportunity an acquisition holds for the acquirer. Earn out are also referred to as performance-linked payouts.

In the last two quarters, a handful of Indian companies have paid close to $140 million in acquiring companies abroad. These acquisitions have happened for all the logical reasons that they normally happen -- acquisition to ramp up size, acquisition for geographical expansion, acquisition to get into newer verticals -- but what is not normal in the Indian context has been the way these new deals have been structured.

Earlier acquisition announcements have always been outright. Money was paid and the company was acquired. Period.

But the spate of acquisition announcements in the last few months has the common thread of earn out clauses inserted; in some cases as high as the guaranteed upfront payment. One of the reasons why such a trend is emerging in the way the deal is being structured is because the deal sizes have gone up.

Traditionally, Indian IT companies have hoarded cash and not invested in inorganic growth save for a couple of exceptions. Historically conservative in using cash for acquisition-led growth opportunities Indian companies have shown the gumption, until now only to make very small boutique acquisitions with the value of such deals being less than $25 million.

Exceptions, of course, are Wipro acquiring BPO company Spectramind for $108 million and TCS acquiring CMC.

Large players like Patni Computers, Cognizant Technology and Satyam Computers have in the past months acquired companies for over $25 million, "We are seeing a clear trend of aggressive buyouts in the market," according to the director of a NASDAQ-listed company operating in India.

Sample this -- Patni acquired Cymbal for $68 million paid over a period of time, Cognizant acquired Fathom for $35 million (including a $16 million earn out), and Satyam has announced its intent to acquire Britain's Citisoft in a phased manner for a guaranteed $39 million (including a $16 million earn out).

"With some of the earlier acquisitions by Indian companies seen as not having worked out well, companies are getting doubly careful with the way deals are structured to ensure continuity in the senior management of the acquired company and realizing the true value of the acquired entity in terms of revenue and profitability," an analyst with a multinational data tracking firm points out.

This has led to companies looking at signing up for significant performance linked payouts, in some cases as high as the guaranteed payout itself.

Patni's Cymbal acquisition is structured in such a way that Cymbal would be paid $35 million on the date of acquisition and the balance of $33 million would be paid over three years based on meeting projected revenue and profit targets.

Likewise, Cognizant's acquisition of Fathom is structured as $19 million payment in cash and stock upfront with a $16 million earn out, and Satyam's acquisition of Citisoft is structured as $23 million guaranteed cash payment (of which $10 million would be paid upfront) and $16 million as earn out.

Acquiring for entering newer verticals

For the first time we are witness to IT companies acquiring smaller companies to enter newer verticals. Hitherto, almost all acquisitions were done primarily to get into the consulting space, expand the geographic footprint or strengthen capabilities in existing verticals. Notable examples include Infosys-Expert Systems, TCS-CMC and Wipro-AMS energy division.

Cognizant, entered the telecommunications vertical through the Fathom acquisition. Patni which is seen to have deep capabilities in manufacturing and insurance, is banking on Cymbal for entering the telecommunications space. Even MphasiS, which is seen as a focused company in the financial services space, recently acquired Eldorado Computing to enter the healthcare space.
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Sanjay Krishnan in Mumbai