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Cognizant in talks to buy Genpact

By BS Reporters in Bangalore/Mumbai/Delhi
September 20, 2010 09:27 IST
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Information technology services major Cognizant is at an advanced stage of negotiations to acquire Genpact, the business process outsourcing (BPO) giant.

Both are listed in the US, but have major delivery centres in India. Investment banking sources said it is still too early to say whether the talks would definitely lead to a deal, but negotiations have entered the final lap.

"We are focused on growth, and that is what our company's leadership is focused on," said N V Tyagarajan, Genpact's COO. A spokesperson for Cognizant said: "As a policy, we do not comment on speculation."

The sources said private equity (PE) players and GE are looking at a possible exit from Genpact. GE, for which Genpact was a captive unit, has around 9.1 per cent stake in the company, while PE firms General Atlantic and Oak Hill hold 41.7 per cent. Besides, Wells Fargo holds 5.71 per cent stake.

The total stake of these PE players, which constitutes around 121.98 million shares, would at the current closing price of Genpact on the NYSE be valued at over $2 billion. Banking sources put the acquisition size to be much higher.

If Cognizant is successful in acquiring Genpact (2009 revenues: $1.12 billion; market cap: $3.63 billion), it could change the ranking in the IT services sector. At the end of 2009, Cognizant's reported revenues were $3.27 billion and it expects revenues of $4.46 billion for 2010.

The combined entity would be over $5.58 billion, very close to India's second-largest IT services company, Infosys Technologies, which expects revenues of $5.81 billion for FY11.

The combined entity would surpass Infosys in headcount with 131,200 people, compared with Infosys' 114,822 as of June 30.

Highly-placed sources in rival organisations say if news of the talks were true, it would be a costly deal for Cognizant. "If it pays a premium of 25-30 per cent on the market value of Genpact, as is being speculated, it hardly makes sense at a time when offshore BPO is expected to be increasingly impacted due to political uncertainties in many developed nations," said one.

However, raising capital for this is certainly not difficult, bankers said. "Since both are listed in the US, they can use stock as currency. Besides, Cognizant is a zero-debt company; it can easily raise money from the market," said a banker on condition of anonymity. Cognizant has $1.65 billion in cash. Genpact has $352 million in cash and debt of $40 million.

TECH-TONIC SHIFT

Company 

Price
Sep 15

FY EPS

FY P/E

2010E

2011E

2010

2011

Cognizant

$63.13

$2.29

$2.61

27.6x

24.2x

Genpact

$16.64

$0.65

$0.82

25.6x

20.3x

Source: Company data and Wells Fargo Securities

Cognizant has been looking for an acquisition target in the BPO segment for some time now. But Genpact will be huge not only in terms of the capital involved, but also from an integration perspective.

BPO operations currently contribute 5 per cent to Cognizant's overall revenues. From a synergy perspective, the combination might just click, said market analysts. Cognizant has been trying to increase its presence in the BPO space.

On the other hand, Genpact has been trying to increase its presence in the IT services segment, which accounts for 16 per cent of its revenues. It expects a flat to low single-digit growth this year. "This contrasts with the more positive growth rates expected by most Indian IT services majors," said a recent Deutsche Bank report on Genpact.

Both firms are strong in the banking, finance services and insurance segment. For Genpact, it was 41 per cent of its revenues; for Cognizant, it was 42.9 per cent. Manufacturing contributed 41 per cent of Genpact's revenues for 2009; manufacturing, retail and logistics were 17.2 per cent for Cognizant.

However, many analysts and industry experts are sceptical about the deal. A recent PE industry data report from the US said this was highly unlikely. "Cognizant's preference was always for smaller tuck-in acquisitions and the company always argues that the offshore BPO market is "going through a transition" and by hinting that the "horizontal BPO market (where Genpact is a major player) has matured and that the better growth profile is in the 'vertical BPO' market", said the report.

Since 2005, Cognizant has made nine acquisitions. All of these have been niche. The firm has in the past defined its acquisition philosophy as three-fold: deepen consulting or domain capability, expand geographic footprint and enrich services mix.

"Further, all our acquisitions have been 'tuck-under' acquisitions. You may have noticed that five of the last eight 'tuck-under' acquisitions by Cognizant have been in the consulting or high-end capabilities space (such as programme management and enterprise analytics). This clearly indicates the importance the company is placing on consulting and other high-end capabilities to address structural challenges and mega trends that our clients are facing (such as globalisation, consumerisation, virtualisation) and provide solutions to complex business problems," said one of the senior managers in a recent analyst call.

Besides, a report by US analyst firm Kaufman Bros said, "Cognizant has historically sounded cautious about the BPO market, implying it didn't want the business to get beyond 10-20 per cent of its mix over the longer term, given material differences with its IT business.

A combination with Genpact would raise the BPO mix of Cognizant to the 25-30 per cent range. Second, a combination with Genpact would be very dilutive to Cognizant's growth rate, if not non-GAAP margins."

Moreover, Genpact derives a full 40 per cent of its mix from GE, which, the report said, has limited up-sell potential for IT work, given that GE is already a very mature client for rivals.

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BS Reporters in Bangalore/Mumbai/Delhi
Source: source
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