igate acquires patni - where is client value

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iGate’s Buy Patni – Vendor’s Growth Strategy, Don’t Mean Client Value Sudin Apte 10th January 2011

The long awaited announcement has finally been made today; this will be the largest IT acquisition India has witnessed so far. While most Patni clients view this as a routine act in the global tech world, they will wait and watch how the transaction pans out. While buyer iGate gets a mechanism to avoid marginalization for a few more years, the diverge background of the two providers hardly offers any value to Patni’s clients. Our research also shows that iGate will witness a large number of Patni’s current employees – both senior managers and developers alike –quitting in the coming months, thereby taking the attrition to well over 30%. Result? Not seeing their delivery teams on the job, clients will take a cautious approach and move the work to an alternate provider. Also, the long drawn statutory and integration process, coupled with the dispensable position Patni was in at most client places, will result in many clients neither renewing many of their contracts nor awarding new projects. And given that Patni shares almost all its accounts with either a top Indian or MNC provider (wherein Patni holds a small piece of business), shifting a part of the work slowly is relatively easy.

A Mid-tier Offshore Provider iGate Takes Over Patni Computer Systems, Three Times Its size Finally, after cancelling the announcement once last week, Patni Computer Systems has been sold. The front-runner in the acquisition process – a mid-tier offshore provider iGate – emerged as the winner. iGate purchased 63% ownership of Patni from the founders (the three Patni brothers including the current Chairman Mr. Naren Patni) and an investor (General Atlantic). In addition, as per the Indian exchange controller’s guidelines, iGate will make an open offer for acquiring an additional 20% stake from financial institutions and retail investors. Subject to statutory approvals and completion of Indian company law formalities, it will take at least three to four months to seal the deal completely before the foray into an actual integration of the two firms.

The News About the Deal Is Full of Myths Electrified with the country’s first ever billion dollar IT industry takeover involving two publicly traded companies, a large section of the media and stock market pundits have been highly excited about the news for the past four weeks. To add to the flurry of confirmed and unconfirmed news articles, iGate cancelled its scheduled press meet last week announcing the deal, at the last moment for unexplained reasons. A high-tech Patni client told Offshore Insights that they were thoroughly confused with information received from the public

© 2011 Offshore Insights Research & Solutions Private Limited. <10th January 2011>

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domain, as they had hardly heard anything meaningful from their supplier under question. With very few Patni clients working with iGate, their apprehensions sky rocketed with the possibility of an unknown company buying their provider. With limited intervention from either player, the Indian IT industry has once more demonstrated its inexperience to manage the media hype as various myths made rounds – not only in India but even abroad, as smart competitors took it a step further and reached out to confuse their clients as well.

Myth 1: This acquisition puts “iGate + Patni” in the top bracket. Reality: The combined entity ranks tenth in the pure play offshore providers list. Just for the record, the last twelve month revenues of these two companies actually sum up to only US$ 940 million. Even if we ignore this nitty-gritty, the joint entity emerges as the tenth Indian or India-centric company after the top five (Cognizant, HCL, Infosys, Tata Consultancy Systems, and Wipro) and the next four mid-tier firms. (Tech Mahindra, Genpact, Mphasis and Mahindra Satyam) Furthermore, the history of tech acquisitions shows that in very rare cases, 100% of the acquired company’s revenues get transferred to the joint entity.

Myth 2: With billion dollar revenues under its belt, the new entity can now compete neck to neck with the likes of Tata Consultancy Services and Infosys. Reality: Top firms are still beyond the reach of the new entity. Tata Consultancy Services reported revenues of US$ 2,004 million for the quarter ended September 30, 2010 – which is more than double the combined annual revenue of the joint entity. Top practice lines at TCS and Infosys – such as ADM or Enterprise Application services – are each well over a billion dollars in size. In contrast, the joint entity’s billion dollar business comes from over half a dozen service lines and industry verticals each. Barring application development, (joint revenue of around US$ 550 million) all other service lines of the combined entity are in the sub $100 million dollar category.

Myth 3: Scale is everything. Reality: Just having scale is passé; solution value matters as well, if not more. Firstly, scale from the client’s perspective is not overall company size but the magnitude of work that the provider does in their area of interest. So it’s not really overall company size that matters when it comes to clinching the deal. Over the past three to four years, top providers have converted their humongous size into higher value in their solutions. Our analysis of several vendor proposals that our clients received shows how firms like Cognizant and Infosys have leveraged their hefty margins to build Centers of Excellence (CoE), develop intellectual property assets, put together industry solutions, and recruit hundreds of domain experts.

Myth 4: Investors, stock market pundits and clients all think alike. Reality: Clients worry about the future of their work. Parameters such as vendor’s revenue, profitability, market cap, and how they stack in Nasscom’s top 20 list – high interest areas for investors – are of limited interest to most clients. They worry more about basic issues like continuity of their delivery team and whether the acquisition will hamper their project timelines. Their views and actions are also based on factors such as what type of work Patni does for them; do they view the relationship with the acquired company as strategic; and who are other incumbent providers in the same account.



Understanding the iGate-Patni Anatomy Companies buy other companies for three reasons – 1) to build scale by leveraging similarities and synergies, 2) to diversify (and in that way grow in size) by acquiring a company that opens new avenues and 3) to kill competition. The current iGate-Patni deal sounds like a blend of the first two, with a higher tinge of the second reason. Besides, both companies are offshore centric and have common clients like General Electric. The similarities between the two include - ADM practice, US centricity, and presence in broader (and arguably vague) industry verticals of Banking, Financial Services, Insurance and Securities, popularly known as BFSI in India. Apart from these high-level synergies, the two firms’ business profile looks fairly divergent as shown in Figure 1.

Top verticals that Patni focused included Insurance (30%), Manufacturing & retail (25%), and High-tech for product development (16%). In contrast, iGate is heavily concentrated in the Banking and Mortgage space (over 55% of its revenue).

Apart from common Application Development and Management (ADM) practice, Patni has a sizeable presence in ERP (15%), R&D services/product engineering (18%), and infrastructure services (7-8%). On the other hand, iGate seldom works in any of these areas. iGate’s iTOP platform and business services provisioning (BSP) strategy that practically takes over clients’ business process ownership on a risk-reward model, is quite different from Patni’s BPO wherein they carry out transactions such as claims processing for insurance and other standard processes like finance, accounts and customer service/tech support.

The combined entity is spread thin across multiple market segments. With very limited features in common, the joint entity – with a revenue size of a billion dollars – will operate in almost every service line that comes offshore and have clients spread across at least eight industry verticals. Apart from one service line (ADM – around $550 million in size) they lack similar scale in every other space they operate in.



Figure 1

Indicatory Financials For Last Twelve Months (approximated)

Indicatory Financials For Last Twelve Months

(approximated)

Patni iGate Patni + iGate

Overall

Revenue (US$ in millions) 688.9 252 950

Typical Profitability % 16% - 18% 18% - 20% 16% - 18%

Net Profits for last twelve months (approximate) (in US$ millions)

115 50 165

Geographic spread of revenue (US$ Millions)

North America 570 217 787

Europe & Middle East 80 20 100

Asia Pac 50 15 65

Break up of revenue by Service Lines (US $ millions)

App Dev & Mntc (ADM) 435 140 575

Pkg App / Enterprise App work 90 45 135

R&D Services/Product Engineering 85 0 85

Infrastructure Management services 40 0 40

BPO / Business Services 50 30 80

Other Services (Testing, Business Intelligence etc)

37 37

Break up of revenue by industry Verticals (US $ millions)

Insurance 210 0 210

Mfg + Retail 200 45 245

Banking and Fin Services 85 160 245

Telecom + Media 90 25 115

Product Engg/High-tech 115 0 115

Healthcare 10 10

Services 0 12 12

Source – Offshore Insights Research



Figure 2

Indicatory Operations Data (approximated)

Indicatory Operations Data (approximated)

Patni iGate Patni + iGate*

People

Headcount 16500 8300 24800

Attrition 26% 16-18% approx 24%*

Clients

Total clients 282 82 340-350

Top client size 11.10% 35% 12-13%

Top 5 clients size 35.60% 71% 40-45%

Top 10 clients size 48.50% 84% 52-55%

$ 1M accounts 98 NA 125 - 130

$ 10M accounts 14 NA 18 - 20

$ 50 M accounts 3 NA 4 to 6

$ 100 M accounts 0 NA 1

Source – Offshore Insights Research

How Will the iGate-Patni Integration Pan Out? The deal is inked, but a long drawn process of merging the two entities will start, at best, only after three to four months. While Patni’s new owners remain busy internally – first in completing the deal process and obtaining statutory approvals and then in integrating a nearly three times bigger firm with their company, clients, competition, and employees will undergo an eighteen month long phase of uncertainty. A series of multiple factors – growing/changing client demands, their perceptions about the deal, awarding of renewals and new projects from Patni’s portfolio, competition, and how existing employees view the merger – will shape the future of the joint entity. Following are our top predictions:

Clients’ top concern is their work, not who buys Patni. Unlike the vendor world and media, clients have very fundamental objectives. They are worried about the continuity of their teams. They would like to see their delivery managers, transition teams, and executive sponsors continue with the joint entity to ensure that the knowledge transfer to Patni over the years is retained with the new company and their projects don’t suffer.

Clients will assess the new management’s focus on their work. Clients selected Patni for a specific work and would definitely want to see this continuity in the integrated entity. They would like to know if the new buyer intends to continue in the space they operate in. Specifically, firms that use Patni for services like product engineering will be concerned as iGate historically doesn’t operate in that space.

Clients want to see a detailed road map and plan for execution of the acquisition. Clients who face tech vendor acquisitions often complain about lack of transparency



Clients’ action items to succeed:

and communication. Most clients informed us that they would like to receive a periodic and detailed integration plan and relevant updates from the new owner.

Patni’s current top management and staffers will look out, and will find takers. Irrespective of whether iGate agrees or not, our informal interactions with Patni staffers – both senior managers as well as developers – show a sense of uncertainty, typical to any such transaction and in all probability, they will start looking out. Luckily for them, the offshore market is seeing good recovery and most tier 1 providers are recruiting heavily. They will not only leverage Patni staffers as a trained resource, but also look for a possible client relationship. We estimate the joint entity will face a substantial rise in its attrition and may lose one in every three or four employees.

Master services agreements (MSA) will continue, but not all renewals will. Our client interactions show that most large clients may actually continue, as in, they will not explicitly terminate the relationship. But they will adopt a ‘wait and watch’ strategy. Given that 90% of the work coming through these engagements/MSAs is via project work or short project renewal based work, clients may not award renewal contracts to Patni and slowly shift to alternate vendors. This situation will continue till the entire merger/reverse merger process is completed – say in a year or 18 months.

Almost 25% of Patni’s revenue will not transfer to its new buyer. Patni, like many other mid-sized firms, has limited differentiation. Further, it shares its 90% clients with either top MNCs and/or top Indians. Ironically, in the books of Patni’s clients, Patni ranks number two or three or even four in the supplier list going by business size ranking. A lot of Patni’s work is of application maintenance type (65% of Patni’s revenue comes from ADM work) and it enjoys a very limited indispensability. Desperate to grow, incumbent competitors will continue eating into Patni’s base.

Role of investor- private equity firm Apax will matter. Private equity money not only lends financial aid but also brings in two distinct advantages. Firstly, Private Equity firms bring financial and management experience and prudence to the company where they invest; secondly, they can open new client doors. If Apax is successful in blending its several portfolio companies with the joint entity, it may replenish a lot of revenue loss from current Patni clients.

As a client, what should you do as the deal progresses? We suggest that you should:

keep an eye on how the equity process happens and how the integration plan pans out. Meanwhile, it is important to take stock of all your ongoing work with Patni and make Plan B ready so you can shift the provider without much disruption.

push your account manager (from Patni) and the new buyer to provide a detailed road map of the integration. As a client, you need to know how exactly the transition will occur and how they plan to treat your work.

insist for continued investments in your areas of interest. Unless a supplier focuses on upgrading capabilities continuously they lose the competitive edge, resulting in you as a client receiving sub-standard service compared to what is available in the market.

re-negotiate with your new buyer and clearly put forward what you care most about – work, people, milestones. Ideally, link a substantial part of your payments to continuity of staff and revised service levels.

involve an alternate vendor in some of your mission critical work to build a knowledge base and mitigate your risks.

igate acquires patni - where is client value

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