Finally, Infosys Technologies did it. For years, one has got tired of hearing that the company was waiting for the right acquisition at the right price. This despite having oodles of cash on its balance sheet that lowered its return on capital. It did make some small acquisitions but nothing which made analysts furiously rework their estimates.
This will be a large acquisition by its standard, it will pay about Rs 3,300 crore to acquire UK’s Axon Group, a business transformation service provider.
There is no Wow! factor here. Maybe there is some hardnosed business logic to the deal, but one expected Infosys to come up with something really big. Something that leapfrogged it to the next level, bringing it right on par with the IT biggies like IBM or Accenture. This acquisition will add about $378mn to its FY’08 revenues of $4.18bn, or just about 9% and contribution to profits is less significant, Axon’s $38mn profit will add about 3.2% to Infy’s $1.16bn profit figure.
Let’s see the strategy behind this deal first.
Axon does large business transformation IT projects focused on the implementation and support of SAP software. It claims to be one of the largest consultancies in the SAP arena. It has done well, sales have grown about 49% in 2007 but some of that growth is attributable to acquisitions (chiefly in North America, which grew by 130%, half of which was attributable to acquisitions). America contributes 34% to revenues, EMEA 61% and the rest from Asia-Pacific.
Infosys gets about 24% of its revenues from consulting and enterprise solutions. SAP is a key part of this business, SAP related revenues grew 65% during FY’08. The rationale according to Infosys is to have the global reach, scale and financial strength to do business transformation deals in the SAP arena. It plans to become a leading global SAP consulting service provider, cross-selling services and benefiting from expertise in different sectors. The move essentially makes its SAP practice a more end-to-end solution, closing the gap between it and global IT majors who perhaps already have these capabilities.
In terms of revenues, Axon gets a large chunk of its revenues from solutions implementation (68%), business consulting gives just a fifth and the rest is application management. So, even as Infosys makes this acquisition to be one that adds weight to its consulting practice, in essence a significant chunk will come to bear in the solutions/services implementation segment. But it does improve Infy’s position in the global SAP services arena.
A presentation from Axon shows it to be in the No 12 spot in terms of SAP business size, with Satyam as the top ranking company with a No 6 rank and Infy coming much lower at No 16. Axon’s reasons are apparent in its filings. It has a leading market position in the UK and is growing in the US. But it faces challenges of new global players with what it call structural advantages posing a threat to European and US service providers. These behemoths like IBM, Accenture, Deloitte and Capgemini can give a one-stop solution to companies not just for SAP but also other technology platforms.
They can thus play aggressively in one segment if they are making money in another, simply to gain market share. Smaller players like Axon cannot compete with them forever. Joining forces with a company like Infosys allows it to move up the chain.
This is not a key issue, Infosys had cash of about $2bn as of March’08 and can easily fund this $750mn or Rs 3,300 crore acquisition out of its internal cash reserves. Of course, there is a possibility if a rival bid emerges which may lead to the cost of acquisition rising.
For Infosys, the deal really does little for its bottom line as Axon has a much lower margin profile compared to Infosys. Axon’s net income margin was 10% compared to 26% for Infosys. Of course, some of this can be attributable to tax shelters and lower costs for Infosys. But even on a pre-tax basis, the margins are lower. The acquisition may also ease some pressure off Infy’s ability to meet or even exceed its guidance in FY09 and FY10, when the full impact of the acquisition will be visible. Relatively lower margins perhaps explains the valuation of about 2 times sales, despite Axon growing rapidly and operating margins improving in 2007.
What is uncertain is perhaps the future and the fact that some of this fast growth is coming from acquisitions. Growing competition from larger companies is likely to lead to falling margins for smaller players, though this is not evident in Axon’s performance as yet. But then it is still a small player and once it starts moving up, will find this increasingly problematic. In 2008, the consensus forecast is a 28.6% growth in earnings but it drops off to 8.4% in 2009.
In sum, Infosys seems to have bought into growth by acquiring Axon. If it manages to rejig the operating structure such that it can lower costs and bring margins up to its levels, then the acquisition will be worth the money and effort. Otherwise, it will just pacify those analysts who never tire of asking the company when it plans to make a big-ticket acquisition.