HP-EDS deal: are Mphasis shareholders jumping the gun?

Update on May 22: EDS has sent a clarificatory letter to the stock exchanges stating that it is not required to make an open offer, under Sebi’s existing regulations. That will disappoint retail shareholders who were hoping for a windfall, though instutional shareholders would have realised that an open offer was not on the cards. Read the text of the letter here.

The MphasiS share price is up by 10% on the BSE, closing on Tuesday at Rs 242.5. The reason would be that a mandatory open offer will be on the way, as its parent company EDS has been acquired by HP in a $13.9bn enterprise value deal. EDS owns a 61% stake in Mphasis, a company listed on the Indian bourses. Normally, Sebi’s Takeover Regulations mandate an open offer for 20% by an acquirer, if there is a change in control. That leads to a windfall for the company’s shareholders as the price is bid up in the market.

Then, of course, there is hope that the foreign acquirer may even attempt to delist the company, which could lead to a bigger windfall. But a line in HP’s release should be enough to make them cautious, it says “under the terms of the merger agreement…” If the acquisition is done through a scheme of arrangement, then MphasiS shareholders are in for a rude shock.

There is no compulsion on HP to make an open offer, as it can take cover under a provision in Sebi’s Takeover Regulations, Clause 3 (1) (j). That clause exempts companies from making an open offer, if the change of control is due to a scheme of arrangement including amalgamation, merger or demerger, either in domestic or foreign markets. A search for the SEC filings was fruitful, as the press releases and presentations do not touch upon this specifically.

The SEC filing makes the structure amply clear. A wholly-owned subsidiary of HP, MergerCo will be merged with EDS, and shareholders will receive $25 for every share held. This structure would mean that HP will most likely not have to make an open offer to MphasiS shareholders in India. It has the liberty to do so if it wishes, but given that the share price will rise sharply, it may prefer a status quo.

From a strategic viewpoint, it is not clear at this moment how MphasiS will gain from the acquisition. Both HP and MphasiS have large operations in the country, which way the integration goes will determine how much MphasiS stands to gain, or lose. The following extract from the analyst conference call transcript does not say much, but it concerns the India operations and a mention about MphasiS too.

“Julio Quinteros – Goldman Sachs – Analyst Okay, and then just real quick quickly lastly for me on the exposure to offshore and India in particular. It looks like, just on some numbers that we have, EDS has roughly 30,000 people in India. I think HP has roughly about the same, plus there is also the MphasiS BFL acquisition — sorry — the acquisition that EDS made. How do you guys plan on rationalizing both the captive units that you guys have coupled with a third-party publicly traded entity in India?

Mark Hurd – Hewlett-Packard – Chairman, President & CEO Well, I don’t particularly want to go into too much depth on that today other than to say that when we think about offshore, just so we are clear or any shore, we just don’t think in isolation of India. That is an important thing. Your numbers on us are roughly right as it relates to our employee headcount in India. But I would also tell you that we have been very global in our deployment of resource around the planet and our service delivery extends well beyond there. So it goes back to Toni’s earlier question that I’d like to make sure we are clear on. We don’t necessarily align offshore to having just an India discussion. We think of it truly as a global delivery capability that is broader than the –.

Ron Rittenmeyer – EDS – Chairman, President & CEO And also as you know in our many calls, we approach it as best shore and we have — we have done a lot in South America, a lot in Eastern Europe. So we are not married to India as our only anchor.

Julio Quinteros – Goldman Sachs – Analyst Yes, I was just asking only because you have the unique situation with the MphasiS BFL company as kind of a publicly-traded entity out there in India. Got it. Thanks, guys. Good luck.
Ron Rittenmeyer – EDS – Chairman, President & CEO We will deal with it as we have been dealing with it.”

HP has had one brush with minority shareholders in India, when its acquisition of Compaq gave it control over Digital Globalsoft, a listed company. Eventually, Digital Globalsoft went private, but not without controversy which included a merger of a HP company, with complaints of unfair valuation. Ultimately, Digital’s shareholders were bought out through a voluntary delisting bid, in which they got a decent exit price.

HP’s first experience would mean it will make its moves carefully this time. During the year, MphasiS’ revenues grew 38% to Rs 2423 crore while its net profit rose by 42% to Rs 255 crore. Profit growth during the quarter however was slower at 14%. It employs about 27000 people with about 60% revenues coming from application services, BPO contributes to about a fifth and the rest from infrastructure management. The last category is the fastest growing business for the company.

HP is in the driver’s seat after the merger, and will call the shots in India too. MphasiS is no doubt a key asset, but one that has a listed tag attached to it. How HP deals with that will determine to what extent MphasiS shareholders gain from the transaction. Interesting times lie ahead for MphasiS shareholders, and yes, they should read up on all that happened at Digital Globalsoft, after it came into HP’s fold till the time it got delisted.

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