During the analyst call post-Cognizant’s second quarter (April-June) results, CFO Karen McLoughlin accepted that the company’s organic revenue has been averaging at $1.5 billion and going ahead merger and acquisitions will be key as they drive organic and inorganic growth.
McLoughlin who was answering a question raised by an analyst said that while there will be years where organic growth has been and will be strong, she added that there aren’t many organizations that have grown organically, consistently, more than $1.5 billion a year.
“I think, certainly we will look to continue to drive growth both organically and inorganically. As we’ve said, we clearly look to increase the volume of M&A transactions that we’re doing. We continue to believe there’s significant opportunity in the market for us to grow and continue to take market share,” she commented.
If that is the case and we look at peers like Accenture, Tata Consultancy Services, and Infosys, and assume that the incremental revenue growth (companies do not give organic revenue break up) per annum has been pegged at a certain rate, does it mean that M&A then becomes a crucial element to drive growth?
In the case of TCS the incremental revenue has been in the range of $1.4-2 billion per year. For Accenture, it is around $1 billion. In the case of Cognizant, it has been in the $1.4 billion range with CY2015 being an aberration ($2billion). “There are a couple of reasons for this, there are less number of monolithic contracts, uncertainty in the global macro environment and disruption being brought by technology. While the enablers for growth are weak, the headwinds are strong,” said Shashi Bhusan, SVP, IDFC Securities.
Analysts also believe that inorganic route of growth will be crucial especially with digital taking centre stage.
Peter Bendor-Samuel, CEO Everest Group believes that the talent based arbitrage market is maturing and as it does its growth is decelerating. New markets based on automation analytics, cognitive and cloud are now starting to take the growth space.
“M&A will be extremely important as we move forward for two reasons. One, mature markets want to consolidate and with M&A being the only way to grow. Two, the incumbents in mature markets such as TCS and Cognizant don’t have the business models, technology or market permission to dominate the new markets. The best way for them to get this is M&A hence I expect to see a significant uptick in M&A both to consolidate the mature market and second to establish a leadership role in the new markets,” he added.
Samuel further added that Accenture which has been aggressively buying digital companies is an example of the second type and the Cognizant acquisition of TriZetto, and Capgemini’s acquisition of iGATE is an example of the consolidation.
Accenture, which has been the most aggressive player in an acquisition, has so far invested about $2.5 billion, over the last three years, in acquiring capabilities. Of this about $850 million was invested in 2015 alone, with 70 per cent of capital used to acquire firms in the digital, cloud and security services. Chairman and CEO Pierre Nanterme in the annual report says that digital-related services grew to $7 billion during the year.
Cognizant so far has invested $200 million in acquiring six targets in the digital space. These include Idea Couture, Cadient, KBACE, itaas, Odecee and ReD Associates (strategic investment). Unlike several of its Indian competitors, Cognizant has also made big ticket acquisition like TriZetto for a sum of $2.7 billion. This alone has made the company sign total contract value of $2 billion since the acquisition in 2014.
Acquisitions seem to be the only way to spur up the numbers. “Based on our research, the Cloud & Digital business is approximately 21 per cent of the IT Services market and growing at approximately 24 percent; the traditional services (e.g., ADM, BPO, Infrastructure) which are 79 percent of the market is growing close to zero per cent. The traditional market has become a brown-field market and is not a green-field market. As you look through these numbers, it becomes clear that growth for the industry requires digital (hence M&A to acquire the skills to operate in the new business model) and requires M&A to get to the growth number as organic growth becomes harder,” stated Jimit Arora, Partner-IT Services, Everest Group.
Arora further elaborates that improvement in the demand environment will not fundamentally help with incremental growth given secular issues in the industry.
But such M&A activity is missing among Indian players, especially TCS. Though the company has preferred to grow organically. The last acquisition it did was of Alti SA in France for Euro 75 million in 2013. Post that the management has been consistent that while they look for an acquisition it also has enough internal resources to build new platforms and offer digital services.
Infosys, which is still on its recovery path, has invested about $390 million since the start of 2015 in buying three companies. The acquisition is key for the company growth, as Vishal Sikka, CEO Infosys has stated that he wants to make Infosys a $20 billion revenue firm by 2020. Of these about, $1.5 billion of incremental revenue will come from companies acquired by Infosys.
Considering the first quarter (April-June) numbers have been softer, as compared to the past quarters, and the overall macro environment is yet again under clouds, Indian IT services should seriously look at the new normal.
“With regard to incremental growth in any given quarter, it will move around, however, the secular trend is for declining growth rates in their core business. It will be hard to grow fast enough in the new growth markets of a small base to offset the decline in growth in the large core markets. It is also likely that we will see a margin decline as companies starved for growth attempt to grow faster through being a price challenger,” concluded Samuel.
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Source: Business-Standard
