Mphasis (an HP Company) is said to have acquired Florida-based Digital Risk LLC. Digital Risk is one of the largest independent providers of Risk, Compliance and Transaction Management solutions to the United States mortgage market.

The acquisition is an all-cash deal valued at USD$ 175 million (about Rs 960 crore) with an additional earn-out component of US$ 27 million, making the total consideration of USD$ 202 million.

Digital Risk will operate as a standalone business unit retaining its brand identity. Digital Risk’s founders will continue to lead the company and the management team and employees will remain with the company and continue serving their customers. This acquisition significantly enhances Mphasis’ onshore presence in the US. Mphasis has plans to expand its footprint in the United States creating up to 500 new US jobs in the near future.

In this transaction, Avendus Capital acted as the exclusive financial advisor and Goodwin Procter LLP acted as legal advisor to Mphasis. Portico Capital Securities, LLC served as financial advisor to Digital Risk and Katz, Teller, Brant & Hild acted as legal advisor to Digital Risk.

The acquisition significantly enhances Mphasis’ onshore presence in the US

About Digital Risk

Founded in 2005, Digital Risk is the largest independent provider of Risk, Compliance and Transaction Management solutions for the complex and dynamic financial services market. The company provides buyers and sellers of mortgages and mortgage-backed securities the analytical, technological and risk management services they need to achieve their goals. The Digital Risk platform delivers transparency at the loan level and precise risk assessment throughout the entire mortgage value chain. With over 1,500 U.S. based professionals, the company counts the nation’s leading services, originators, aggregators and investors among its clients. Digital Risk is independent and not affiliated with any originator, issuer, servicer or investor. Headquartered in Orlando, Digital Risk has additional operations in New York, Dallas, Denver, Chicago, Boca Raton, Tampa and Jacksonville.

In 2009, Digital Risk launched an aggressive expansion in Central Florida, boosted by $1.3 million in state and local tax breaks that would eventually create nearly 450 jobs more than doubling its workforce in Maitland at the time. In 2010, drawn by $525,000 in economic incentives, it established an operation in Jacksonville, where it now employs more than 300 people. In 2012, it opened a new office in Boca Raton, three months after opening one in Los Angeles.

About Mphasis

Mphasis, a unit of Hewlett-Packard Co, is an information technology services company based in Bangalore, India. Mphasis (then, Mphasis BFL Limited) was formed in June 2000 after the merger of the US-based IT consulting company Mphasis Corporation (founded in 1998) and the Indian IT services company BFL Software Limited (founded in 1992). Mphasis is ranked number 7 in India IT companies and overall number 165 by Fortune India 500. The company has 29 offices in 14 countries with delivery centers in India, Sri Lanka, China, North America and Europe. Currently, HP owns close to 62% in Mphasis.

Mphasis is engaged in providing information technology services to its customers around the world. Mphasis provides integrated solutions that include business process outsourcing, infrastructure technology, and application services. The markets served by the company are financial services & insurance, healthcare, manufacturing, government, transportation, communications, and consumer & retail industries.

Mphasis has been on a journey of transformation since 2010 focusing on the Financial Services Industry. Since then all the acquisitions have been central to their strategy of offering specialized services in chosen segments. In 2010, Mphasis acquired Fortify Infrastructure Services, a provider of offshore based remote IT operations and management (ROM) services followed by the acquisition of Wyde Corporation, an international software vendor and creator of Wynsure- an industry leading Insurance Policy Administration Solution in 2011.

Valuation

The acquisition is an all-cash deal valued at US$ 202 million including US$ 27 million of earn-out to be paid over 30 months upon achievement of revenue and EBIT targets. The deal is net of cash and debt.

It amounts to about 1.4 times Digital Risk’s likely 2012 revenues. The deal is among the cheapest by an Indian IT company for acquisition of a company overseas. In the case of earlier deals such as HCL-Axon, Infosys-Lodestone, and Wipro-Infocrossing, the price-to-revenue multiple has generally tended to be 1.8 to 2.6 times.

Mphasis derives about 55 percent of its revenues currently from HP the rest comes from its own direct channels. For MphasiS, sales from the HP channel have been slowing over the past few quarters. This deal is likely to reduce dependence on the HP channel and also provide growth impetus.

It’s important to note here that the acquisition will also be margin dilutive, as Digital Risk operates at profit margins of 12%, lower than Mphasis’ margins of 19-20%.

Being focused on the US market, Digital Risk is also likely to increase Mphasis’ proportion of revenues from the North American region — now at 64 percent.

Synergy

With the acquisition one of the major positives for Mphasis is the fact that the non-HP or the direct revenues (which are expected to contribute 50% of the total revenues) will now show robust and a much-needed improvement in order to mitigate the impact of low revenues in HP, which has been a major overhang on the company’s overall performance. From a service offering perspective, the acquisition would give Mphasis access to higher value services catering to the mortgage market such as risk, compliance, and transaction solutions. There is no overlap in clients and the new company compliments Mphasis’ existing business in the financial service industry and presents significant cross-selling opportunities.

Also for Mphasis, the deal brings deep domain expertise and risk and compliance, a high growth area within the Banking and Capital market industry. It also allows them to focus on micro-verticals such as mortgage and improve their strength in areas such as forensics and analytics.

Digital Risk is focused on a very fast growing risk and compliance market in the US. The acquisition significantly increases Mphasis’ direct business footprint, thereby addressing the concentration risk that they have been having.

Mphasis’ purchase of Digital Risk will offer an exit route for PE firm Century Capital, which owned about 40% in the company. The acquisition provides Digital Risk a global footprint to accommodate clients’ global risk and compliance needs, access to U.S. facilities to further accelerate the growth of U.S. operations and access to Mphasis’ technology and analytical centers of excellence. With this acquisition, Digital Risk can expand their scale through offshore services. Mphasis provides them with the global reach and scale that it has in terms of size. Also, being part of a US$ 1 billion family would be helpful for Digital Risk to get more business from their existing customers. There are possibilities for growth through revenue synergies and opportunities in terms of margin improvement.

Conclusion

The acquisition fits well with Mphasis’ specialization strategy within the Banking and Capital market. Digital Risk adds a critical dimension to its strong value proposition for the financial services industry. The elements that have led to the success of Digital Risk from its leadership, employee base, to its brand identity and technology platform will be a valuable addition to Mphasis’ portfolio. It is not a generic acquisition but a highly specialized, domain-specific transaction.

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