Is Wipro showing IT industry how to use its cash?
Whether Wipro bets in SaaS and BPaaS space work out well or not, investors should be pleased it is at least choosing not to sit on a pile of cash that earns poor returns
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Wipro Ltd reported another quarter of sluggish revenue growth; in constant currency terms, revenue grew just 0.9% in the September quarter. Besides, it has guided for growth of only 0-2% in the December quarter.
But investors have got used to sub-par growth rates from the company. What’s unusual is the aggression it has shown lately in trying to get out of this low-growth rut.
On Thursday, Wipro announced the acquisition of Appirio Inc., a US-based cloud services firm for $500 million. The firm has annual revenue of less than $200 million, implying a pricey tag of around 2.5 times revenue. Note that such firms typically operate with single-digit operating margins, which means the price-earnings valuation of the asset may be as high as 50-70 times.
Analysts are convinced the deal will be earnings dilutive in the near term. But they are also excited about the company’s prospects. Appirio is one of the largest independent cloud services implementation partner for SaaS (software as a service) vendors such as Salesforce and Workday. Wipro also gets access to one of the largest crowdsourcing communities called Topcoder.
Analysts at Kotak Institutional Equities said in a note to clients, “The acquisition leapfrogs Wipro in Salesforce and Workday implementation over other Indian IT (firms) and places it among the top-5 players globally along with IBM, Accenture and Deloitte.” Besides, they said the deal would enhance Wipro’s ability to take this capability to its existing large clients; improves its digital positioning and also open up opportunities for integrated deals as opposed to simple reliance on implementation revenue.
While Wipro is already present in this segment, revenue from the practice stood at just $40 million. Analysts at Nomura said the acquisition will put Wipro ahead of its Indian IT peers, besides helping the company transition well in the ongoing shift from on-premise software to SaaS.
On 11 February, Wipro announced the $460 million acquisition of HealthPlan Services, a leading business process as a service (BPaaS) provider in the US health insurance market. It had also closed in on another BPaaS provider, Viteos, although the deal was called off after it took too long to close. Kotak’s analysts point out that the company is also actively engaged in in-house development of BPaaS solutions, and has been investing in platforms and intellectual property. “Wipro is playing quick catch up after initial lag in digital with clear identifiable bets. Some of the acquisitions will hurt the P&L (profit and loss) and lead to dilution of earnings. Wipro is willing to take the hit in order to create a more sustainable growth engine and business model,” the analysts said in the note.
Peers have been relatively cautious and have lagged in terms of investments in emerging technology and solutions. As a result, their growth, too, has slowed, while competitors such as Accenture Plc have done far better, thanks to numerous acquisitions in recent years.
Of course, the Street’s response to Wipro’s deals has been a bit restrained. The company’s shares have underperformed again this year. One reason is investors tend to be myopic and focus on short-term performance. The other is that Wipro, like most Indian IT firms, doesn’t have a great track record of integrating acquisitions well. According to analysts at JPMorgan India Pvt. Ltd, Infocrossing, the company’s last large acquisition, had not helped Wipro consolidate its then-leadership position in IT infrastructure-management. It was acquired for $600 million in August 2007. If anything, they add, Tata Consultancy Services Ltd and HCL Technologies Ltd took over leadership in infra-management despite Wipro’s large acquisition.
But clearly, Wipro can’t be faulted for not trying. Investors will hope that it keeps its eye on the ball and works on integration issues in its attempt to regain industry-leading growth.
Investors can also take comfort from the increasing return ratios. Wipro has increased its payout ratio to 48% in fiscal 2016, from 41% in FY15 and 30% in the preceding four years.
Whether the company’s bets in the SaaS and BPaaS space work out well or not, investors should be pleased that Wipro is at least choosing not to sit on a pile of cash that earns poor returns.