Nowadays, whenever an information technology (IT) company makes an acquisition, most analysts see it as a case of buying revenues to offset the adverse impact of the recession. Wipro Ltd’s purchase of Citigroup’s India-based captive IT services division is no different.
The company is paying $127 million (about Rs616 crore today) and has in turn been guaranteed revenues of $500 million over six years by Citigroup.
According to an analyst with a domestic brokerage, one can expect net margins of about 12-15% in this business. This means an annual profit of $10-12.5 million. At the higher end of that band, Wipro would be able to earn a return of about 10% on its investment. Although interest rates are currently at around 10%, post-tax returns would be lower. Hence, the deal seems accretive both in terms of earnings per share and return ratios. But only marginally, and that begs the question whether the deal is worth the risk, considering that this increases the company’s exposure to the beleaguered banking sector.
Citigroup, in particular, has been selling some of its assets to raise cash and tide over the crisis, and some analysts expect the bank would not exist in its current form in a few years. Now, the captive IT division acquired by Wipro provides services to various Citi units worldwide, and it remains to be seen how a divestiture of any such unit would impact Wipro. These very concerns had caused the markets to turn negative about Tata Consultancy Services Ltd when it acquired Citigroup’s captive business process outsourcing business of a few months ago.
Will Indian IT companies’ strategy of buying revenues work? While such acquisitions could provide some buffer, the key concern some analysts are having is that some of the purchases may not be a wise use of the cash on the books. HCL Technologies Ltd’s purchase of Axon Group Plc. is a classic example, where the cash was earning a higher return in the bank.
Even with Wipro’s purchase, given the long payback period, the deal is rather risky and the company has to extract relatively high margins for the deal to be worthwhile from a net present value perspective.
According to a fund manager with a domestic brokerage, some companies, in their desperation to buy revenues, are adopting the wrong strategy of purchasing India-based firms. The ability to extract efficiencies in offshore operations is limited. It would be much better to wait for a few months, after which good opportunities will be available in overseas markets at reasonable prices, he says.
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