Hyderabad: French IT services company Cap Gemini SA is acquiring Nasdaq-listed iGate Corp. for $4.04 billion in cash in an attempt to strengthen its presence in the Indian and North American market and across client sectors such as retail, healthcare and engineering.

The deal, the 10th biggest acquisition of a US-based technology firm by a European company (according to financial data tracker Dealogic), will create an organization with €12.5 billion in combined revenue and 190,000 employees.

Analysts said the deal appears to make sense for both companies, but pointed to possible issues around integration at a time when the IT services business itself is transforming rapidly.

It also points to issues related to scale and spread that continue to remain relevant in the business, even as new service and pricing models and automation threaten to rewrite the way companies work.

“This acquisition, in one fell stroke, levels the playing field to a large extent both in terms of capacity as well as breadth of coverage areas and industry verticals," Partha Iyengar, vice president and head of research, India, at technology researcher Gartner Inc., said.

“The added huge bonus for Capgemini is that it gives them, again in one move, a great presence and foothold in the US market, which has always been a challenge for them as a Europe-centric provider. This boosts their presence and revenue in the largest market for global sourcing and gives them a credible offering for the US market," Iyengar added.

New clients, businesses

The acquisition of New Jersey-based iGate will potentially add marquee clients such as Royal Bank of Canada (RBC) and General Electric Co. (GE) to Capgemini’s portfolio. It will also give Capgemini access to clients in the financial services business, which represents 42% of iGate’s revenue.

The deal will increase the combined entity’s revenues in North America by 33% to an estimated $4 billion.

iGate drew 79% of $1.3 billion annual revenue from North America in 2014.

But Capgemini might succeed in transferring only $800 million to $1 billion of iGate’s $1.3 billion revenue, according to Sudin Apte, chief executive officer and research director at Offshore Insights Research and Solutions Pvt. Ltd, a research firm specializing in IT services.

iGate’s clients, such as RBC and GE, that have steered clear of Capgemini so far may not move to Capgemini because of the acquisition, he said. Besides, clients of iGate’s product engineering business that accounts for over $100 million of the company’s revenue will not be comfortable sailing with Capgemini, which doesn’t have a specialization in the space, Apte added.

Indian IT outsourcers such as Tata Consultancy Services Ltd, Infosys Ltd and Wipro Ltd, and Cognizant Technology Solutions Corp. might smell an opportunity to snatch this business.

These companies will face competition from the merged entity for business in India.

“This (merger) will also give to the Group’s Indian operations a new scale, allowing us to compete on par with the best US-based and Indian-based companies," Paul Hermelin, chairman and chief executive officer of Capgemini, said in a statement.

The combination of iGate and Cap Gemini provides cross-selling revenue synergies of $100-150 million and annual efficiency gains estimated at $75-105 million to be achieved within three years, the companies added in the statement.

The merger will strengthen Capgemini’s expertise in application and infrastructure services, business process outsourcing and engineering service. It also strengthens Capgemini’s position in the retail, manufacturing and healthcare sectors.

A good deal

The acquisition is a sweet deal for investors but on the expensive side, Sanchit Vir Gogia, chief analyst and group CEO of Greyhound Research, said, pointing out that iGate has been on the block for the past four years.

Lacking a specialization, iGate “has not been heading anywhere", and the company chose to sell out following investor pressure, Apte said. “With improved margins and better valuation, this is possibly (the) best timing."

Capgemini’s attempt to focus on the US almost signals its offshore disappointment in continental Europe, Apte added. Almost 70% of the company’s business comes from Europe.

The merger has been approved by iGate’s shareholders, who hold 54% of the capital. iGate has a 30-day window to accept a better offer; the deal is subject to regulatory approvals.

The transaction also provides an exit to private equity firm Apax Partners Llp, which helped the 2011 buyout of Mumbai-based Patni Computer Systems Ltd by iGate for $1.22 billion.

Apax holds 28.91% in iGate after it converted its debt into shares.

Ashok Vemuri, chief executive of iGate, declined to disclose, in a conference call, the returns Apax would be pocketing from the deal.

“In Capgemini, we have found a partner that will advance our ability to innovate and build industry solutions that will enhance the value proposition we bring to our clients. In addition, this powerful combination will provide exciting opportunities for our employees to expand their capabilities," Vemuri said.

Vemuri said during the call that he would remain with iGate until the merger process is completed. Post the integration, he said he will play a “very important part" in the combined entity.

Capgemini is financing the deal with a mix of cash, equity and debt, and will offer $48 for every iGate share as part of the definitive merger agreement. IGate’s shares were trading at $47.44 on the Nasdaq at 9.50pm on Monday.

The transaction is expected to close in the second half of 2015.

The challenge

The biggest challenge for Cap Gemini is the multi-cultural integration of the two companies that are rooted in American and European mores, analysts said.

“The daunting task of blending two companies—especially in India—of large size and distinct cultures starts (now)," Apte said.

Gartner’s Iyengar pointed out that Capgemini’s track record of integrating Kanbay International Inc. in 2006 was “not the biggest success", and the company has a tougher task at hand with an even bigger acquisition.

“They will have to move very quickly to convince clients that projects are safe and that the acquisition gives iGate clients a much bigger capability and deeper domain expertise in some domains (which it does). If they are not successful in doing this, they risk the flight of clients, especially in the US," Iyengar said in a note.

Capgemini expects the integration to be smooth. “Building on both companies’ previous experiences of integrating acquisitions and a strong cultural fit, the integration is expected to be smooth," it said in the statement.

“On purely strategic considerations, we are ambivalent on this deal," Thomas Reuner, managing director for IT outsourcing research at consulting firm HfS Research, said. “It would give Capgemini a significant beneficial boost in many capabilities but the integration challenges and the cultural alignment required to make it successful... means this runs the risk of being a significant distraction grounded in the current market," he explained.

At a time when traditional outsourcers are looking for niche buys that add software intellectual property or vertical capability, such as Infosys (Panaya) or Cognizant (Trizetto), Capgemini still has significant holes in its portfolio. HfS said Cap Gemini has to quickly strengthen its expertise in industry verticals and focus on specific niches such as strong analytics.

Hermelin said the company would develop new offerings in the emerging digital services space by hiring talent.

“We will invest in digital, we will invest in cloud integration but it will be through hiring of key individuals," Hermelin said in the call.

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