Home >Market >Mark-to-market >Laggard Polaris cuts a good deal for shareholders
For perspective, in the 10 years before the de-merger was announced, Polaris shares declined by about 20%, while the BSE IT index rose by over five times during the same period.
For perspective, in the 10 years before the de-merger was announced, Polaris shares declined by about 20%, while the BSE IT index rose by over five times during the same period.

Laggard Polaris cuts a good deal for shareholders

Polaris decision to de-merge and eventually sell the IT services business to Virtusa has come as a welcome relief for shareholders

In hindsight, the erstwhile Polaris Financial Technology Ltd’s decision to de-merge its products business last March has worked out tremendously well for shareholders. Their effective returns since the de-merger was announced work out to 80-90%.

For perspective, in the 10 years before the de-merger was announced, Polaris shares declined by about 20%, while the BSE IT index rose by over five times during the same period. Polaris was stuck in a rut, and in this backdrop, the de-merger and eventual sale of the IT services business to Virtusa Corp. has come as a welcome relief for shareholders.

What’s more, for a business that was going nowhere—Polaris’s IT services revenues fell marginally in dollar terms on a year-on-year basis last quarter—it has extracted a handsome EV/Ebitda (enterprise value/earnings before interest, tax, depreciation and amortization) valuation of 10.5 times trailing earnings.

Has Virtusa, then, overpaid for increasing its scale in the banking and financial services vertical?

Its shareholders seem to think so. Virtusa has lost $108 million in market capitalisation since the deal was announced. If the company’s open offer is successful, it will end up paying $270 million for a 75% stake in Polaris Consulting and Services Ltd (the IT services arm).

Its investors are worried about the deal being earnings dilutive both in the current financial year as well as the next. Besides, Virtusa has agreed to certain minimum productivity savings in order to retain Polaris’s largest client, Citigroup Inc. What this essentially means is that revenues from existing projects will decline in the near-term, and if the said targets aren’t met through productivity savings, then profits could also take a hit, as Virtusa will have to make good by giving price discounts. According to Virtusa, Citigroup accounted for 45% of Polaris’s revenues and will account for over 15% of the combined entity’s revenues.

But are shareholders being too near-sighted? Kris Canekeratne, Virtusa’s chairman and chief executive officer, says that Polaris brings a lot to the table. For starters, the combined entity is expected to reach revenues of close to $900 million for the year till March 2016, and being close to the $1 billion mark will help the company qualify for bidding in much larger projects. It also brings exposure to corporate banking and transaction processing, areas where Virtusa doesn’t have a large presence. In addition, the acquisition opens the doors to the Japanese and Australian markets.

As far as the worry around the Citi deal goes, it’s also possible that the combined entity can win new deals and make up for the loss in revenues from existing projects. Virtusa has also done well in the past few years by tapping into the increasing demand for digital services. Its revenue growth has averaged around 20%, higher than most outsourcing companies, and investors have rewarded this, with the Virtusa stock trebling since early 2013.

Also, with the Polaris acquisition, its banking and financial services portfolio will now be close to $500 million, and benefits of scale and cross-selling should help this business grow.

The moot question is if the value accretion will reflect in Polaris’s books as well, going forward. Canekeratne says that accounting will be fair to both companies, and that revenues accruing from Polaris’s heritage clients will be accounted in its books, unless they engage in new projects involving Virtusa’s offerings. Likewise, if Virtusa’s clients are sold Polaris’s offerings, the accretive revenues will be accounted in the latter’s books.

But traditionally, investors tend to be wary about value gradually depleting in the majority-owned subsidiary. As such, the open offer is a good opportunity to exit for Polaris’s shareholders.

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