Thumbs down to Infy-Capgemini deal

A few months ago, before its entry its into the elite Nasdaq-100 index, the then CEO Nandan Nilekani indicated that the first major acquisition by Infosys could well be in Western Europe or in the BPO space, in response to the oft-repeated query on its acquisitions.

On Thursday, market reports seemed to indicate that Infosys was not only eyeing companies in Western Europe but a player that’s almost thrice in revenues, Capgemini.

Indian IT companies have been trying to break into the high-margin consulting business but without much success. For Infosys, consulting revenues made up just a little over 3% of its topline in FY07. According to estimates of research firm Gartner, the global IT consultancy business today is around $55 billion, and expected to grow at a CAGR of 7% to $71 billion by 2010.

Consulting is an opportunity, no Indian IT firm with global ambitions can afford to ignore. An inorganic growth strategy may prove to be the driver and the impetus that the business needs, since none of the players have been able to crack it so far. Capgemini would provide this to Infosys.

The reactions to whether such a move will actually benefit Infosys have been mixed in the analyst and investment banking community. While the consultancy business and a strong European presence of Capgemini are clear strengths that Infosys will gain from, the likely valuation of Capgemini and the potential hit that Infosys will take in its profitability margins, are getting the thumbs down from i-bankers. Abhay Aima, head of equities and private banking group, HDFC Bank, is being cautious about the deal.

Says Aima, “While in the long term it may be a brilliant strategy, what matters to the investor is what the stock swap and the valuation will be in the short term. That is assuming the deal does indeed happen — right now, both companies have denied it.”

Harit Shah of Angel Broking is more sceptical about the deal and says, “Infosys is growing very well organically at over 40%. When it is growing at such a good rate, it doesn’t make sense for it to acquire Capgemini that is growing at 6%. Also, such a large acquisition would change its balance sheet dramatically.” He advocates that Infosys should acquire a niche consulting company in the US and Europe, if it wants consulting capability. But there are some who believe that this might in fact be a good idea. One investment banker we spoke to told ET, “It makes sense for them to acquire a consulting organisation. This apart, it also gives them a local presence in Europe.”

If Infosys were to go through the deal while it might acquire a bigger presence in the consulting space and gain a footprint in Europe it won’t be a bed of roses. It will need to address some core issues pertaining to the existing operations of Capgemini, apart from integration and cultural issues.

Capgemini’s employee base is almost as large as that of Infosys, so Infosys could well be looking at potentially laying off a significant number of people. Also, Capgemini’s operations emerged from the red only in 2005 and its margins are still at 5.8% at the EBDITA level, compared to Infosys’ 31.6%.

Some experts, though, believe such blips are only temporary. Investment strategist, Gul Teckchandani, says, “Downloading functions from the western world into India has largely been accepted. This will definitely allow for decent offshore arbitrage for the Indian companies.”