iGate, the billion dollar wannabe

In the summer of 2010, 47-year-old Phaneesh Murthy, chief executive of iGate, a Bangalore-based and NASDAQ-listed outsourcer, found himself looking down over the edge of a 35-foot cliff on Big Island in Hawaii. The infotech maven was on holiday and had found another outlet to push his personal daring. Minutes after, peeking nervously over the edge, he went cliff-diving down this steep precipice into the blue waters below.

Text by Rahul Sachitanand

Months later, Murthy has transferred some of his holiday gumption to his work, when the company he steers announced on 10 January, 2011, that it would acquire Patni Computer, a much older and three times larger IT services firm, headquartered in Mumbai. Murthy has spent the last four years transforming iGate (once called Mascot Systems) from a body-shopper (more politely called a staffing services firm) into a technology outsourcer. From a -9 per cent operating margin four years ago, iGate today makes around 20 per cent.

Text by Rahul Sachitanand

iGate searched long and hard for a company to help it jump the queue into the billion-dollar club and had, according to company officials, nearly two dozen different permutations and combinations before it finally decided on the deal. In the end, customers and target clients may have forced Murthy's hand. "Customers often artificially impose constraints such as a billion dollars in revenue or 25,000 employees to bid," Murthy told this writer a day after announcing the deal. "Scale (of business) and differentiation (of strategy) is a must."

Text by Rahul Sachitanand

So, at the end of the day, iGate acquired Patni for $921 million from General Atlantic and three Patni founders, and another 20.6 per cent as part of a mandatory open offer, coughing up around $1.2 billion for this deal. iGate will use $700 million in a bridge loan from RBC Capital and Jefferies to fund part of the deal, raise $100 million through internal accruals and some $270 million from investor Apax Partners. (A file photo of Narendra K Patni, chairman and founder of Patni)

 

Text by Rahul Sachitanand

While the deal's done (it will take a month or longer to be sealed), there are many questions floating about.  Why Patni? The company's been stuck in a bit of a rut for the past three years and its predicament has only been worsened once the economic slowdown hit. The company, once employers to Infosys founders N.R. Narayanamurthy and Nandan Nilekani, has been left in the dust by tier 1 firms and more recently by the likes of HCL Technologies. Patni has had four CEOs in five years and has struggled to attract new business with a "for sale" sign stuck on it for a while now. Having said that, Patni does have $700 million in revenues and customers such as GE in its kitty - an ideal size for Murthy to launch into the billion-dollar stratosphere. Of course, the fact that the slowdown has lowered Patni's valuation to little over 15x CY2011 earnings (compared to over 20x three or four years ago) has only made it a more worthwhile buy.

Text by Rahul Sachitanand

What about Patni's senior managers? Few industry folk expect Jeya Kumar, Patni's CEO, to stay on once the deal has been closed. He's run Sun Microsystems' $5 billion services business, been CEO of MphasiS (owned by HP) and ego, more than anything else, may see him exit. Having recently appointed a young CFO in Sujit Sircar, Murthy may be reluctant to make change on that function, too.

Text by Rahul Sachitanand

Scaling up will be a challenge: In the IT services business, size is everything. Potential clients look for the number of $100 million clients you have, size of your sales and marketing front end and of course overall headcount. At 25,000 people, the combined entity is a relative featherweight in the billion-dollar club. Analysts also say that the top 10 clients hold the key for iGate since they contribute 71 per cent of total revenues. Edelweiss Research says average annual revenue for each of the top 10 clients of the merged entity will be $50 million compared to $1.4 million for remaining clients.

Text by Rahul Sachitanand

Will iGate itself be sold soon? This move can't be ruled out in the medium turn. Everyone's going offshore in the outsourcing industry, including the notoriously conservative Japanese, who form the second largest market for IT services. Consolidation is only expected to intensify as customers begin to choose fewer, yet larger vendors to deliver IT services. At a billion dollars in scale, iGate itself may be an ideal size for a takeover sometime soon.

Text by Rahul Sachitanand

What about employees? iGators, or simply iGate employees, will be given a 125% variable compensation pay out, Murthy told his employees at a town hall meeting. Patni employees get nothing. Neither company has announced a specific retention package for employees, so the combine may want to cherry pick the best talent on show going forward. However, this may be the best time for predatory competitors to make a snatch and grab of top talent.

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Will both brands stay? It is unlikely. The bets are on the Patni brand slowly getting phased out and iGate gaining centre stage. Neither brand has the clout of an IBM or Infosys among clients, investors or employees, so it's a call Murthy and team will need to take some time soon.

Text by Rahul Sachitanand

What about the rest of the mid-tier? There's trouble in the middle of the Indian IT industry. Barring a few specialists (KPIT Cummins in manufacturing) the generic software services outfits could find the going harder in future. Already, MindTree is stuttering, having converted a wireless products business into a services one and Sasken too has had its share of troubles. Further down, the likes of Mastek have struggled for traction for a few years now.

Text by Rahul Sachitanand