Business Today

Indian IT's big deal

HCL sees a potential acquisition of Axon as transformational, but its finances may be stretched if a bidding war breaks out. For HCL it’s an attempt to further leverage its Blue Ocean strategy of focusing on untapped or uncluttered markets.

Rahul Sachitanand        Print Edition: October 19, 2008

Three years ago, Vineet Nayar laid down a bold three-stage plan to leapfrog his rivals in the IT services market. Last fortnight the CEO at HCL Technologies, India’s fifth-largest IT services firm, took another step in that direction—and in the process took on Bangalore based rival Infosys Technologies, currently #2 in India, by revenues. In August, Infosys had attempted to conclude the biggest overseas acquisition by an Indian IT services company when it made a Rs 3,300-crore bid for UK-based SAP consultancy Axon. Last fortnight, HCL muscled its way into the fray by making a counterbid for Axon that’s 8.3 per cent higher. At the time of writing, analysts were expecting Infosys to revise its bid, and HCL to duly respond with another counter-bid.

Vineet Nayar
Whilst Infosys was looking to strengthen its consulting business by acquiring Axon, for HCL it’s an attempt to further leverage its Blue Ocean strategy of focusing on untapped or uncluttered markets. Also by combining a string of process overhauls, industry partnerships and acquisitions, Nayar hopes to transform HCL into a global IT powerhouse. Currently, HCL, with revenues of $1.9 billion, is well behind Tier I rivals TCS, Infosys and Wipro. Nayar, however, believes all this will change. “The Axon deal will be transformational for us,” he told the media last fortnight when announcing HCL’s counter-bid. Just hours before that, he had concluded three-month-long discussions with Axon’s top management, which eventually resulted in HCL’s offer. Axon holds similar attractions for both software companies.

With compounded average revenue growth of 35 per cent over the last five years, operating margins of 18 per cent and access to untapped markets such as the public sector, Axon makes for a compelling proposition. “Axon has complementary skillsets to HCL … they are in the front end, blue printing and architecting deals and we’re strong with implementation,” Nayar adds. HCL has already taken some initiatives in the third phase of its plan to become a global IT giant. Its acquisitions have thus far been focussed on the back-end (see Urge to Merge), areas such as BPO and expense management. “Now the company wants to make its first big deal as it seeks to sew together its expertise in back-end processes with the huge opportunity offered in SAP and specifically enterprise consulting,” says a Mumbai-based analyst.

K. Gopalakrishnan
According to industry estimates, the enterprise applications market is expected to grow from $88 billion to $104 billion between 2007 and 2010, while the SAP segment will grow from $24 billion to $35 billion in the same time. “Indian companies can address just $1.5-1.8 billion of the SAP services market,” estimates Ram Krishna, HCL’s Head of Application Services.

The stage appears set for an allout bidding battle. “This is not a counter bid, but a proactive one,” claimed Nayar in a conference call with analysts. According to industry watchers, this deal boils down to who blinks first. While HCL has raised £400 million from Standard Chartered Bank for this bid (at an interest rate of approximately 6-6.5 per cent), it will also pump in around £41 million from its own finances. “Infosys has much deeper pockets with around $2 billion in reserves compared to $570 million for HCL,” says an analyst.

The aggressive move for Axon is also important for HCL to get around 2,000 SAP analysts on board and ramp up its business. “We get around 11 per cent of our revenues from enterprise applications, compared to 24-44 per cent for our large rivals. The HCL-Axon combine will take this share up to 30 per cent,” says Nayar. In Infosys’ case the deal is expected to double its 2,000-stong SAP consultant base. Satyam reportedly houses the largest number of SAP consultants among Indian IT services companies, but clinching the Axon deal should give Infosys or HCL a chance to leapfrog their Hyderabad-based rival. “We get a small percentage of revenues from consulting and blueprint, whereas Axon gets 88 per cent of its revenues from this segment,” says HCL’s Krishna.

Pressure on growth
HCL's growth has stalled, even as margins have expanded.

For HCL, industry watchers say, this is an opportunity to step into the big league, something Shiv Nadar, the company’s Founder and Chairman, has coveted for years. “HCL has always been the outsider at the top of the table and they want to make a statement by bidding for Axon,” says one industry executive. In the last few years, HCL has stepped up its branding as it seeks to be seen in the company of its larger Indian and global rivals. “Expect Nadar to go for broke. They want to be counted in the big league,” adds the executive.Despite HCL’s ambition, Infosys is not expected to walk away from this deal. In a statement to the media soon after HCL announced its intent to buy Axon, Infosys said, “...Infosys is considering its position and urges Axon shareholders to take no action at this time.” Happily for the Bangalore-based company, it has already got a commitment of 18 per cent of Axon’s shares from some key shareholders and top management. “This is Kris Gopalakrishnan’s (Infosys’ CEO) first deal and we’ll need to see how long Infosys will hold its nerve,” says an analyst. With a 70 per cent plus increase in share price over the last six months and suitors for their shares, Axon’s shareholders may be the ultimate winners in this contest.

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