Considering the June quarter numbers have been softer, as compared to the past quarters, and the overall macro environment is yet again under a cloud, Indian IT services should seriously look at the new normal
During the analyst call after Cognizant’s June quarter results, chief financial officer Karen McLoughlin accepted that the company’s organic revenue had been averaging at $1.5 billion a year and going forward, mergers and acquisitions would be key growth drivers.
McLoughlin, answering a question by an analyst, said there weren’t many organisations growing organically, consistently, more than $1.5 billion a year.
“Certainly, we will look to continue to drive growth both organically and inorganically. As we have said, we clearly look to increase the volume of M&A transactions we’re doing. We continue to believe there is significant opportunity for us to grow and continue to take market share,” she said.
If we look at peers Accenture, Tata Consultancy Services (TCS) and Infosys, and assume the incremental revenue growth (companies don’t give organic revenue break-up) per annum has been pegged at a certain rate, does it mean M&As have become a crucial element to drive growth?
In the case of TCS, incremental revenue addition has been $1.4-2 billion per year. For Accenture, around $1 billion. In the case of Cognizant, about $1.4 billion, with CY15 an aberration ($2 billion). Analysts believe the inorganic route of growth will be crucial, especially with digital taking centre stage.
Peter Bendor-Samuel, chief executive officer (CEO), Everest Group, believes the talent-based arbitrage market is maturing and its growth is decelerating. New markets, based on automation analytics, cognitive and cloud, are beginning to take the growth space.
“M&A will be extremely important as we move forward for two reasons. One, mature markets want to consolidate, with M&A being the only way to grow. Two, the incumbents in mature markets such as TCS and Cognizant don’t have the business models, technology or market permission to dominate the new markets.
The best way for them to get this is M&A. Hence, I expect to see a significant uptick in M&A both to consolidate the mature market and second to establish a leadership role in the new markets,” he said.
Samuel added Accenture, which has been aggressively buying digital companies, is an example of the second type and the Cognizant acquisition of TriZetto, and Capgemini’s acquisition of iGATE of consolidation.
Accenture, which has been the most aggressive player in acquisition, has invested about $2.5 billion over the last three years in acquiring capabilities. Of this, about $850 million was invested in 2015 alone, with 70 per cent of the capital used to acquire firms in the digital, cloud and security services.
Chairman and CEO Pierre Nanterme in the annual report says digital-related services grew $7 billion. Cognizant so far has invested $200 mn in acquiring six targets in the digital space. These are Idea Couture, Cadient, KBACE, itaas, Odecee and ReD Associates (strategic investment).
Unlike several of its Indian competitors, Cognizant has also made big-ticket acquisition, like TriZetto for $2.7 billion. This alone has made the company sign a total contract value of $2 billion since the acquisition in 2014.
Acquisitions seem to be the only way to spur the numbers. “Based on our research, the cloud & digital business is approximately 21 per cent of the information technology services market and growing about 24 per cent yearly; the traditional services (ADM, BPO, infrastructure), 79 per cent of the market, is growing close to zero per cent.
The traditional market has become an expansion of a market and is not a new market. As you look through these numbers, it becomes clear that growth for the industry requires digital (hence, M&A to acquire the skills to operate in the new business model) and M&A to get to the growth number as organic growth becomes harder,” stated Jimit Arora, partner-IT Services, Everest Group.
Improvement in the demand environment will not fundamentally help with incremental growth, he says given secular issues. But, such M&A activity is missing among Indian players, especially TCS.
Though the company has preferred to grow organically, the previous acquisition it did was of Alti SA in France for euro 75 million in 2013. After that, the management has been consistent that while they look for acquisition, it also has enough resources to build new platforms and offer digital services.
Infosys, which is still on a recovery path, has invested about $390 mn since the start of 2015 in buying three firms. Acquisition is a key for the company’s growth as CEO Vishal Sikka has stated he wants to make it a $20-billion revenue firm by 2020. Of these, about $1.5 billion of incremental revenue will come from companies acquired.
Considering the June quarter numbers have been softer, as compared to the past quarters, and the overall macro environment is yet again under a cloud, Indian IT services should seriously look at the new normal.
“With regard to incremental growth in any given quarter, it will move around. However, the secular trend is for declining growth rates in their core business. It will be hard to grow fast enough in the new growth markets of a small base to offset the decline in growth in the large core markets. It is also likely that we will see margin decline as companies starved for growth attempt to grow faster through being a price challenger,” concluded Samuel.
Photographs: Reuters