With a gradual erosion in valuation of mid- and small-sized IT and IT enabled services firms on the stock markets due to rupee fluctuations and a US slowdown, experts estimate as much as 50 per cent rise in merger and acquisition deals in the domestic IT industry over the next 12 months.
"There will be a 50 per cent growth in value for merger and acquisition deals in the domestic space of the IT and ITeS industry," says CG Srividya, partner, specialist advisory services, Grant Thornton. In 2007, as many as 59 pure merger and acquisition deals took place in the domestic IT and ITES space, together valued at $370 million (around Rs 1,550 crore). The figure, accordingly, is expected to be slightly over Rs 3,000 crore (Rs 30 billion).
"The cost advantage for domestic IT and BPO companies has reduced in the last two years, especially with salary levels increasing and rupee appreciating against US dollar," she said.
On an average, there has been a 15 per cent rise in employee's salary in last three to four years. And the value of rupee against the dollar appreciated from its lowest level of Rs 46.9 in July 2006 to Rs 39.25 in October 2007.
On Wednesday, rupee stood at 42.98 against the US dollar. There are around 250 IT and ITeS firms listed on the Bombay Stock Exchange - second largest industry after the non-banking financial sector - and the US is the major market for over 95 per cent of these firms. Out of these, around 220 firms have a turnover of less than Rs 250 crore (Rs 2.5 billion) and are considered to be small-sized firms.
There are about 30 firms with an annual revenue between Rs 250 crore and Rs 2,000 crore (Rs 20 billion), which are considered to be mid-sized firms. Especially these firms are feeling the heat.
"Mid-cap consolidation will take place amongst domestic IT companies," said Ranu Vohra, managing director, Avendus Advisors, a leading investment banker in the IT and ITeS space. However, the firm estimates the total merger and acquisition including the inbound, outbound and pure domestic deals to grow at 15-25 per cent in 2008. For the ITeS industry, it estimates a 15-20 per cent growth in the same period.
"Large companies have long-term contracts and they have the ability to squeeze vendors on the sheer scale of their operation," Vohra said.
In the last two years, there has been a 300 to 400 basis points (bps) erosion in the operating margins of the IT and ITeS companies, making the small- and mid-size IT firms vulnerable for acquisition. The domestic IT and ITeS industry, which had an estimated $31 billion revenue in 2007-08 was flourishing on outsourcing and offshoring with a cost advantage of 1:6 over its biggest market - the US.
"Today at best it is 1:3," said Avendus Advisors, a leading investment banker in the Indian IT and ITeS space, referring to an international media estimate.