The global IT and BPO services market is witnessing heightened M&A activity. Last year the market saw a total of 436 deals being signed globally, translating into an estimated cumulative deal value of $52 billion. This is a huge leap over M&A deals worth about $3 billion in the services space in 2006.
M&As highlight the changing nature of an industry, where leadership slots are up for grabs, and competitive differentiators are still emerging. In such a scenario, speed is of essence for establishing a new more compelling business model, and the inorganic route becomes the favored one over the slower organic one. Sourcing companies are favoring the inorganic route, and the pace of M&As in the services industry is gathering steam.
The growth we saw last year may not continue in percentage terms, but in absolute numbers, we will see significant increase in the volume and aggregate value of deals. This is partly due to the base effect, and partly due to the buoyant markets and stretching valuations. We may not see a significant volume growth in the big-ticket billion dollar plus deals, as most of the “good picks” seem to have been taken. On the lower end of the spectrum, we believe there will be a significant amount of consolidation and acquisition, especially in the higher-end BPOs, as mid-sized to large firms look to acquire niche capabilities, and growth engines of the future. Captive spin-off opportunities will continue to generate interest.
By 2010, M&As in the services space will exceed $100 billion globally, with cross-border deals accounting for more than half the pie. In addition, India will continue to be the most active geography after the U.S.A., and we will see a predominantly outbound action originating there. M&A action is also expected to grow multifold in Europe, as services firms target Europe both as a customer as well as a delivery geography. Service providers of different sizes, in diverse geographies will use M&As in distinct ways to further their interests. Let us explore these diverse motives and the likely impact on deal making.
U.S. Firms
Large American firms will continue to make small strategic acquisitions both in the U.S.A. and offshore. For the ones that have not yet cemented their India strategy, it is now or never. Besides India, these players will look to establish secondary offshore bases in countries like the Philippines, China, Vietnam and Eastern Europe.
The smaller U.S. firms, not having any offshore presence are ripe for the picking by either small to mid-sized offshore firms looking for a front end, or a large player looking to add on a high-end complimentary set of service line or competency. Particularly, low-margin services firms in the U.S.A. will be prime targets for acquisitions or private equity (PE) backed buyouts. U.S. midcaps have been rather slow in adopting a global approach to service delivery. The ones in distress will look for consolidation, and will be more open to drastic acquisitions or buyouts, both domestic and overseas.
European Firms
Europe is likely to see a lot of consolidation, as Europe-based firms look to compete with the global services firms. A number of European firms have been trying to create significant offshore presence, but have not been as successful as their U.S. peers. They have been a little late in making the move. Lack of cultural integration with the offshore (India being the predominant geography) has proved to be a big stumbling block for the European players.
These European firms do have the advantage of proximity and familiarity with their home ground, which compared to the U.S.A., is more difficult to penetrate for the offshore players. Even large U.S. companies have not been able to dominate the European market, which has a lot of local characteristics and nuances to deal with. Large to mid-sized offshore companies, looking to diversify their customer base beyond the U.S.A., will also continue to seek small European firms to serve as front ends. Eastern European firms will be acquisition targets for the American and offshore firms, looking to set up bases to serve the European demand.
Offshore Firms
The big challenges in front of offshore service providers are: Moving to complex end-to-end outsourcing contracts, and broad basing their client footprint to reduce dependence on the U.S.A. as the primary demand geography. The top-tier companies have cemented their position as the best in class “offshore providers,” but there is still a long way to go for them to be regarded as the best-in-class option for “outsourcing” in general. It would take enhanced onsite footprint, ability to take on end-to-end outsourcing of functions and enhanced domain knowledge of the client’s business.
Acquisitions will be the favored route for getting the missing parts of the puzzle. We will see increased pace of acquisitions in the U.S.A., once these firms learn to efficiently manage integration issues. Acquisitions will be made for specific skills onsite and offshore, and higher-end domain knowledge onsite. Offshore firms will still be circumspect in evaluating acquisitions in Europe, since language and cultural barriers are harder to overcome. We may see a lot of partnership-based relationships with some equity participation, rather than complete buyouts.
The tier-1 firms in Asia (other than India) are already looking to expand both their front-end presence as well as their delivery capabilities. In the coming years, we will see a lot of PE-backed acquisitions originating in countries like China, the Philippines and Vietnam, besides India. In turn, the global majors who don’t have delivery centers in these countries will look for acquisitions to have alternates to their India centers.
Besides the traditional M&A deals, we may also see innovative transaction models that combine outsourcing and acquisition, a case in point being the Infosys-Philips deal. This is an outsourcing deal, it involves asset transfer to the service provider at a price. This model may be employed by companies to get a delivery foothold in an Eastern European destination, which can then be developed further as a delivery plus business process development base for the customers located in Europe.
Avinash is the Chairman and CEO of Tholons, a services globalization and investment advisory firm. Nishant is a specialist in globalization strategy formulation. He has led several M&A and consulting engagements for U.S.- and European-based clients.
