Earnings impact, valuation concerns for Capco deal to weigh on Wipro stock

Intent to scale up BFSI portfolio is positive but analysts see integration and execution risks

Shares of Wipro declined more than 4 per cent on Friday as concerns over execution and valuation regarding its deal to acquire Capco left investors unenthused.

According to the company, the deal is EPS-dilutive in the first year. Analysts peg the EPS (earnings per share) hit to be in the range of 4 to 9 per cent in FY22 with Wipro’s operating profit margins seen contracting by as much as 200 basis points during the same period. However, the company expects margins to improve as it realises the revenue and cost synergies from the acquisition and estimates EPS to turn accretive from the third year.

Yet, there are downside risks analysts point out. “We see significant risk from this acquisition on account of a) integration risk due to Wipro’s weak track record, and b) execution risk on challenges related to realising potential synergies. The execution risk is further aggravated by a weak growth performance by Capco over the last two years — even after adjusting for the drag due to Covid-19,” said analysts at domestic brokerage Motilal Oswal Securities.

Valuation is another aspect the Street was not impressed with. “Capco’s revenues have declined compared to where (they were) in 2018, yet the valuation paid is 75 per cent higher than the previous transaction. Clearly, Wipro is building in significant revenue synergies. In our view, the deal is expensive,” said Kawaljeet Saluja, research analyst, Kotak Institutional Equities.

Additionally, consulting firms are difficult to integrate and Capco will be no different though risk magnitude could be lower than others, added Saluja.

Even though the firm may have overpaid and concerns over execution remain, there are certain aspects that are appreciated by analysts. For one, the deal — the biggest in the firm’s history — will make Wipro one of the largest end-to-end global consulting, technology, and transformation services providers to the BFSI (banking, financial services, and insurance) sector.

The acquisition will provide Wipro access to 30 large BFSI clients and create a large global financial services business of $3.2 billion versus the current $2.5 billion, with a strong footprint in consulting and business transformation. “Capco acquisition reflects Wipro’s aspiration and bold bet to accelerate revenue growth and augment capabilities,” said analysts at Emkay Research.

Now, it is for Wipro to prove that the Street's concerns may be overdone.