Mid-tier IT, BPO space sees surge in consolidation as firms chase scale

Need to garner scale, attractive valuations giving rise to consolidation in the space

Mid-sized information technology and business process management (BPM) services firms are witnessing a wave of consolidation in recent times as a decline in legacy business and the need to expand digital capabilities are prompting firms to seek scale in orders to stay competitive. 

On the other hand, industry observers are of the opinion that given the attractive valuation of mid-tier IT companies, many promoters also want to cash in the gains by selling out stakes to interested parties.

"For most of the mid-tier IT services firms, the customer base is not very diverse, with high concentration with a few customers. So, in an environment where the core business is getting commoditised, one needs to be a reasonably sized player in the market to get some traction," said V Balakrishnan, chairman of Exfinity Ventures, who was also a former board member and chief financial officer at Infosys.

"If the consolidation is complementary, then it will help them to cross-sale and diversify their customer base," he added.

The Indian IT services industry has seen a spate of mergers and acquisitions in the past two years. Pune-headquartered KPIT announced its merger with CK Birla Group-owned Birlasoft earlier this year to create an over $700 million combined entity, with plans to split it into two separate firms.

Similarly, in March, Aegis -- a business process outsourcing firm and the portfolio company of Capital Square Partners -- announced its merger with US-based Starteck. Upon completion of the deal, the entity will have a revenue of $700 million, with over 50,000 employees and operations in 12 countries. 

In June this year, France-based back-office service provider Teleperformance announced plans to acquire BPO services company Intelenet, which was owned by private equity major Blackstone, for around $1 billion (Rs 68 billion). The deal marked the exit of Blackstone with a four-times return, its largest in Asia so far. Similarly, Altran Technologies of France acquired engineering services firm Aricent from KKR and others, with an enterprise valuation of $2 billion, late last year.

More recently, there are reports suggesting the probable exit of promoters of Noida-based IT services firm NIIT Technologies. Private equity (PE) players such as Bain Capital, Blackstone, Carlyle, Apax Partners and Advent are learnt to have shown interest in buying the promoters' stake in the company. Similarly, V G Siddhartha, the largest investor of mid-size IT services firm MindTree, who is also the founder of Café Coffee Day, is reportedly looking at selling his around 26 per cent stake in the Bengaluru-headquartered firm. Global PE giants such as KKR have shown interest in taking a position in the company, according to media reports.  

However, analysts remained sceptical about PE funds buying out promoters' stake given the valuation upside mid-tier companies have seen in the past two years.

"PE players come in when the cost structure is very skewed. But, in the IT industry, most of these companies run very efficiently from the cost perspective. It is likely to be a consolidation play for size rather than a PE play in these companies," Balakrishnan said.

Experts also believe that PE investments, for the large part, only keep financial gains in mind, rather than having an intent to improve operational efficiency. "If PE players come in, that will be an investment-oriented decision rather than anything to do on the operational side," said Siddharth Pai, a former outsourcing advisor and founder of Siana Capital.