The strategic buyout of Axon will increase Infosys' share in the high-growth SAP segment and consolidate its position in Europe.
Infosys Technologies chose to finally break the shackles of conservatism last Monday, by making an offer to acquire UK-based SAP consultancy services firm Axon Group for £407.1 million ($753 million or Rs 3,310 crore).
This all-cash deal would make the acquisition the largest overseas acquisition by an Indian IT company, surpassing Wipro's buyout of US-based Infocrossing last year for $600 million. This is Infosys' second acquisition of an entire company. The first came in December 2003 when it acquired Australian company Expert Information Services for $22.9 million.
The move marks a clear attempt by India's second largest software services exporter to move up the value chain in the services spectrum and focus on the high-growth business of consulting.
Quite a find
Axon is one of the largest consultancy company in the world, focused exclusively on the provision of SAP services and solutions.
The company has clients spread across diverse sectors including aerospace, retail, manufacturing and utilities in about 30 countries.
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The company has a sound track record, with zero-debt on its book and having registered CAGR of 42.7 per cent in revenues and 68.2 per cent in profits over CY2003-07, although a part of the growth has been fueled by the 11 acquisitions that the company has made in the last few years.
For H1 CY08, Axon declared better than expected results, with revenues up 28 per cent year-on-year (y-o-y) to £123.9 million (Rs 1,007 crore) and EBITDA up 17.2 per cent y-o-y to £18.1 million (Rs 147 crore). Consensus research estimates for Axon peg full-year revenues at £244 million and recurring EBITDA at £40.7 million.
Based on these forecasts, the acquisition price represents a multiple of 1.67 times its 2008 revenues and 10 times it’s EBITDA, which is very reasonable, considering that consulting firms are generally valued two to three times their revenue. Though not strictly comparable, Infocrossing acquisition by Wipro was made at 2.6x revenue.
Cashing in on the opportunity
It is probably not a bad time for a buyout because share prices have come off sharply. Axon’s price has corrected by 46 per cent from its 52-week high of £9.28 made in September 2007.
The buy also removes some amount of money from Infosys' cash-laden balance sheet. Infosys had $1.7 billion of cash at the end of June 2008, which would come down to about $1 billion, adjusting for the acquisition.
On the earnings front, the acquisition is expected to be largely earnings-neutral. The loss of interest income on the free cash would largely be made up by the earnings from Axon in 2009. The synergies that Infosys derives from the acquisition can thus be considered as an added benefit that the cash would generate in the long run.
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# interest rate = 9%
* tax rate = 15%
Multiple benefits
Focus on high growth segment: Consulting and Enterprise Solutions segment has grown at a CAGR of 65 per cent over the last three years and amounted to nearly $1 billion in FY08; nearly 24 per cent to Infosys' total revenue. Axon's complete business comes from this segment and its CY07 topline is about 42 per cent of Infosys' FY08 revenue from this field, thus making a substantial addition to Infosys. Axon could well prove to be an important growth engine for Infosys in the years to follow.
Enhanced capabilities: Axon brings on board close to 2,000 SAP consultants with high-end consulting capabilities, required in verticals like aeronautics and oil and gas. “Adding quality consultants organically would have been the biggest challenge for Infosys. Doubling its consultants in one-shot is one of the biggest positive of this deal for Infosys,” opines Anil Advani, head of research, SBICAP Securities. Infosys can now leverage its size and global presence along with Axon's consulting expertise to win big transformational deals with multi-year values of $50-100 million in the US and Europe. This makes sense for Axon too, given the stiff competition from bigger players like Capgemini and Accenture in these markets.
Diversification: As per the Forrester Research estimates, the deal now brings over a hundred new clients including British Telecom, Xerox, Vodafone and Barclays Bank along with industry verticals such as public sector to Infosys' fold.
“Historically, Indian companies have struggled to find a foothold in Europe, as the market is not only fragmented but protectionist in nature”, adds an analyst. The acquisition will reduce exposure from US (currently 63 per cent) by 3 per cent and increase the share from Europe by the same proportion (currently 27 per cent).
Things to watch
Improving Axon’s margins and cultural integration are the two biggest issues that Infosys faces, apart from the possibility of a counterbid from another suitor.
Even as Axon garners one of the best margins among its peers, the blended margins of Infosys (post acquisition) will be lower as Axon’s operating margins at 15 per cent are half that of Infosys; the difference is due to a varied business models (onshore v/s offshore).
Infosys would now have to work on improving Axon’s margin by offshoring part of the incremental business (of Axon) to its SEZ based in India. And while Infosys has no experience of managing such a large acquisition and integrating two diverse culture firms, given that the current Axon management is committed to stay for a period over two years, there is fair possibility of a reasonably smooth integration.
The deal is expected to be consummated by the year-end and would add to Infosys’ financials from January 2009. The next 30 days will be critical for Infosys as this is the period during which a competing bid could be tabled. In the event that Axon accepts a competing bid Infosys is entitled to a break fee of £4 million.
| LONG TERM PLAY | |||||
| Rs crore | FY08 | Without Axon | With Axon | ||
| FY09E | FY10E | FY09E* | FY10E | ||
| Net sales | 16692 | 21240 | 25534 | 21540 | 26975 |
| Net profit | 4659 | 5891 | 6901 | 5893 | 6990 |
| OPM (%) | 31.4 | 30.5 | 30.0 | 30.2 | 29.1 |
| NPM (%) | 27.9 | 26.9 | 25.9 | 26.4 | 24.3 |
| EPS (Rs) | 81.3 | 102.5 | 119.6 | 102.5 | 121.4 |
| P/E (x) | 21.5 | 17.0 | 14.6 | 17.0 | 14.4 |
| E: Analysts estimates * - 3 months consolidation of Axon | |||||
Outlook
Infosys derives 34 per cent of its revenue from the banking, financial services and insurance vertical and its exposure to the North American market stands at 63 per cent of its FY08 revenue.
Although the global macro environment is not very encouraging on account of delayed decisions by the customers, flat pricing and trouble in the banking and financial services sector, Infosys' management and business model are better equipped than its peers to handle these issues.
In its annual analyst meet held last week, the management indicated that its hiring plans are on track and the company should meet the target of having about 25,000 gross additions in FY09.
Also, pricing for the company has been stable and instances of larger-scale price renegotiations have not been many. On account of depriciation in rupee, Infosys revised its FY09 revenue and earnings guidance in July. While the company expects revenues to grow by about 27.5-29.5 per cent to Rs 21,278 - Rs 21,622 crore, growth in earnings per share is forecasted to grow between 24.4-26.6 per cent to Rs 97.8-100.5.
The Axon-deal is positive for Infosys. Trading at Rs 1,748.50, expect the stock to deliver returns of 15-20 per cent.