Computer Sciences Corp has agreed a $1.3bn takeover deal with Covansys, a Michigan-based IT services vendor that specializes in providing low-cost services from Indian centers.
CSC, the sixth largest IT services supplier in the world, has lagged behind its peers in terms of its global sourcing strategy, but said that the takeover will double its headcount in India, the world’s largest low-cost IT skills hub, to 14,000 employees.
The closest parallel to this deal is Capgemini’s $1.3bn purchase of Chicago-based Kanbay International last year, through which the French vendor gained a large offshore development arm in India, as well as a mature client-facing operation in the US.
The price tag on both takeovers may be identical, but CSC is paying a higher premium. Capgemini stumped up $29 per share to acquire Kanbay, which worked out at a mark-up of 16% over its closing price before the deal was announced, whereas CSC has agreed to pay $34 per share, a premium of 27% over Covansys’ closing price of $26.80 on Wednesday.
A comparison of the two companies suggests that CSC is getting slightly more for its money in some regards. Kanbay brought 6,500 employees to Capgemini including 5,000 at three Indian development centers. It was on course for full-year 2006 revenue of $413m with earnings per share expected to come in at $0.85, and the company’s operating margin was a healthy 11.4% in the first nine months of last year.
In contrast, Covansys has 9,000 staff including approximately 7,000 located offshore at centers in Bangalore, Chennai, Mumbai, and Vadodara. In full-year 2006, Covansys reported a 4% decline in diluted EPS to $0.95, on revenue that rose 4.9% to $545m, with an operating profit margin of 10.6%.
Covansys makes the bulk of its revenue from application maintenance and development projects, and also provides testing and validation, and systems integration services, and owns a stake in a business process outsourcing arm called Fortune Infotech.
Covansys had 50 multimillion-dollar accounts at the end of last year, with major accounts including Allianz, Ford, and Lucent. Some 86% of its 2006 sales came from clients in the US although it also has operations in Canada, Belgium, the UK, Spain, Germany, Italy, China, and Singapore.
Over the last 18 months, Covansys has been beset by investigations into its accounting processes. The problem first surfaced in October 2005, when the company postponed its earnings release for the third quarter because of an internal investigation (that did not reveal any reporting issues) and then because of a reassessment by its auditors BDO Seidman. In January 2006, Covansys said it had completed a re-examination of its revenue-recognition policies.
But problems resurfaced last October when Covansys missed the filing deadline for its third-quarter results due to continuing reviews of its accounting practices. The results did not actually appear until January 2007, by which time the Nasdaq exchange had found Covansys in non-compliance with regulations and threatened delisting.
CSC said that the takeover would take the size of its Indian workforce to 18% of its global headcount, which puts it on a similar level to its rivals. Following the Kanbay deal, Capgemini has more than 12,000 or 16% of its total workforce based in India, while EDS has more than 15,000 or 11% of its 131,000 staff in the country. Accenture leads the way and is expected to have 35,000 or 22% of its 160,000 staff based in India by the middle of this year.
Shares in Covansys rose more than 24% in morning trading to $33 following the announcement of the takeover agreement, just under the offer price, while CSC saw its share price slide 0.5% to $55.70.
We said that the time of the Capgemini/Kanbay deal that Covansys and other western offshore specialists were very much in play as potential acquisition targets for international players looking to quickly ramp up their global delivery networks.
Vendors such as Covansys are attractive as they are perceived as having a western corporate culture and a mature client-facing sales and marketing operation, which in theory should make them less painful to integrate than a supplier based in India. Other companies that fit this bill include US outfits Sapient and Syntel, and UK applications and business services player Xansa.
Covansys has looked vulnerable ever since its accounting problems hit its share price, and after streamlining its structure over the last 18 months with a couple of disposals and tightening its focus on a number of key vertical markets, the business is in reasonable health. However, it lacked the scale to win the size of business that the tier one Indian vendors are regularly securing, so CSC will try to sell its much broader and deeper portfolio to the Covansys client base.
The takeover also indicates that CSC is back on the front foot after considering a sale last summer. After weighing up its strategic options, it pulled down the For Sale sign and undertook a $2bn share buyback, and the purchase of Covansys sends out a message that it is tooling up to become more cost-competitive in a market where global delivery capabilities have become a prerequisite on commercial sector tenders.
One clear trend is that western IT services providers are increasingly aggressive about using M&A activity as a way to grow their resource bases in India, as intense competition in the country’s labor market makes it increasingly difficult to recruit the right quantity and level of skills organically. In the last three years, CSC, EDS, Capgemini, IBM, Perot Systems, have all executed takeovers designed to boost offshore numbers, and more should follow.