India: Let The Deals Begin
It felt like the lights went on again in Bangalore. Almost as soon as U.S. President George W. Bush was reelected and the specter of a Democratic Administration that might pull the plug on outsourcing receded, the deals began to flow. On Nov. 8, Infosys Technologies Ltd. (INFY ), India's top software services company, announced a $1 billion secondary offering of its shares. That same day, General Electric Co. (GE ) sold a stake in its New Delhi-based outsourcing subsidiary to U.S. investors for $500 million.
Bangalore is talking deals again. India's $16 billion tech outsourcing sector -- centered around the southern city of 6.5 million -- is growing at 30%-plus annually as ever more foreign companies farm out help desks, software writing, accounting, and more to armies of young Indians manning phones and computer workstations day and night. By 2008 the business could bring in $50 billion a year, estimates India's software services trade association, Nasscom. The group believes as much as 30% of corporate tech work can be outsourced, and so far less than 10% has been.
That potential has dealmakers from around the world licking their chops. In the next 18 months, investment bankers are expecting a wave of mergers and acquisitions as competitors rush to achieve the critical mass needed to serve global clients in everything from call centers to financial analysis. "It's going to be a sizzling sector," says Vedika Bhandarkar, head of investment banking at J.P. Morgan India (JPM ). "There will be more M&A, more consolidation, more U.S. listings."
Both multinationals and locals will be jockeying for position. Even though business is booming, so many companies have sprung up that pricing competition has become cutthroat. In all, India has 400 outsourcing companies, ranging from tiny 25-person shops doing simple data entry to behemoths such as 13,000-employee Wipro-Spectramind, the back-office arm of Wipro Ltd. (WIT ). And their demand for college grads is so great that half the workers at many outsourcing companies quit every year to take better jobs. That's driving up costs: Wipro and Infosys this year boosted wages by 10% to 15% across the board to keep workers from jumping ship. "Large acquisitive players will see [M&A] as a means of reducing competition," says Pradeep Mukherjee, managing director of neoIT.com Inc., a Bangalore outsourcing advisory firm.
There's likely to be a scramble to gain local knowledge, too. The outsourcing industry was pioneered by the Indians, so the most successful shops have been homegrown. Except for GE and Citibank (C ), foreign operators came late to the game and have been playing catch-up. In April, IBM Global Services paid $150 million for New Delhi's Daksh, a call-center operator with 6,000 workers and customers around the world. That purchase catapulted IBM (IBM ) into the top ranks of Indian outsourcing players. Insiders say other U.S. services firms may seek similar deals. "Like IBM, Accenture (ACN ) and EDS (EDS ) will look to buy scale here," predicts K.P. Balaraj, managing director of VC firm WestBridge Capital. Accenture declined to comment. EDS says it is more likely to pursue organic growth.
There's no shortage of potential targets. Insiders say suitors are talking to 24/7 Customer, a 4,000-person call-center operator in Bangalore funded by California's Sequoia Capital. VCustomer, an operator with about 4,000 employees in Delhi and Pune and backed by private equity fund Warburg Pincus LLC, is also a potential target. Neither company would confirm any takeover talks.
UP FOR GRABS
It's not just locals that are up for grabs -- as the GE deal shows. The U.S. giant set up its back-office operation in India in 1997. Since then the unit, GE Capital International Services (Gecis), has grown into a $430 million giant with 17,000 employees in four countries handling sophisticated processes such as data modeling and actuarial analysis, in addition to customer service. Now, though, GE thinks Gecis will fare better as a semi-independent shop serving a diverse customer base rather than just GE. So it's selling off 60% of Gecis to U.S. venture funds General Atlantic Partners LLC and Oak Hill Partners LLC for $500 million. "We want to build a global business," says Gecis President Pramod Bhasin.
Bankers expect more such sales. Like Gecis, the Indian call-center and back-office operations of the likes of American Express (AXP ) and Standard Chartered Bank may have grown so big and expensive compared with local players that it no longer makes sense to keep them in-house. Both have more than 4,000 employees in India. But because such outfits serve only their parent, they aren't as hungry and aggressive as homegrown players. Analysts say the costs of these so-called captive outsourcing operations are up to 40% higher than local rivals'. "They will face the same value-unlocking pressures that GE faced before deciding to spin off its back-office operation," says Prasad Baji, vice-president at Bombay boutique investment bank Edelweiss Capital Ltd.
The purchases aren't just one way. So far most jobs flowing to India have been relatively low-level call-center positions. But as India's outsourcers take on more sophisticated work such as analyzing balance sheets or managing logistics, they are looking to buy operations overseas. On Oct. 30, Scandent Group, an Indian-owned Singapore company with operations in Bangalore, bought Cambridge Integrated Services Group, the $230 million back-office arm of Chicago insurer Aon Corp. (AOC ), for an estimated $175 million. That makes Scandent the third-largest insurance back-office outfit in the U.S. While Cambridge will remain a U.S. company, Scandent plans to list it on the Indian stock exchange.
Other Indians are on the prowl. A year and a half ago, Wipro-Spectramind got 2% of its revenues from processing insurance claims and providing accounting services. Today the sector represents 15% of the company's business, so Spectramind plans to "proactively target that market" and is weighing acquisitions, says CEO Raman Roy. Computer maker HCL Technologies Ltd., which gets 65% of its revenues from call-center-based tech support for the likes of British Telecom (BTY ), wants to buy a U.S. company that will add skills such as financial analysis.
There's no shortage of ambition in Bangalore. Although worries in the U.S. about jobs flowing overseas could still slow the sector's M&A activity, the possibility of a serious backlash against outsourcing seems to have faded with Bush's reelection. So bring on the dealmakers.
By Manjeet Kripalani in Bombay, with Josey Puliyenthuruthel in Bangalore