The wave of consolidation in the offshore information technology (IT) services space continues unabated. Close on the heels of Polaris Financial Technology Ltd’s sale to Virtusa Corp., Geometric Ltd has agreed to be acquired. Like most of its peers in the mid-cap space who have recently been acquired, minority shareholders will be delighted with the price its erstwhile owners have been able to extract from the buyer.
Geometric has sold its stake in its joint venture (JV) with Dassault Systèmes SA at a valuation of Rs.68 per share. The remainder of its business has been acquired by HCL Technologies Ltd at an approximate valuation of Rs.191 per share. Geometric shares last traded at Rs.196, which means that the deal offers a handsome 32% upside to its investors. In fact, in end February, just before reports of a deal with HCL Technologies hit the Street, the shares traded at only around Rs.145. Gains for investors from the deal, therefore, are effectively around 80%.
Incidentally, effective returns for Polaris shareholders since it de-merged its products business, before eventually selling the retained IT services business, worked out to 80-90%. But, as pointed out in this column earlier, it doesn’t make sense to expect similar results from other mid-cap IT companies, even where a sale is imminent. Mphasis Ltd is a case in point where investors are likely to be disappointed with the eventual sale price.
Does this mean HCL Technologies and Dassault have overpaid? The portion HCL purchased has been valued at 1.4 times trailing 12-month revenue, while the Dassault JV has been valued at 2.4 times revenue. It’s important to note here that the JV enjoys earnings before interest, taxes, depreciation and amortization (Ebitda) margins of more than 25%, while Geometric’s remaining business had margins of 15.5% in the December quarter.
Based on annualized December quarter earnings, HCL paid 8.6 times Ebitda, while Dassault paid 9.1 times Ebitda. Both from a revenue and profit perspective, these aren’t frightfully expensive valuations.
But some analysts are questioning the utility of Geometric’s unexciting portfolio of services for HCL Technologies. Services such as product life cycle management, and computer-aided design and computer-aided manufacturing (CAD/CAM) are far from being growth drivers in this age as Geometric’s sluggish growth itself has testified. The fact that the better-performing JV with Dassault is not a part of the deal is a let-down as well.
HCL will have to work hard and cross-sell its existing services to Geometric’s clients to make the acquisition work. On the positive side, the fact that it has acquired an offshore-centric company will make integration relatively smooth. And, of course, it helps that it isn’t a very large acquisition.
As such, HCL investors may well shrug off news of the acquisition when trading resumes on Monday. Geometric’s investors, on the other hand, have much to cheer.