Industry Insight

This counter offer is not unexpected: HCL has been in talks with Axon for some months.

Infosys now has to make a counter-bid to Axon within 21 days.

Even the original Infosys offer would have made this the largest acquisition outside of India by an Indian IT services company, surpassing Wipro's acquisition in 2007 Infocrossing for $600m.

The next offer for Axon is likely to approach 690 pence per share, or closer to 2.3 times revenues, up from Infosys' initial valuation of 2 times revenues, which in the current market environment is keen.

The interest in Axon reflects

• Its strong SAP capabilities: if Infosys were to acquire Axon, it would become one of the "Top 10" SAP services vendors globally. For HCL. enterprise application services is one of eight focus areas for growth
• The increased focus by Indian vendors on the European marketplace as they look to reduce their dependence on revenue from U.S. clients. (In H1 2008 Axon derived 56% of its revenue from Europe and 42% from North America). Axon also brings a delivery center in Malaysia with c. 700 employees, which would be attractive to both Infosys and HCL.

HCL, by far the smaller suitor ($1.9Bn revenue in the 12 month period ended June 30th 2008, compared with Infosys $4.4Bn), would be challenged to raise the funds for an acquisition this size. In its last quarter, HCL reported a decline in its net profits and currently has c. Rs 2,500 crore cash in hand: the company would need to take a sizeable loan to finance this deal. HCL is stronger in IT infrastructure management and in BPO than it is in enterprise applications management. Building its EAS business is a current corporate focus: the acquisition of Axon would more than triple its EAS revenue and signifcantly change the nature of the activity.

Infosys has irrevocable undertakings from three of the founders of Axon, who together hold 17.9% of Axon's shares, to vote in favor of its offer: overall Infosys has received irrevocable undertakings covering 18.1% covering Axon's shares. In addition the company has sufficient resources to outbid HCL should it wish. However, Infosys has always been cautious by nature, particularly in its approach to M&A activity, and may choose not to enter a bidding war.

Infosys was looking to finalize the deal by November: even if Infosys is ultimately successful, HCL's new offer delays this.

Maximus' Systems segment accounted for 14.2% of group revenues in fiscal 2008 nine months year-to-date.

The business is declining and unprofitable. In FY 2008 year-to-date, the Systems segment posted revenues of $86.4m, down 7% year-over-year, and a negative operating margin of 17.5%.

Its disposal will significantly improve Maximus' profitability. At Group level:

• Revenues for fiscal 2008 year-to-date were $607.3m, and operating margin was 7.5%.
• Reclassified FY 2008 year-to-date results for continuing operations, with the divestiture assumed (and corporate costs previously allocated to the Systems segment reallocated to the other segments), show revenue down 8.4% to $556m, but a major improvement in operating margin to 12.3%.

This deal in particular expands Arvato Services' footprint for public sector CMS services beyond Germany and the U.K. to the Spanish market.

Qualytel had revenues of over €116m ($163.9.) in 2006: this is a significant addition to Arvato Services' CMS business.

The reversing of HP's outsourcing business into EDS is a wise approach to the integration given its scale and the different cultures of the firms. Within outsourcing EDS' processes are more mature also HP will benefit from EDS' scale.

Major complementarities across geographies, verticals and offerings

Geographically there is a good fit between the U.S./U.K. bias of EDS and HP's relatively strong presence in mainland Europe. In addition HP has a presence in major emerging markets such as China, whereas EDS was not in a financial position to invest in longer-term opportunities.

In terms of industries, EDS brings an installed base of large government sector clients, an area in which HP lacked the necessary scale for large outsourcing contracts

In terms of offerings:

• Both companies are strong in IT infrastructure management services. The increased scale should enhance this, with HP leading on innovation. The new entity will integrate HP's and EDS' initiatives in developing automated service platforms while leveraging HP Labs. It becomes the major competitor globally to IBM
• EDS has been building its application services business which generated $6.4Bn revenue in 2007. While it is an area HP has been targeting for several years, it has lacked real scale or high-end experience
• From a BPO perspective the merger is highly synergistic. The new entity has a strong F&A capability, a key missing ingredient within EDS's BPO portfolio. Similarly, ExcellerateHRO brings benefits admin and multi-process HRO capability, hastening the development of HP's own embryonic HRO capability. While ExcellerateHRO has been struggling in multi-process HRO and is now facing the recompete for the U.K. armed forces contract and has not met EDS' expectations to date, HP brings a manufacturing client base (including its F&A clients) and payroll capabilities: these could help generate new business. The one back office BPO area where neither company has significant capability is procurement. In the front office EDS has a major contact center business and is enhancing its portfolio with verticalized offerings, including for the manufacturing sector. The acquisition also gives HP an ability to expand its BPO client base beyond the manufacturing sector into key verticals such as government & defense and financial services. Overall the acquisition greatly assists HP in developing a full-service portfolio for BPO back-office functions, enabling it to compete strongly with IBM and Accenture in these areas. It also assists HP in breaking into industry-specific BPO in the financial services and government sectors.

Cost synergies

While it improved in 2007, EDS' operating margin was still low (5.8%) and opportunities remain to take out costs. Some synergies will relate to G&A expenses, an area in which HP has built up significant experience in recent years from its own restructuring. Other synergies will come from using HP's hardware maintenance organization, and from shared R&D.

Beyond those of integration challenges that "EDS, an HP company" faces include:

• Large EDS renewals that may opt for multi-vendor sourcing e.g. U.K. DWP, NMCI
• The Agility Alliance, where several participants (Xerox, Sun, EMC) are HP competitors and have now signed partnerships with CSC. EDS large ITO contract with Xerox expires in June 2009: Xerox could switch to CSC.

This acquisition:

• Adds TEM capabilities into HCL's remote infrastructure management (RIM) offerings
• Enhances HCL's capabilities in F&A BPO to include TEM. HCL intends to leverage its TEM capabilities in other sectors including utilities and freight.

Genpact sees large growth for F&A BPO services in Latin America and with this second delivery center (another is located in Mexico) the company is well positioned to exploit the opportunities in this market, as well as continue to serve North American clients from this near-shore location.