Research Brief

iGate’s Buy Patni – Vendor’s Growth

Strategy, Don’t Mean Client Value
Sudin Apte
10 th January 2011

The long awaited announcement has finally been made today; this will be the
largest IT acquisition India has witnessed so far. While most Patni clients view
this as a routine act in the global tech world, they will wait and watch how the
transaction pans out. While buyer iGate gets a mechanism to avoid
marginalization for a few more years, the diverge background of the two
providers hardly offers any value to Patni’s clients. Our research also shows that
iGate will witness a large number of Patni’s current employees – both senior
managers and developers alike –quitting in the coming months, thereby taking
the attrition to well over 30%. Result? Not seeing their delivery teams on the job,
clients will take a cautious approach and move the work to an alternate provider.
Also, the long drawn statutory and integration process, coupled with the
dispensable position Patni was in at most client places, will result in many clients
neither renewing many of their contracts nor awarding new projects. And given
that Patni shares almost all its accounts with either a top Indian or MNC provider
(wherein Patni holds a small piece of business), shifting a part of the work slowly
is relatively easy.

A Mid-tier Offshore Provider iGate Takes Over Patni Computer

Systems, Three Times Its size
Finally, after cancelling the announcement once last week, Patni Computer Systems has been
sold. The front-runner in the acquisition process – a mid-tier offshore provider iGate –
emerged as the winner. iGate purchased 63% ownership of Patni from the founders (the
three Patni brothers including the current Chairman Mr. Naren Patni) and an investor
(General Atlantic). In addition, as per the Indian exchange controller’s guidelines, iGate will
make an open offer for acquiring an additional 20% stake from financial institutions and retail
investors. Subject to statutory approvals and completion of Indian company law formalities, it
will take at least three to four months to seal the deal completely before the foray into an
actual integration of the two firms.

The News About the Deal Is Full of Myths

Electrified with the country’s first ever billion dollar IT industry takeover involving two
publicly traded companies, a large section of the media and stock market pundits have been
highly excited about the news for the past four weeks. To add to the flurry of confirmed and
unconfirmed news articles, iGate cancelled its scheduled press meet last week announcing
the deal, at the last moment for unexplained reasons. A high-tech Patni client told Offshore
Insights that they were thoroughly confused with information received from the public
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domain, as they had hardly heard anything meaningful from their supplier under question.
With very few Patni clients working with iGate, their apprehensions sky rocketed with the
possibility of an unknown company buying their provider. With limited intervention from
either player, the Indian IT industry has once more demonstrated its inexperience to manage
the media hype as various myths made rounds – not only in India but even abroad, as smart
competitors took it a step further and reached out to confuse their clients as well.

Myth 1: This acquisition puts “iGate + Patni” in the top bracket.

Reality: The combined entity ranks tenth in the pure play offshore providers list. Just
for the record, the last twelve month revenues of these two companies actually sum up to
only US$ 940 million. Even if we ignore this nitty-gritty, the joint entity emerges as the tenth
Indian or India-centric company after the top five (Cognizant, HCL, Infosys, Tata Consultancy
Systems, and Wipro) and the next four mid-tier firms. (Tech Mahindra, Genpact, Mphasis and
Mahindra Satyam) Furthermore, the history of tech acquisitions shows that in very rare cases,
100% of the acquired company’s revenues get transferred to the joint entity.

Myth 2: With billion dollar revenues under its belt, the new entity can now
compete neck to neck with the likes of Tata Consultancy Services and
Infosys.
Reality: Top firms are still beyond the reach of the new entity. Tata Consultancy
Services reported revenues of US$ 2,004 million for the quarter ended September 30, 2010 –
which is more than double the combined annual revenue of the joint entity. Top practice lines
at TCS and Infosys – such as ADM or Enterprise Application services – are each well over a
billion dollars in size. In contrast, the joint entity’s billion dollar business comes from over half
a dozen service lines and industry verticals each. Barring application development, (joint
revenue of around US$ 550 million) all other service lines of the combined entity are in the
sub $100 million dollar category.

Myth 3: Scale is everything.

Reality: Just having scale is passé; solution value matters as well, if not more. Firstly,
scale from the client’s perspective is not overall company size but the magnitude of work that
the provider does in their area of interest. So it’s not really overall company size that matters
when it comes to clinching the deal. Over the past three to four years, top providers have
converted their humongous size into higher value in their solutions. Our analysis of several
vendor proposals that our clients received shows how firms like Cognizant and Infosys have
leveraged their hefty margins to build Centers of Excellence (CoE), develop intellectual
property assets, put together industry solutions, and recruit hundreds of domain experts.

Myth 4: Investors, stock market pundits and clients all think alike.
Reality: Clients worry about the future of their work. Parameters such as vendor’s
revenue, profitability, market cap, and how they stack in Nasscom’s top 20 list – high interest
areas for investors – are of limited interest to most clients. They worry more about basic
issues like continuity of their delivery team and whether the acquisition will hamper their
project timelines. Their views and actions are also based on factors such as what type of work
Patni does for them; do they view the relationship with the acquired company as strategic;
and who are other incumbent providers in the same account.

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Understanding the iGate-Patni Anatomy

Companies buy other companies for three reasons – 1) to build scale by leveraging similarities
and synergies, 2) to diversify (and in that way grow in size) by acquiring a company that opens
new avenues and 3) to kill competition. The current iGate-Patni deal sounds like a blend of
the first two, with a higher tinge of the second reason. Besides, both companies are offshore
centric and have common clients like General Electric. The similarities between the two
include - ADM practice, US centricity, and presence in broader (and arguably vague) industry
verticals of Banking, Financial Services, Insurance and Securities, popularly known as BFSI in
India. Apart from these high-level synergies, the two firms’ business profile looks fairly
divergent as shown in Figure 1.

 Top verticals that Patni focused included Insurance (30%), Manufacturing & retail
(25%), and High-tech for product development (16%). In contrast, iGate is heavily
concentrated in the Banking and Mortgage space (over 55% of its revenue).

 Apart from common Application Development and Management (ADM) practice,

Patni has a sizeable presence in ERP (15%), R&D services/product engineering (18%),
and infrastructure services (7-8%). On the other hand, iGate seldom works in any of
these areas. iGate’s iTOP platform and business services provisioning (BSP) strategy
that practically takes over clients’ business process ownership on a risk-reward
model, is quite different from Patni’s BPO wherein they carry out transactions such as
claims processing for insurance and other standard processes like finance, accounts
and customer service/tech support.

 The combined entity is spread thin across multiple market segments. With very
limited features in common, the joint entity – with a revenue size of a billion dollars –
will operate in almost every service line that comes offshore and have clients spread
across at least eight industry verticals. Apart from one service line (ADM – around
$550 million in size) they lack similar scale in every other space they operate in.

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Figure 1 Indicatory Financials For Last Twelve Months (approximated)

Indicatory Financials For Last Twelve Months

(approximated)
Patni iGate Patni + iGate
Overall
Revenue (US$ in millions) 688.9 252 950
Typical Profitability % 16% - 18% 18% - 20% 16% - 18%
Net Profits for last twelve months
115 50 165
(approximate) (in US$ millions)

Geographic spread of revenue (US$ Millions)

North America 570 217 787
Europe & Middle East 80 20 100
Asia Pac 50 15 65

Break up of revenue by Service Lines (US $ millions)

App Dev & Mntc (ADM) 435 140 575
Pkg App / Enterprise App work 90 45 135
R&D Services/Product Engineering 85 0 85
Infrastructure Management services 40 0 40
BPO / Business Services 50 30 80
Other Services (Testing, Business
37 37
Intelligence etc)

Break up of revenue by industry Verticals (US $ millions)

Insurance 210 0 210
Mfg + Retail 200 45 245
Banking and Fin Services 85 160 245
Telecom + Media 90 25 115
Product Engg/High-tech 115 0 115
Healthcare 10 10
Services 0 12 12

Source – Offshore Insights Research

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Indicatory Operations Data (approximated)

Figure 2
Indicatory Operations Data (approximated)

Patni iGate Patni + iGate*

People
Headcount 16500 8300 24800
Attrition 26% 16-18% approx 24%*
Clients
Total clients 282 82 340-350
Top client size 11.10% 35% 12-13%
Top 5 clients size 35.60% 71% 40-45%
Top 10 clients size 48.50% 84% 52-55%

$ 1M accounts 98 NA 125 - 130

$ 10M accounts 14 NA 18 - 20
$ 50 M accounts 3 NA 4 to 6
$ 100 M accounts 0 NA 1

Source – Offshore Insights Research

How Will the iGate-Patni Integration Pan Out?

The deal is inked, but a long drawn process of merging the two entities will start, at best, only
after three to four months. While Patni’s new owners remain busy internally – first in
completing the deal process and obtaining statutory approvals and then in integrating a
nearly three times bigger firm with their company, clients, competition, and employees will
undergo an eighteen month long phase of uncertainty. A series of multiple factors –
growing/changing client demands, their perceptions about the deal, awarding of renewals
and new projects from Patni’s portfolio, competition, and how existing employees view the
merger – will shape the future of the joint entity. Following are our top predictions:

 Clients’ top concern is their work, not who buys Patni. Unlike the vendor world and
media, clients have very fundamental objectives. They are worried about the
continuity of their teams. They would like to see their delivery managers, transition
teams, and executive sponsors continue with the joint entity to ensure that the
knowledge transfer to Patni over the years is retained with the new company and
their projects don’t suffer.

 Clients will assess the new management’s focus on their work. Clients selected Patni
for a specific work and would definitely want to see this continuity in the integrated
entity. They would like to know if the new buyer intends to continue in the space they
operate in. Specifically, firms that use Patni for services like product engineering will
be concerned as iGate historically doesn’t operate in that space.

 Clients want to see a detailed road map and plan for execution of the acquisition.
Clients who face tech vendor acquisitions often complain about lack of transparency

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and communication. Most clients informed us that they would like to receive a
periodic and detailed integration plan and relevant updates from the new owner.

 Patni’s current top management and staffers will look out, and will find takers.
Irrespective of whether iGate agrees or not, our informal interactions with Patni
staffers – both senior managers as well as developers – show a sense of uncertainty,
typical to any such transaction and in all probability, they will start looking out. Luckily
for them, the offshore market is seeing good recovery and most tier 1 providers are
recruiting heavily. They will not only leverage Patni staffers as a trained resource, but
also look for a possible client relationship. We estimate the joint entity will face a
substantial rise in its attrition and may lose one in every three or four employees.

 Master services agreements (MSA) will continue, but not all renewals will. Our
client interactions show that most large clients may actually continue, as in, they will
not explicitly terminate the relationship. But they will adopt a ‘wait and watch’
strategy. Given that 90% of the work coming through these engagements/MSAs is via
project work or short project renewal based work, clients may not award renewal
contracts to Patni and slowly shift to alternate vendors. This situation will continue till
the entire merger/reverse merger process is completed – say in a year or 18 months.

 Almost 25% of Patni’s revenue will not transfer to its new buyer. Patni, like many
other mid-sized firms, has limited differentiation. Further, it shares its 90% clients
with either top MNCs and/or top Indians. Ironically, in the books of Patni’s clients,
Patni ranks number two or three or even four in the supplier list going by business
size ranking. A lot of Patni’s work is of application maintenance type (65% of Patni’s
revenue comes from ADM work) and it enjoys a very limited indispensability.
Desperate to grow, incumbent competitors will continue eating into Patni’s base.

 Role of investor- private equity firm Apax will matter. Private equity money not only
lends financial aid but also brings in two distinct advantages. Firstly, Private Equity
firms bring financial and management experience and prudence to the company
where they invest; secondly, they can open new client doors. If Apax is successful in
blending its several portfolio companies with the joint entity, it may replenish a lot of
revenue loss from current Patni clients.

As a client, what should you do as the deal progresses? We suggest that you should:
Clients’
action items
to succeed:  keep an eye on how the equity process happens and how the integration plan pans
out. Meanwhile, it is important to take stock of all your ongoing work with Patni and
make Plan B ready so you can shift the provider without much disruption.
 push your account manager (from Patni) and the new buyer to provide a detailed
road map of the integration. As a client, you need to know how exactly the transition
will occur and how they plan to treat your work.
 insist for continued investments in your areas of interest. Unless a supplier focuses on
upgrading capabilities continuously they lose the competitive edge, resulting in you
as a client receiving sub-standard service compared to what is available in the market.
 re-negotiate with your new buyer and clearly put forward what you care most about
– work, people, milestones. Ideally, link a substantial part of your payments to
continuity of staff and revised service levels.
 involve an alternate vendor in some of your mission critical work to build a
knowledge base and mitigate your risks.

© 2011 Offshore Insights Research & Solutions Private Limited. <10th January 2011>