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This morning, Underweight-rated G announced a definitive agreement to
acquire Headstrong, an offshore-based IT services firm providing services
to banking and capital markets, for $550M in cash. We are familiar with
Headstrong, and believe the company is quite strong in the capital markets
arena within IT services. We were surprised by the deal; G is making a
fairly large move outside its core BPO roots, but our initial reaction is
positive since 1) the deal should be GAAP accretive assuming no
significant cost synergies, 2) the valuation is reasonable, and 3) it
strategically diversifies G to offer more integrated ITS/BPO services with
access to domain expertise and clients in the productive capital markets
sector. We do see challenges in integration, and will watch employee
retention closely once the deal closes.
• Acquisition and valuation details. The acquisition price of $550M
represents 2x CY11E revenue and 12-14x EBITDA (JPM view) –
reasonable relative to recent deals in space. This compares with 1.5x
revenue and ~7.5x EBITDA that IGTE paid for PTI earlier this year
(although PTI has a much lower growth profile), and 2.4x sales and 14x
EBITDA that Capgemini paid for KBAY in 2006 (which we believe was
a much closer peer for Headstrong in terms of growth and business mix).
Genpact intends to finance the deal using cash on its balance sheet and
new debt ($350M), and believes its net debt/EBITDA will be 0.4 post
this acquisition. G expects the deal will close by May 2011, and will be
accretive to its GAAP earnings in 2011.
• Strategic rationale. This acquisition is about growth, and not cost
synergies, and will ultimately be measured that way. G believes the
acquisition will bring domain and IT services expertise in the capital
markets vertical, and will be consistent with its recent efforts to reinforce
the underperforming core ITS business. Building scale in a crowded IT
services market is not easy, but we like that Headstrong has a relatively
narrow focus for Genpact to grow from. The acquisition will also lower
G's exposure to GE (from ~38% in CY10 to 29% by CY11 end, by our
estimate). We also expect G should be able to generate cross-selling
opportunities from the deal as it offers integrated IT/BPO services, but
we don’t see any real benefit until next year. We don’t believe Genpact is
moving away from BPO with this deal, but it does de-emphasize the
pure-play BPO model. We like the overall rationale and direction, but
believe integration will be key, as the cultures and employee retention
will be key. Note: G’s core IT services business generated $180M in
revenue in CY10 and was flat (vs. industry’s growth of 20%+)
• Impact on G’s financials. We believe the acquisition could be slightly
dilutive to G's margins (even excluding amortization and deal expenses) over
the near term, but a potential increase in Headstrong’s offshore mix should
bring its EBITDA closer to G’s. G’s near-term organic growth rate should
modestly improve, specifically for its IT Services business. The combined
company should generate ~75% of its revenue from BPO (and the rest from
IT services). Net debt/EBITDA is expected to be 0.4.
• About Headstrong. Headstrong should generate roughly ~$260-270M in
revenue in CY11 (representing ~20% growth), most of which stems from
capital markets, in our view. It focuses on a niche area within capital markets:
wealth management, risk and compliance, credit derivatives. We believe it
generates roughly 15% of revenue from business consulting and one-third of
revenue from services billed at more than $200/hr (vs. an average bill rate of
~$75/hr for offshore firms). The company has around 3,700 employees, with
30% on-site leverage. Average revenue per employee of $65k compares with
~$40-50k for most other offshore firms, in our view. We believe that Morgan
Stanley is its largest customer at 20-25% of total revenue. We believe
Headstrong generates ~15% EBITDA margins (EBIT potentially in lowdouble digits), but a potential increase in offshore leverage should help it
expand margins.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
This morning, Underweight-rated G announced a definitive agreement to
acquire Headstrong, an offshore-based IT services firm providing services
to banking and capital markets, for $550M in cash. We are familiar with
Headstrong, and believe the company is quite strong in the capital markets
arena within IT services. We were surprised by the deal; G is making a
fairly large move outside its core BPO roots, but our initial reaction is
positive since 1) the deal should be GAAP accretive assuming no
significant cost synergies, 2) the valuation is reasonable, and 3) it
strategically diversifies G to offer more integrated ITS/BPO services with
access to domain expertise and clients in the productive capital markets
sector. We do see challenges in integration, and will watch employee
retention closely once the deal closes.
• Acquisition and valuation details. The acquisition price of $550M
represents 2x CY11E revenue and 12-14x EBITDA (JPM view) –
reasonable relative to recent deals in space. This compares with 1.5x
revenue and ~7.5x EBITDA that IGTE paid for PTI earlier this year
(although PTI has a much lower growth profile), and 2.4x sales and 14x
EBITDA that Capgemini paid for KBAY in 2006 (which we believe was
a much closer peer for Headstrong in terms of growth and business mix).
Genpact intends to finance the deal using cash on its balance sheet and
new debt ($350M), and believes its net debt/EBITDA will be 0.4 post
this acquisition. G expects the deal will close by May 2011, and will be
accretive to its GAAP earnings in 2011.
• Strategic rationale. This acquisition is about growth, and not cost
synergies, and will ultimately be measured that way. G believes the
acquisition will bring domain and IT services expertise in the capital
markets vertical, and will be consistent with its recent efforts to reinforce
the underperforming core ITS business. Building scale in a crowded IT
services market is not easy, but we like that Headstrong has a relatively
narrow focus for Genpact to grow from. The acquisition will also lower
G's exposure to GE (from ~38% in CY10 to 29% by CY11 end, by our
estimate). We also expect G should be able to generate cross-selling
opportunities from the deal as it offers integrated IT/BPO services, but
we don’t see any real benefit until next year. We don’t believe Genpact is
moving away from BPO with this deal, but it does de-emphasize the
pure-play BPO model. We like the overall rationale and direction, but
believe integration will be key, as the cultures and employee retention
will be key. Note: G’s core IT services business generated $180M in
revenue in CY10 and was flat (vs. industry’s growth of 20%+)
• Impact on G’s financials. We believe the acquisition could be slightly
dilutive to G's margins (even excluding amortization and deal expenses) over
the near term, but a potential increase in Headstrong’s offshore mix should
bring its EBITDA closer to G’s. G’s near-term organic growth rate should
modestly improve, specifically for its IT Services business. The combined
company should generate ~75% of its revenue from BPO (and the rest from
IT services). Net debt/EBITDA is expected to be 0.4.
• About Headstrong. Headstrong should generate roughly ~$260-270M in
revenue in CY11 (representing ~20% growth), most of which stems from
capital markets, in our view. It focuses on a niche area within capital markets:
wealth management, risk and compliance, credit derivatives. We believe it
generates roughly 15% of revenue from business consulting and one-third of
revenue from services billed at more than $200/hr (vs. an average bill rate of
~$75/hr for offshore firms). The company has around 3,700 employees, with
30% on-site leverage. Average revenue per employee of $65k compares with
~$40-50k for most other offshore firms, in our view. We believe that Morgan
Stanley is its largest customer at 20-25% of total revenue. We believe
Headstrong generates ~15% EBITDA margins (EBIT potentially in lowdouble digits), but a potential increase in offshore leverage should help it
expand margins.
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