Analyst Corner: Tech Mahindra – Need to keep eye on rising pace of acquisitions

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Published: February 27, 2020 2:30:22 AM

The total outlay on acquisitions in FY20E is ~$240 million or 37% of OCF.

tech mahindra, mahindraTechM’s acquisition philosophy has a few threads — acquisition for competencies, especially in next-gen areas or expansion in verticals/geos, and manageable in size and inexpensive ones.

Tech Mahindra’s appetite for acquisitions has increased with the announcement of six transactions in FY20. While the philosophy of acquisitions, viz capability-based, small in size and largely in next-gen areas, is well-appreciated, we keep a close eye on the increasing frequency of transactions. TechM’s multiple re-rating in the past 24 months has been based partly on improved capital allocation. The total outlay on acquisitions in FY20E is ~$240 million or 37% of OCF.

TechM’s latest acquisition of Zen3 Infosolutions brings on board two features — capability in Azure and enterprise software product engineering and a rich client base. Key financials of Zen3 — revenue rate of $50 million on annualisation of H1CY19 revenues and Ebit margin of ~10%. Purchase consideration is $64 million split between $42 million upfront and $22 million through earnouts. This is TechM’s sixth acquisition this fiscal. Other key acquisitions were Mad* Pow, BORN Group and Cerium Systems.

TechM’s acquisition philosophy has a few threads — acquisition for competencies, especially in next-gen areas or expansion in verticals/geos, and manageable in size and inexpensive ones. This is borne out in the size ($2 million-$95 million range for acquisitions in FY20) and nature of acquisition. Processes involved in integration and driving synergies are also logical — TechM allows acquired entities to operate under own brand with a fair degree of independence with scope for cost synergies, TechM has increased focus on creating and selling integrated solutions combining both in-house offerings and acquired competencies, and incentives based on synergy benefits align managerial interests with that of TechM. While it is too early to comment on the success of recent acquisitions, results from past acquisitions are encouraging.

Even with a fairly logical acquisition strategy, not all have worked. We are fine with the acquisition philosophy but keep a close eye on its pace. One of the important elements of TechM’s re-rating was improved discipline on cash utilisation. Acquisitions done in FY20 will entail an outflow of $240 million or 37% of OCF. We remain constructive on TechM due to a combination of growth acceleration, 5G opportunity and relatively inexpensive valuations.

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