The acquisition of Capco is likely to remain an overhang on multiples of Wipro till the time street finds comfort in integration.
Software giant Wipro last week announced the acquisition of British consultancy firm Capco for $1.45 billion, its biggest purchase. Since the details of the deal became public, Dalal Street has not been kind towards Wipro. The share price of the IT major is down 5.2% since last Thursday to now trade at Rs 415 per share. Analysts have raised concerns about the deal and have trimmed price targets, ratings of the Information Technology firm.
The acquisition of Capco is likely to remain an overhang on multiples of Wipro till the time street finds comfort in integration, according to analysts at ICICI Securities. “Several earlier attempts by Indian IT (including Wipro) to buy or build sizeable consulting practices have not been successful. However, learning from HCL Tech’s then bold bet on software products (similarly adjacent to IT) suggests there can always be a first,” the brokerage firm said in a note.
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Why are brokerages concerned
The deal will build strength in the financial services vertical of Wipro by adding $720 million revenues to the existing $ 2.5 billion of revenues of Wipro and provides access to 30 large clients of Capco, according to Kotak Securities. However, some are still concerned. “Wipro has paid ~17X trailing EBITDA, expensive in our view,” said Kotak Securities. “It is interesting to note that FIS sold down 60% stake in Capco to a private equity player in 2017 valuing the firm at US$800 mn. Capco’s revenues have declined compared to where it was in 2018, yet the valuation paid is 75% higher than the previous transaction,” they added.
Ambit Capital said that acquisitions in the consulting space have seen limited success in the past. “The issues have been in terms of lack of alignment of consulting employees to cross-sell downstream outsourcing business. How Wipro navigates the cultural differences of a high-cost partner-driven consulting outfit versus the cost-focused outsourcing outfit is a key thing to watch,” they said. Wipro has said that it currently intends to let Capco run as a separate entity.
“Implied 1-year forward P/E could be 35-45x (vs 21x of Wipro) – very much on the higher side as the timing is coinciding with lifetime peak valuations of technology assets,” said ICICI Securities. With lofty valuations, they added, risk of integration challenges / future impairments cannot be ruled out.
Time to sell
Ambit Capital already had a ‘Sell’ rating on the stock underperform peers on growth, driven by weaker positioning in developed markets and large verticals. Ambit has a target price of Rs 345 per share on Wipro. ICICI Securities has now downgraded the stock to ‘Sell’ and reduce their target multiple to 17x FY23E EPS against 19x earlier. The target price has been set at Rs 350 apiece.
Kotak Securities holds a slightly better view with an ‘Add’ rating but has cut Fair Value to Rs 450 per share from Rs 465. “A big bet for sure but Wipro has overpaid for the acquisition and carries integration risks,” they added.
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