August 29, 2008

Infosys accquisition of Axon group: My view point

Infosys recently announced the accquisition of the Axon group. Most of the analysis I have seen is centred around whether the deal is EPS accretive or dilutive. I think this kind of analysis is superficial and misses the point. A deal can be EPS dilutive and still be adding value and vice versa (more on that in a later post).

In this specific case, Infosys is accquiring an ERP (SAP in this case) consulting firm with net margins of around 10%. ERP consulting is a high margin, high growth business for Infosys. The typical gross margins are sometimes in excess of 50%.

How do I know ? disclosure : I worked with infosys in their ERP practise in the past. The ERP business for Infosys has seen phenomenal growth in the last 8 years and has done exceedingly well. Their Oracle and SAP practises have done very well too (I have personally seen the practises grow in the last 6-7 years). Infosys has managed to constantly increase the offshore component of ERP projects and thus maintain high margins.

Axon has gross margins in the range of 25-30%. In addition they are based out of UK, US and Malaysia. I am not sure of how much offshoring Axon does, but any improvement in the onsite/ offshore component of their existing projects due to the backend infrastructure of Infosys will enhance their margins. This is a good deal where Infosys gain the front end part of the business ( clients, onsite consultants, relationships , Knowledge etc) and Axon (which will be now be a part of infosys) will see improvements in margins due to higher offshoring.

Is everything hunky dory then ? Not necessarily. Integration of Axon into infosys will be a challenge. Infosys has an ‘Indian’ company culture (I do not mean it in a negative way). They are very conservative on expenses and there are other typical ways of doing things. Axon (about which I do not have any special insight) must have a more European culture. Integrating two such diverse culture will be a challenge. The key asset for an consulting company are its people. If the integration is poor, then employees from Axon (or even from exisiting practise in Infosys) could leave. I think that may not be a major issue in the long term. The company will work on retaining the key employees.

So overall, there is more to this deal than just plain EPS numbers. The ERP practise (especially SAP) is doing well for the company. Addition of Axon will provide further scale to the SAP consulting business of infosys and will add value down the road.

Additional disclosure : I hold infosys stock


VISHNU said...

Hi Rohit,

I know infosys can improve the profit margin by increasing the offshore component.

But this is not the correct question to ask..

Correct questions to ask
1)Whats the premium paid to acquire the company ?
2) Can Infosys grow organically by simply recruiting people and attracting clients INSTAED of aqcuiring company with the premium ?

Sometime doing nothing and growing organically is best option though its quite boring for top management.(I want to remind Peter Lynch bladder theory of managment).

Best quote I like is from Accenture CEO " It is easy to hire 10,000 people in india at Peanut salaries than acquiring companies at mind blowing PE"

Still Infosys can do wonderfully , may be this acquisition will be fruitful for INFY. But definetely this is not a good decision.

After the departure of Mohandas Pai from Finance , we can confidently expect Infosys to acquire more companies in Future.

Kris Gopalakrishanan said INFY is changing its strategy to Growing higher though it affect margins.(Anything for shareholders?)

Though INFOSYS increased its intrinsic value and shareholder wealth in past , whether it will continue to do so despite of managerial changes (CEO/ CFO) is a GOOD (infact BIG) question..

Now I understand why Warren dont like to change the CEO of his companies..


street said...

Now Indian companies do a better job of integrating with foreign cos. Also Infy already has spent many years so far developing ODCs in Mexico, china etc and have the necessary experience to integrate Axon, a co from Eu where Infy has had significant experience too.

Does Axon extend the market segments that Infy caters to in SAP? Not just adding new clients, but clients from diff industries or sizes?

Rohit, nice blog btw. I haven't seen many blogs (though there are many ygroups) of Indian investrs. I recently made a new site for the investor and broker community - please let me know if you're keen on being one of the initial people to join!


Rohit Chauhan said...

Hi vishnu
i have opposite viewpoint on growing through accquisitions.
i have always felt infosys has been too conservative with accquisitions.

growing an ERP/ IT practise is not easy. It is comparitively easy to get people, but that is not the key issue. key issue is to get the correct front end - customer relationship and sales.

Infosys has done that for SAP in the past, but it has been slow and moderately successfuly. But if you want to move to the big league and have the scale (on front end) to do it, then accquisition is critical.

the comment from accenture makes sense 'for them'. IBM, accenture etc have the front ..the relationships etc. they need to build the offshore capability. Indian vendors however need the front end part of the business..and fast this business you cannot wait forever to build scale

on valuation, i think 20 times earnings are not too high. I have not seen axon's AR, but a growing business at 20 time PE is not too expensive.

In addition client relationship which infosys will get through such an accquisition helps in getting a lot of ADM and other downstream work ..which axon may not be interested in


Santosh Puthran said...

I had made a similar analysis on the
Management Accountant Blog


* Axon Global business is primarily SAP and the consultants (employees) would have enjoyed a growth in salaries with the growth in market.
* Management takes decisions quickly since they are focussed in one line of business. Moreover the profitability were not much of concern since the projects were either less profitable or more profitable.

Post Acquisition

* Infosys will be able to knock on the doors of their customers with Axon expertise on SAP solutions. This would generate more revenue overall
* Infosys is a large organisation with many lines of business. So policy decision will be made taking into all the line of business into account.
* The name Axon may disappear from the market place with SAP offerings will be one of the line of business.

I am not sure whether Axon employees will be benefited by the takeover since Infosys is quite conservative in salaries and but focusses more on benefits. Infosys has a socialist culture. So it would be interesting to watch how Infosys retains the Axon employees who were accustomed to get good salary rises every year.

With Regards,

Santosh Puthran

Rohit Chauhan said...

Hi santhosh
I do not have an idea about Axon and its employees. however i agree that this accquisition would allow infosys to sell other services to the same set of clients.
I agree with the culture risk you have mentioned in your post


Raghu said...

I agree to your fundamental insights on the acquisition. However, for the short to medium term, I'm bearish on Infy. The acquisition would take time to be EPS accretive.

Santosh Puthran said...

Hello Rohit,

A couple of my friends are in Axon. I spoke to them, they are not quite happy with Infy takeover.

They left Indian companies to join MNC for better work culture. With Infy taking over, they are afraid they will be back to where they were.


Santosh Puthran