After Mindtree, it’s NIIT Tech: Why is midcap IT selling like hot cakes?

NEW DELHI: The midcap IT space is buzzing these days. Private equity player Baring Private Equity (Asia) has agreed to buy out the founder-promoters’ 30.60 per cent stake in NIIT Technologies for Rs 2,627 crore. An open offer will follow for an additional 26 per cent stake.

In the past, promoters of many mid-tier companies such as Hexaware, Polaris and Syntel have exited the businesses. Going by what the analysts say, we may see more such deals in the coming days.

The NIIT Tech deal has materialised days after engineering and construction major L&T became the biggest stakeholder of Mindtree after buying out strategic investor VG Siddhartha’s 20.4 per cent stake.


What is drawing investors to midcap IT?
Some like Morgan Stanley says the exit of the promoters indicates that the best is behind. “The industry is maturing and growth rates have slowed down,” the global brokerage said in a note.

Others are not as cynical. “Large players are looking for niche services to add to their overall offering. Mindtree stake acquisition (by L&T) would be along this line of thinking. NIIT Technologies is a differentiated model compared with traditional services business,” said Amar Ambani, Head of Research at YES Securities.

Baring, the acquirer of NIIT Technologies, also own 62.2 per cent in Hexaware though an entity called HT Global IT Solutions Holdings.

“Midcap IT firms can continue their high growth phase only when IPR (intellectual property rights) is involved. Largecap firms are taking bigger leap in digital investment, but midcap IT firms have little access to this area,” said Sameer Kalra of Target Investing.

PhillipCapital said size is becoming an important factor to driving growth. Also, many midcap IT companies with low promoter holdings are suffering from succession planning issues. There could more M&A activity in the midcap IT space.

The recent acquisitions can be divided into two categories. The first one is where the target company is India-listed firms; Mphasis’ acquisition by Blackstone and Hexaware’s acquisition by Baring are two examples of the first category.

The second involves acquisitions primarily in the private or listed space in US. These acquisitions are intended to enhance offshore capabilities, depth to verticals and access new markets. The acquisitions of iGATE and Syntel by Capgemini and Atos are good examples of this trend.

Kotak Institutional Equities counts a number of reasons for the India-linked acquisitions.

“Digital has altered the sourcing mindset. Clients are now willing to experiment and engage with new vendors. They look for vendors with next-gen capabilities and the nimbleness to work with ecosystem partners. A few mid-tier companies have successfully competed against large players in their focus segments. Small-sized digital projects augur well for mid-tiers; good execution on pilot projects opens doors in a large account,” it said.

Mid-tier IT companies are smartly allocating resources to a few areas of competence. Knowing what not to do is half the battle won, Kotak said.

Besides, as deal sizes shrink, shorter tenures and relatively smaller deals (say $50 million) fall in the sweet spot of mid-tiers, the brokerage said.

Lastly, midcap IT firms hold a better pool of talent, as a slowdown in growth rate of tier-1 IT companies has constrained career growth and ESOP-led wealth creation for managerial talent, who are now happy to move to mid-tier firms for higher compensation and a greater say in the business.

Are midcaps good buying opportunities?
Ambani of Yes Securities said his brokerage is not overweight on IT services at present. Within this space, it is relatively overweight on HCL Technologies and prefers largecaps.

Brokerage Kotak Securities said one should not think mid-tier IT firms are suddenly in a better position to outperform tier-1 companies.

“The crux is that the operating environment has eased enough for these companies to not be at a disadvantage. Standard ingredients for success viz, a strong management team, reasonable digital positioning, ability to succeed against all competition in core areas of competence still apply and adequate investments in business is needed to grow consistently and defend margins,” it said.