Wipro's Infocrossing Acquisition Could Herald A New Age of Buyouts

With the announcement of Infocrossing's acquisition for around $410mn ($18.70/share for 22.10 mn shares outstanding), Wipro (NYSE : WIT) has heralded a new era of big acquisitions.

Investors will be eager to see how this acquisition helps the bottom line of the company. Infocrossing's net worth as of Mar-31/2007 was $127 mn (with $157mn in goodwill) and its market cap as of Aug 7 was $400mn.

Revenues for 2006,2005 and 2004 were $229mn, $148mn, $104mn. Operating income during this period was $25mn, $10mn and $12mn, and net income was $8mn,$2.5mn and $19mn. Interest expense for Infocrossing was $25mn for 2006 and Income tax expense of $6.8mn(35% tax rate).

With the assumption of 20% return on investment , over four years Wipro should generate $400mn of cash from this new company, recouping the investment.

Comments

[Ciba Gator]

I promised myself that I would stop responding to your posts, but I couldn't control myself....

Net income in 2006 was $8 million, you wrote. You didn't provide a free cash flow number, but let's assume that it is in-line with net income (growing companies usually have lower free cash flow than net income since they have to spend more to grow, but let's take the optimistic view here). If so, then a 20% annual return would yield:
9.6+11.5+13.8+16.6=$51... million of cumulative cash in the next four years, not $400 million.

If you are just multiplying 20% each year times the book value of the company, that makes no sense. A 20% "ROI" implies that Infocrossing will earn roughly $25 million in 2007 (20% of $127 million "net worth"). Take a look at the income statement or analyst estimates -- is IFOX going to earn $25 million this year (triple the 2006 level!!!)? Or next?

By the way, perhaps the companies you look at have 20% ROI, but most companies earn only a slight premium to their cost of capital, which is often much lower than 20%.

[Deepak Shenoy]

IFOX's cash flow is here:
finance.yahoo.com/q/cf...;annual

Net cash flow is about 5.4 million. Even if you take out the "sale purchase of stock" which could be a stock option issue, we're talking 11 million or so. It doesn't add up to 400 mm.

Considering that in India you can get interest of about 6% post tax on free cash, Wipro just gave up $24mm in interest income per year for a company that delivers $8mm in net profits. Assuming it doubles IFOX's profits in 2007, and grows 30% from there, we are talking about 16+21+27+34=98 million in three years of added up netprofits which we can say is equivalent to the free cash flow. Wipro can earn $107 million compounded interest post tax. That means it'll take more than four years to break even on this deal just considering interest (not considering opportunity cost). Not very nice, honestly.

But someone please tell me if my assumptions are way too conservative. Should I consider doubling profits every year? Even that would take two years to break even on interest lost.

[Dayanand]

Coming out of the intricacies of finacial accounting on calculations of cash flow, lets talk PLAIN ENGLISH. As the whole deal was on cash so any shareholder will be curious to know as to what will be the time frame Wipro expects before it gets back its $400mn.As we are discussing IT outsourcing business so I guess it is not unusual to anticipate 20% ROI, because that is quite conservative compared to the growth rate of industry.

In this high growth IT outsourcing indutry if Wipro says that they will invest $400mn and wait for 10 years to get their money back (assuming your single digit ROI). The shareholders will get a heart attack.

The very reason people are investing in IT outsourcing business is because of its high growth rate.If they were to expect single digit growth rate then they might go to some less risk financial companies like Citigroup.

BASIS FOR WIPRO'S INVESTMENT : The whole world knows that Infocrossing will nobe generating $400mn in cash flow next 5 years, and that is not Wipro estimates. The reason they are taking over this infrastructure management company is to use Infocrossing's standing in the market to help its core business of application outsourcing.

Explaining this in plain english, let us say there is a IT staffing company in India that had 10 programmers who were working for Indian clients and earning about $1,000 evey month. If an American software company buys that Indian staffing company for $100,000 then they dont expect the programmers to generate a cash flow of $100,000 by working for Indian clients. What they would instead do is are-deploy those resources to develop their latest product . If they are able to develop the product in two years and sell the software product to its clients earning a net profit of $100,000 then they have recouped their investment in 5 years. Plus they have created two assets :
1. the software product that will have earning power for years to come.
2. Experienced programmers who are well versed with their product development.

STRATEGY OF REDEPLOYING THE ASSETS : This is the strategy Wipro is going to undertake once it acquires the company, it is going to re-deploy the assets in line with its business model.

[ratsharp]

Dear Dan...
PLAIN ENGLISH Please do not inundate the blog world with such ridiculous arguments as" The whole world knows" ..."plain english" et al.
Give intelligent answers such as :
- Expect a higher NM from current 5% ( comparable to other leaders in this space like HCL Technologies .. of 18-20%) from this business , once the interest exp are removed and some "wipro premium" on margins
- improvement in capacity utilization from 50% currently to higher ..say 75%..
- bought at 2.5X sales by a company which is at 5X+ sales...
- look at rev/employee multiple , compare to other IMS players ... and compare with wipro's existing multiple

Since obviously you dont want to talk about accounting but about the bigger picture ..Atleast Be Concrete in your responses

[Dayanand]

It is not necessary for an intelligent answer to contain world's all financial jargons . With my experience of interaction with an averrage investor , I guess he or she is looking for business analysis he or she understands which is PLAIN ENGLISH.

[Ciba Gator]

Agree with pratshar. You don't have to use jargon, but at least focus on the actual numbers instead of just telling stories. The "average investor" is quite intelligent and capable of handling facts and figures.

Anyway, if I understand your story correctly, you are suggesting that WIT will take the infrastructure assets and people they just acquired and redeploy them to do what--applications work?

Based on your story, are you saying that Company X with huge margins and growth rates should buy Company Y that has lower margins and growth because they can redeploy Company Y's assets such that Company Y delivers margins and growth in-line with Company X?? So Microsoft should buy Patni and all of a sudden Patni will become a cash machine because they are going to develop software in the Microsoft model?

[Dayanand]

Yes Microsoft could buy Patni and use its resources for software development provided it suits there acquisition criteria. Microsoft bought hotmail for 400mn in 1996.As such hotmail was a free e-mail service providing very little revenue. But when it was combined with MSN it became a great asset with huge potential of getting advertising revenues.

Coming back to your point on Patni being acquired by Microsoft. Patni's resources are specializing in several technologiies: mainframe, web, SAP, microsoft to name a few....this means more than half of the resources wont be much of use for Microsoft's product development.........a cobol programmer with 10 years experience will be of little value to microsoft, and 30% of Patni's resources are COBOl experts (based on my personal experience of working in that company for 7 years).

Let us say there is an outsourcing company in India that is specializing in microsoft technologies and has about 1,000 employees and is selling at $x. If it costs Microsoft India more than $x to add 1,000 employees then obviously they would jump on that Indian outsourcing company because Microsoft will get its additional employees at a cheaper price......as of now I dont see any such company in India.