Wipro: Strategic Implications Far Outweigh Fullish Infocrossing Purchase Price

Ashish R. Thadhani (Gilford Securities) recently sent a note to clients in which he reiterated his Buy rating on Indian IT service provider Wipro Limited (WIT), following its acquisition of Infocrossing (IFOX). Excerpts follow:

• Investment Conclusion. We are taking this opportunity to reaffirm our Buy rating, $19 target price and estimates: fiscal 2008 EPADS of $0.55 on revenue of $4.664 billion (39% YoY growth); and fiscal 2009 EPADS of $0.68 on revenue of $6.015 billion (29% YoY growth). Our estimates imply 36%/26% compound revenue/EPADS growth in calendar 2006-08. In 12-months, our target price would correspond to 25-30x forward EPADS – a premium to the current valuation (24x).

• Wipro announced recently that it will acquire Infocrossing (IFOX) for a total cash consideration of approximately $600 million. This ranks as one of the largest international acquisitions by an Indian software company even though it will augment annual revenue by ~5%. Wipro’s net cash stands at $730 million following the Unza acquisition.

• Based on calendar 2007 estimates, the purchase price translates into 2.4x revenue and 43x EPS. Investors may have concluded – somewhat hastily in our view -- that the latter is generous for a company expecting 10% revenue growth and a 12% operating margin in 2007. (On August 9, Infocrossing reported June quarter EPS of $0.10 vs. $0.09 a year ago on revenue of $62.0 million, up 9% YoY – in line with prior expectations.)

• However, Infocrossing offers several strategic benefits: five world class U.S. data centers with a replacement value of $200-300 million; deep expertise in the Managed Services, Mainframe and Healthcare domains; and a largely complementary client base of 190 Fortune-1000 clients. These include Ford, Novartis and Sunoco. Given low current utilization, incremental EBITDA margins could exceed 40%. In fact, Wipro management has indicated that the transaction will be EPS-accretive from the outset based on anticipated margin improvement, cross-selling opportunities, etc. Most important, the addition of Infocrossing capabilities should differentiate Wipro vs. Indian peers, strengthen its U.S. presence and enable it to compete more effectively against IBM, Hewlett Packard and EDS for higher value Infrastructure Management contracts.