Wipro: Turning A New Chapter In The Growth Story With Capco
- Wipro announces the acquisition of Capco for $1.45 billion.
- The deal makes sound strategic rationale, but the price paid seems expensive relative to Capco's growth profile.
- In addition to the added risks involved with the integration, Wipro will also see near-term EPS dilution, which could weigh on the shares.
- I like the steps taken by the new management, but remain neutral at current levels.
Wipro (NYSE:WIT), a major India-listed IT services company with main businesses across financial services, retail, and healthcare, boldly opened a new chapter in its growth story with the acquisition of Capco, a UK-based consulting company for $1.45 billion (equivalent to c. 10% of its revenue base). I am positive overall on the acquisition, especially considering the new CEO's familiarity in the area, and see scope for the combined entity to drive synergies within the BFSI ("Banking, Financial Services, and Insurance") area. The key drawback, however, is the premium price paid and the execution risk associated with this more aggressive go-to-market approach and integration process. With shares also trading at a hefty valuation multiple relative to historical levels, I view the risk-reward as balanced and remain neutral.
Capco Acquisition to Boost BFSI Revenue
Through the acquisition of UK-based Capco, Wipro appears to be focused on strengthening its BFSI capabilities not only in terms of global scale and delivery, but also by adding digital workforce skills to penetrate new areas in banking and payments, wealth management, insurance, and capital markets. The scale is significant – management is guiding toward the pro-forma BFSI revenue increasing to $3.2 billion (from $2.5 billion previously), with room for further expansion as Capco adds a global footprint and a leading market position in Europe (a key focus area for new CEO Thierry Delaporte). Another key top-line opportunity lies in the potential for Capco to cross-sell to other sectors through Wipro's client base.
Source: Capco Acquisition Presentation Slides
Admittedly, Capco's revenue growth has slowed in recent years, which raised some concerns on the conference call. And while the trend seems in line with the slowdown in banking spend amid declining interest rates, management is guiding toward Capco seeing revenues recover from here as rates normalize and banking spend picks up post-pandemic, which seems reasonable. I think the more pertinent concern is key personnel retention, considering consulting companies are typically acquired for their leaders and relationships. The extent to which Wipro can navigate potential culture clashes, for instance, will likely be critical for the acquisition to generate meaningful synergies ahead. As such, I would keep an eye out for metrics like contract wins, employee churn, and market share gains in Europe in the upcoming quarters to gauge the deal progress.
A Premium Price for Capco
According to the current deal terms, Wipro will acquire 100% of Capco for a purchase consideration of $1.45 billion using a mix of cash and debt. Relative to Capco's reported 2020 revenues of c. $720 million, this implies a premium c. 2.0x EV/Sales multiple. I would note, however, that the headline multiple does not include any revenue synergies from the combined entity (management did not quantify any specific targets on the call). However, the transaction is guided to be margin-dilutive by c. 200bps in the initial two years before turning accretive by the third-year post-acquisition. While the dilution will likely weigh on investor sentiment, I see no issue from a funding perspective considering Wipro's c. $5.2 billion net cash position. Assuming no unforeseen hiccups, the transaction should close by June 2022 (in line with guidance).
Source: Capco Acquisition Presentation Slides
I like the strategic rationale, but I am concerned that Wipro has paid a premium multiple at c. 2x EV/Sales and c. 20x trailing EV/EBITDA (assuming in line consulting margins) despite Capco's sluggish recent growth. This could result in an overhang on Wipro's multiple near-term, as investors will likely adopt a wait-and-see approach on the acquisition before re-rating Wipro accordingly. As things stand, Wipro should see a c. 6–7% dilution to fiscal 2022 EPS, although I see upside to these targets depending on synergy realization.
A Positive Step in the New Wipro Story
While the outcome of the Capco acquisition remains uncertain, I like the boldness of Wipro's new CEO – the last time Wipro embarked upon a similar playbook was in the early 2000s via the "String of Pearls" strategy. The new CEO appears to be making radical changes, as demonstrated by last year's restructuring effort (recall that Wipro even created a new "Chief Growth Officer" role), with further simplification of the existing business also likely going forward.
However, the company has a mixed track record on execution, which keeps me cautious. Peers HCL Technologies and Tech Mahindra have made similar bold acquisitions in prior years with mixed post-integration results. Furthermore, although the Capco acquisition checks all the right boxes strategically, adding strong domain expertise and a global consulting practice, the acquisition is expensive at an EV/Sales multiple of c. 2.0x relative to the sluggish growth profile of Capco. With plenty of cash still left to deploy on Wipro's balance sheet, I would keep a close eye on the price paid for future acquisitions.
Tech Mahindra (LCC)
Consideration (USD ‘million)
Source: Company Data, Press Releases
Overall, Wipro's aggressive new growth ambitions and its latest acquisition have reinvigorated the shares, outlining a path toward correcting its lagging growth trajectory. However, we remain in the early stages of the turnaround process, and it is unclear the extent to which these steps will materialize in a positive impact on earnings going forward. Furthermore, the integration process adds complexity and dilutes near-term EPS, which could weigh on the valuation. At current levels, Wipro shares also appear to be already priced for a fundamental turnaround at a significant premium to historical levels, which keeps me neutral.
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