Capgemini announced today its intention to acquire IGATE. Capgemini is offering $48 per share, or $4.04bn, a premium of ~5% over current IGATE share price. IGATE had debt at end 2014 of $686m and cash on hand of $192m. This offer gives IGATE an enterprise value of ~$4.53bn. Capgemini is thus paying a massive 15.5 x 2014 earnings ($292m) and nearly 3.6 x 2014 revenues.

The acquisition will:

• Create a company with combined revenues of €11,769m, that achieved a revenue growth of 5.3% in 2014, versus 4.7% standalone Capgemini
• Increase Capgemini’s headcount by 30k to 177k
• Expand Capgemini’s presence in North America, which Capgemini has been indicating for some time is its immediate priority for inorganic growth. North American revenues are ~€3,178m (27% of total revenues versus 21% for standalone Capgemini)
• Drive growth in the financial services sector, as Capgemini did back in 2007 with its acquisition of Kanbay. IGATE brings in some large financial institutions including RBC, UBS, RBC, and Metlife. Capgemini believes it can grow many of these individual relationships as well as win new client logos
• Significantly expand its offshore delivery capability. Capgemini will now have over 100K employees in India, and will also be able to leverage IGATE’s corporate university in Pune to quickly onboard and train resources as new engagement are obtained
• Capgemini intends to expand the level of investment that IGATE had been  in IP. 

Capgemini believes it will be able to compete more effectively with its peer group of Accenture and IBM with the capabilities and scale that the IGATE acquisition will give it. The company did not provide insight into the execution challenges of this take-over, such as product/service rationalization or client engagement process changes. However, Capgemini is aware of those issues and holds out the Kanbay acquisition as proof of its capability to successfully address them.

So, why has Capgemini gone for inorganic growth now?

The consolidation phase of the economic cycle has started. Declining revenue growth opportunities are driving cost take-out initiatives, with these initiatives taking place at multiple levels in the operations environment. From the perspective of financial institutions, cost take-out levels are as follows:

• Reduce OPEX by exiting capital intense lines of business (e.g. lending, proprietary investing) and reduce infrastructure (both bricks & mortar and operations infrastructure (e.g. IT and shared services)
• Reduce CAPEX by outsourcing to achieve labor arbitrage, increased automation, shared overhead.

Other cost take-out considerations are:

• Shared services/captives: shared services centers are not growing their footprint today. However, they are outsourcing low-value, standardized processing to third parties and taking on complex processing from parent units. This shift is being done with little, if any capital investment from the parent. Meeting these challenges requires support from LOBs or (preferably) third-party support
• BPS vendors: tier one financial institutions over the past fifteen years have outsourced all that is doable under current methodologies. In fact, wage growth in emerging economies is undermining cost effectiveness of current BPS engagements. However, operational footprints remain low (~10% of overall operations) and as processes have been standardized in-house or declined in overall value, banks are looking to outsource previously retained processes. In addition, there remains much to be done with automation of processing (typically a 1% to 5% opportunity for overall cost reduction) and consolidation of operations for multiple geographies
• IT vendors: banks are asking IT vendors for support in consolidating country-specific operations delivery into globally delivered operations (e.g. from one to three continental locations). Cloud delivery of IT processing is a major undertaking for banks, but they can only do this with the support of third-party IT services vendors.

Cost take-out is not being driven by efficiency so much as highly standardized, scale operations. These changes in operations are being driven by third-party vendors because the banks cannot fund the scale required to achieve meaningful cost reductions per transaction.

Vendors who will be successful will be able to harvest larger revenues from a relatively static revenue pool. This necessitates inorganic growth by vendors to achieve scale across processes with each client, and global scale presence in each market where tier one financial institutions are present. Many vendors deliver to all markets, but very few deliver at scale in all markets. Capgemini is intent on competing with tier one IT/BPS vendors in all major markets and this acquisition is a key step to achieving that scale.

In summary:

• Inorganic entry or growth in new markets is critical to success
• Cost control is shifting from “less spending is more” to “greater utilization of required investments is more”
• Capgemini acquired IGATE to compete as a tier one global IT/BPS vendor with the critical capabilities required to succeed in the decade ahead.