On October 14, the Xchanging board recommended a final cash offer by Capita of 160p per share. The offer, valuing Xchanging at ~£412m, represents a premium of ~44% to the closing price on October 2, 2015 (the last business day before the start of the offer period), 52% to the prior three-month average price and 64% to the one-month average price. 

Capita states it believes the acquisition would:

• Position Capita as a leading provider of technology-enabled BPS
• Provide a stronger platform for Xchanging to accelerate sales growth and to develop its offerings
• Enable Capita to secure £35m+ in cost synergy benefits
• Be immediately earnings accretive.

Capita has been in discussions with Xchanging since early August regarding a possible offer, upping its initial 140p offer to its final 160p proposal on September 24 - which Xchanging’s board confirmed it would be willing to recommend on September 29 should Capita make a firm offer. Capita was granted due diligence access and had until 5pm on November 2 to make an announcenent.

There is another suitor, Apollo, with whom Xchanging has been having discussions about a potential 170p offer. Will this announcement push Apollo into making a counter offer? Xchanging's share price has surged since the news of the potential talks (over 165p at the time of writing, though still below its one-year peak).

Xchanging has been contending with a range of issues, and its global portfolio lacks coherence, partly a reflection of its heritage in a few large and diverse “Enterprise partnerships”. Xchanging is currently between CEOs, Ken Lever having announced his intention in July to step down at the end of the year, and new CEO Craig Wilson not yet started.

If Capita were to complete, this would be its largest ever acquisition, dwarfing its second largest, the £157m acquisition of avocis this February (though there have been a number of £50m+ acquisitions since 2011, helping Capita expand into new markets or extend its IT capabilities).  So why is Capita so interested?  

In recent years, Xchanging has repositioned and invested to emphasize its capabilities in “technology-enabled BPS”- exactly what Capita is emphasizing with its own various BPO offerings.  Also, the private sector is increasingly important to Capita (over 60% of its current pipeline is in commercial sectors) and Xchanging would increase its presence in the Lloyds market, where Capita already has a presence for specialist services.

Looking in more detail at Xchanging assets that would be attractive – or at least very relevant - to Capita:

1. Xuber software suite for the non-life commercial market: the biggest investment to date (a whopping $200m+ in total investments since 2011), both in platform development and in acquisitions: in 2014, Xchanging invested £75.6m in acquiring Total Objects, whose binder software is now integrated into the Xuber suite, and Agencyport Europe,extending its software into the health insurance sector, with software for international private medical insurance and exposure modeling (acquisition was delayed), plus a further £11.7m on development of Xuber. Xchanging has found converting interest in Xuber to sales more challenging than anticipated, particularly in the U.S. Will Capita’s greater commercial clout help? It would inherit sales teams from Xuber, Total Objects and Agencyport Europe that need integrating into a single unit to cross-sell, where relevant, the portfolio. Would Capita place the Xuber business in its newest operating division “Capita Digital and Software Solutions”, or would it place it in an insurance sector division?
2. The Xchanging Claims Services BPS unit : Capita is already active with a range of specialist services in the London insurance market: this capability would neatly expand its portfolio
3. Xchanging’s business in Germany, where it provides investment account administration BPS for Fondespot Bank, will also be of interest to Capita, who is building a presence in the DACH region, via an acquisition spree in the CMS BPS market, also via an insurance BPS contract with Zurich. The complex administration services in Germany that Xchanging would bring in to Capita would fit well in its Asset Services division
4. Procurement: Xchanging has been through a significant change of direction with its procurement services in recent years, to technology-led offerings, boosted by the acquisitions of MM4 (which was U.S centric) and Spikes Cavell Analytics Ltd (SCAL, which was U.K public sector centric). These offerings may find traction in the Capita client base
5. Expanded offshore IT services capabilities: in India, Xchanging has centers in Chennai and Pune, Bangalore, and tier 3 cities such as Shimoga (Karnataka).  It also has a center in Kuala Lumpur, Malaysia, most providing IT infrastructure services to YTL Communications, and a smaller ADM unit in Singapore (where Capita also has a small presence, targeting the reinsurance sector). There is also some offshore BPO activity in India and Malaysia. Capita may rationalize some of these sites, but would certainly be interested in the expanded offshore application services and BPO delivery capabilities
6. IT services: Xchanging has some networking capabilities, with a client base in the education and health sectors, as well as Lloyds – this would fit well into the Capita IT Enterprise Services division, which has grown through a series of acquisitions in recent years

And less attractive to Capita?

• The Australian operations, where Xchanging’s New South Wales Workers’ Compensation contract was not renewed, and where its procurement business has not really gained traction.
• The U.S. business: Capita’s international efforts are currently focused on Northern Europe. It would be a major change of strategy for Capita to start targeting the U.S., and its management will be highly aware of other service providers who have tried and failed to penetrate the U.S.

But overall, Xchanging’s portfolio is particularly well suited to Capita's business and where it is looking to develop over the next few years. And the cost synergies from the head office rationalization are also a particularly good match.  

We thus believe is highly unlikely that, even if there is a higher counter offer from Apollo, the Xchanging board will change it recommendation to shareholders: Capita presents a better option longer term. Howver, a counter offer from another IT services vendor might be more attractive.

NelsonHall has just published a comprehensive Key Vendor Assessment on Capita. We have also historically included Xchanging in the KVA program.