This week started with the announcement by Atos of its intended acquisition of Syntel for $41 a share, a total consideration of around $3.57bn including Syntel’s net debt of $201m, in an all-cash deal.

Syntel being acquired is not a total surprise: the company has faced some challenges recently, and in the previous four weeks its share price had been going up strongly (from $31.61 a share on June 27 to $39.13 at the end of last Friday, a jump of 24%). And Atos making a significant acquisition in the U.S. was very much on the cards. In fact, the companies said that they have had discussions about a possible tie-up going back to 2014, predating Atos’ previous major acquisition expanding its North American presence, that of Xerox ITO in 2015.

At nearly 3.7x revenue and 14.5x EBITDA, the purchase price at first glance looks high, but it’s a premium of just 5% on Friday’s close and of 14% on the last 30-day share price average. Assuming regulatory clearance, the acquisition will transact (unlike Worldline’s hostile bid for Gemalto): Syntel’s founders and affiliated entities (who own 51.1% of the company’s shares) have committed to vote their shares in favor, both companies’ boards have unanimously approved the transaction, and we do not expect to see a counter bid. Barring any regulatory challenges, the companies expect the acquisition to close by the end of the calendar year.

So why is Syntel attractive to Atos? In short, Syntel will provide:

• A boost to Atos' North America business ($823m revenues in 2017, representing 89% of its total revenue), in particular for application services – filling in the Business & Platform Solutions (B&PS) gap in Atos’ North American business we have commented on previously (see here for example)
• Three large clients: Amex, State Street and FedEx, which together accounted for just under 45% of Syntel’s revenues in 2017 (~$415m)
• A boost to its BFS and Insurance sector businesses (approaching $420m and $140m in revenue in 2017 respectively), also a significant U.S. application services practice in the Healthcare/Life Sciences vertical to complement Atos’ recent healthcare sector acquisitions
• A large Indian delivery capability: Syntel has ~18k (mostly delivery) personnel based in India with some large campuses in Mumbai, Pune, Chennai and Gurugram (previously known as Gurgaon) and has developed an effective resource planning model enabling fast deployment in new projects
• And, unlike some recent Atos’ acquisitions, it will be immediately margin accretive.

Syntel’s challenges have included its heavy dependence on H-IB visas with little substantive onshore capability, and a lack of discretionary budgets in many of its major accounts, particularly in BFS: the company’s revenues have been declining for some time (2017 revenues were down 4.4%, with BFS sector revenues down over 11%, the primary factor being a 30% decline in revenues from AmEx, following the completion of a large project).

Atos refers to 40% of Syntel’s revenues coming from digital (cloud, social media, mobile, analytics, IoT and ‘automation’). Syntel currently reports that revenue from digital projects accounted for 20.5% of total Q1 2018 revenue (Q4 2017: 19.7%), growing at 21.6% y/y with the other ~19.5% of revenues related to the automation and modernization activities that build the foundation for implementing digital capabilities.

Major initiatives have included:

• A focus on growing some of the top 4 to 50 clients, and here there has been some success: in Q1 2018, this group represented 52.5% of total revenue, growing at around 17% y/y
• Ongoing enhancements to its Syntbots intelligent automation platform, underpinning all its service lines, including additions in machine vision, NLP, ML and virtual assistants
• The Syntel X.0 workforce transformation model launched in 2017, aligning competency building with career planning and performance management to develop a future-ready workforce.

The simple addition of Syntel to Atos will:

• Increase its global revenues from €11.9bn to around €12.7bn
• Boost its operating margin from 10.6% to 11.5%
• Extend its Business & Platforms (B&PS) business from 26% to 31% of its global revenues
• Extend its North American business from 16% to 21% of its global revenues
• More than double its India-based headcount, to 32.5k.

But, of course, Atos is looking for more than a simple addition. In its rationale for the acquisition, Atos declares it is looking for additional revenue synergies, reaching ~$250m by 2021, with half achieved by 2020, from cross-selling opportunities in both the European and U.S. client bases. We think there are significant opportunities from:

• Cross-selling Syntel digital offerings, offshore-delivered apps development, testing and application modernization services into some of Atos’ European clients, particularly in BFSI and retail
• Cross-selling Atos’ infrastructure services into some of Syntel’s larger U.S. accounts
• Developing an integrated end-to-end portfolio for targeted segments of the U.S. healthcare sector.

Atos also expects the increased offshore delivery and revenue synergies will add $50m to the operating margin. To facilitate this, Atos is moving ~$1.2bn of its current B&PS work (~33% of 2017 global B&PS revenues) to operate under the Syntel model upon completion of the acquisition. This includes the entirety of the North American B&PS footprint (~$160m, <5% of global B&PS 2017 revenues), plus select contracts from other regions. Key aspects of Syntel’s delivery model that Atos is looking to utilize include increasing offshore leverage also the use of automation and agile delivery.

Atos is also targeting ~$120m from G&A optimization by end 2021 from the combined scale, including consolidation of facilities in India (Atos expects to move its employees based in Chennai and Pune into available space in Syntel’s larger campuses in these cities), plus the alignment of KPIs in B&PS

Will there be challenges in the integration? Of course. Some of the immediate ones that come to mind include:

• Aligning Syntel’s 'Customer for Life' ethos, with its implied customized approach, with Atos’ more standardized “Digital Transformation Factory” framework
• Managing attrition in India, though we imagine this will be easier now that employees will be working for a larger, more global organization
• Managing the reverse integration of some of Atos’ B&PS larger contracts into the Syntel delivery model
• Up and/or cross-selling larger transformational engagements into Syntel’s top 4-50 client base, which includes a long tail of small accounts; this will require substantive awareness raising.

Given the level of reverse engineering in B&PS, the role played by Syntel senior management will be fundamental. Syntel CEO Rakesh Khanna will join Atos’ Executive Committee and will be key to driving this.

And of course, Atos has a well-honed integration methodology and has successfully integrated some large and some more problematic acquisitions over the last decade.

The addition of Syntel will certainly fill in the B&PS hole in North America, add substantive offshore delivery, bring in IP such as its SyntBots and MIII (manage, migrate, & modernize) framework, and improve B&PS margins.

The acquisition should accelerate the B&PS transformation globally including in the application of intelligent automation to service delivery. It also means Atos globally has a more balanced portfolio in its IT services offerings. We think there are further potential benefits, for example in leveraging some of the IP that Syntel will bring in to develop more industry-specific offers for sectors such as healthcare payer and financial services.