IT firms acquire niche players in ER&D to generate new revenue streams
Information technology (IT) services companies are increasingly acquiring niche players, mostly in engineering research & development (ER&D), as it is a high-growth sector offering opportunities to generate new revenue streams.
Cognizant’s acquisition of Belcan for $1.3 billion earlier this week, as well as Infosys’ dual acquisitions of in-tech for $480 million and InSemi for $34 million earlier this year, are clear indicators of this trend.
“We believe that acquiring Belcan will strengthen Cognizant’s position in the sizeable and fast-growing ER&D services market,” said Cognizant Chief Executive Officer (CEO) Ravi Kumar S.
“Infosys continues to strengthen its ER&D leadership with decades of experience in digital engineering. Together with in-tech, Infosys Topaz, and the recently acquired InSemi’s semiconductor expertise, we have successfully created deeper capabilities for the next phase of automotive innovation in the arena of software-defined vehicles,” Dinesh Rao, executive vice-president (V-P) and co-delivery head at Infosys, said at the time of the acquisition.
Analysts pointed out several advantages that IT companies gain from these acquisitions.
“The primary advantages include access to cutting-edge ER&D capabilities, which are crucial for enhancing business resilience, shaping future revenue streams, and maintaining a competitive edge in a software and data-driven world. It allows expansion into the high-growth ER&D sector, which boasts a robust 10 per cent annual growth rate, outpacing the stagnant 2 per cent growth of traditional IT services. It also leads to higher valuations, as companies with substantial ER&D portfolios are rewarded with premium valuations by the market,” said Sidhant Rastogi, president of Zinnov.
Sandeep Nayak, partner at Bain & Company, concurs, “Over the past year or so, the core IT services business has been a bit stressed, and many of the deals are not net new. Such niche acquisitions have the potential to create new buying centers, new revenue streams, and new areas of growth. A lot of the success depends on how well the integrations are being done.”
For the majority of Indian outsourcing vendors, the proportion of ER&D services to overall revenue falls within a band of high single digits to mid-teens, said Pritesh Thakkar, research analyst at Prabhudas Lilladher.
“Given that spending on IT services remains weak at the current juncture, outsourcing vendors are seeking new opportunities to fill these gaps. Additionally, the addressable market potential for ER&D services continues to increase, as original equipment manufacturers and Tier-I suppliers are more willing to outsource than before, and there are few potential players in the market to capture these opportunities. Furthermore, the premiumisation, domain expertise, and skillset required to deliver ER&D projects are much higher than those needed for IT services,” said Thakkar.
IT companies are climbing the value chain by acquiring companies that specialise in specific industry sectors, said Aditya Narayan Mishra, managing director and CEO of Ciel HR Services.
“Acquiring companies with such niche capabilities gives them immediate access to specialised talent, expertise, and technologies; also, deep client relationships. This strategy helps large IT firms fortify their service offerings, command price premiums, and improve profitability.”
With product engineering capabilities, IT firms are also able to meet client demand for greater agility and accountability in the delivery of services.
“The trend of Indian IT firms enhancing their product engineering offerings, either by acquisition or organic growth, will continue. Traditionally, service engagements were focused on specific tasks, such as managed infrastructure services or application support and maintenance. However, our clients are increasingly recognising the need to transition from these traditional outsourcing models to continuous product engineering services, which offer the benefits of increased agility, accountability, and end-to-end ownership,” said Manjunath Bhat, V-P analyst at Gartner.
There are examples of other acquisitions as well.
This year, mid-sized IT firm Happiest Minds acquired Noida-based digital engineering firm PureSoftware for $94.5 million and the US-based digital product engineering company Aureus Tech Systems for $8.5 million.
Last year, HCLTech acquired ASAP Group, a German automotive engineering services provider, for €251.1 million (about $270 million). In 2022, Tech Mahindra acquired the German digital engineering firm Com Tec Co IT for €310 million ($333 million).
First Published: Jun 12 2024 | 9:00 PM IST