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Wipro's $1.45 bn deal with Capco disappoints Street; here's why

Topics Wipro | Buzzing stocks | Markets

Wipro’s bold and big bet on Capco is interesting for sure but one where risks outweigh returns, KIE analysts said
Dalal Street gave a lukewarm response to Wipro's buyout worth $1.45 billion (over Rs 10,500 crore), its biggest ever, of London-headquartered Capco as the shares of the firm tanked 4 per cent on the BSE to Rs 421.30 in Friday's trade following the announcement of the deal.

Wipro on Thursday said the acquisition will provide it access to 30 new large banking and financial clients and strengthen its position in the Banking, Financial Services and Insurance (BFSI) sector. The BFSI segment accounted for over 30 per cent of Wipro's IT services revenue in the December 2020 quarter that stood at $2,071 million.

The deal comes at a time when businesses globally are betting on technology and increasing their spends on digital to support growth during the pandemic.

Wipro expects significant revenue synergies from the combined entity, although it has not quantified any specific goals. It sees the acquisition to be margin-dilutive in FY22 (200bps impact) and EPS to turn accretive by the third year post the acquisition.

Following this, most brokerages retained their 'Neutral' to 'Negative' stance on the IT bellwether with some even slashing their targets for the stock as they flagged integration and execution risks associated with the deal.

"We see significant risks from this acquisition on account of a) integration risk due to Wipro’s weak track record and b) execution risk on challenges related to realizing potential synergies. The execution risk is further aggravated by a weak growth performance from Capco over the last two years – even after adjusting for the drag due to Covid-19," Motilal Oswal Financial Services (MOSL) analysts said.

Capco's revenue in a calendar year (CY) 20 stood at $700 million. Its revenue declined in CY19, largely led by a slowdown in few clients in the capital market and in CY20, revenue grew by 6 per cent, impacted by the ongoing Coivd situation.

Capco’s revenues have declined compared to where it was in 2018, yet the valuation paid by Wipro is 75 per cent higher than the previous transaction, which analysts find to be expensive.

Analysts at MOSL noted such a move should result in additional pressure on Wipro’s share price in the near term as investors would wait for benefits from the acquisition to start accruing before rewarding the company.

"Wipro’s bold and big bet on Capco is interesting for sure but one where risks outweigh returns. Wipro is undergoing a major transformation exercise that entails changes to personnel, organization structure, go-to-market approach and incentive structures. A big bet could have been avoided especially when the demand environment is so good," said Kawaljeet Saluja and Sathishkumar S, research analysts at Kotak Institutional Equities.

A toll on Ebit margins also worries analysts as they see it eating away at the gains from operational efficiency and pressurising the bottom line.

"Wipro has indicated a 2 per cent Ebit margin impact on the IT services business in FY22, led by higher amortization charges in the earlier years. However, long-term Ebit margin in the consulting business with onsite heavy presence is likely to hover in the high single-digit range, which implies a 70-100 bps impact on overall Ebit margins for the company," said Rishit Parikh of Nomura.

The brokerage retained its 'Reduce' rating on the stock with a target price of Rs 410.

MOSL said Wipro continues to be its least preferred name in the large-cap coverage due to its weak growth performance and maintained a 'Neutral' rating on the stock with a target price of Rs 450. The brokerage sees successful completion of this acquisition resulting in its FY22 dollar revenues rising 700bps and a negative impact of 6–7 per cent on FY22 EPS.

Brokerages Antique Broking and Phillip Capital too maintained 'Hold' and 'Neutral' ratings on the stock.


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