Did Genpact pay too much for Headstrong?

Business process outsourcing (BPO) firm Genpact may have overpaid for information technology (IT) services firm Headstrong, which it acquired in April for $550 million, financials of the privately held IT services show.

According to Genpact’s disclosures to the US market regulator Securities and Exchange Commission (SEC), Headstrong had revenues of $221 million for the year to December 31, 2010 and its earnings before interest, taxes, depreciation and amortization, or Ebitda, stood at around $29 million.

The acquisition price paid by Genpact works out to nearly 19 times (19X) the Ebitda, which is much higher than prevailing valuations (8-10X) and valuations in deals that happened in the recent past.
iGate’s $1.2 billion acquisition of Patni Computer Systems in January happened at a much lower Ebitda multiple valuation of 7.5X.

Asked about the deal valuation being on the higher side, a New York-based spokesperson for Genpact responded via email that the firm is in a quiet period ahead of its quarterly earnings announcement and won’t be able to comment in detail.

“I will reiterate what we said publicly at the time of the acquisition announcement — that this (Headstrong) is an excellent strategic, operational and cultural fit that gives us great domain expertise in capital markets,” the spokesperson added.

Prevailing valuation is around 8-10 times the Ebitda, according to Amit Singh, executive director and co-head, business process outsourcing group at home-grown investment bank Avendus Capital, which was an advisor in UK’s Serco buying India’s BPO firm Intelenet for $635 million.

Amneet Singh, vice-president, global sourcing, at advisory Everest Research, feels the deal is a “fairly expensive buy” on the face of it, but Singh says some of it may be explained by the bidding pressure from competition that Genpact faced while trying to complete the transaction.

There were media reports about Genpact and some other IT firms being interested in buying Headstrong.

“Even on the revenue multiple, the Genpact deal was valued at about 2.5X, which compared to about 1.5X of the iGate-Patni deal, is fairly expensive,” said Everest Research’s Singh. “It definitely can raise expectations among other fence sitters looking for a sale opportunity.”

Other Industry watchers say that while revenue and Ebitda multiples are rule-of-the-thumb indicators, it has to be looked at in tandem with other factors, like how badly the buyer wanted the services and skill sets represented by the seller.

“Genpact was keen on diversifying its portfolio beyond BPO offerings by having some IT services capability and it made sense to buy what Headstrong represented, making them willing to pay a premium,” said Sid Pai, partner and managing director of the Indian arm of TPI, world’s largest outsourcing advisory.

Analysts approve of Genpact’s reasons for buying headstrong but see integration challenges.

“We like the overall rationale and direction, but believe integration will be key, as the cultures and employee retention will be key,” Tien-tsin Huang and Puneet Jain, IT analysts at JP Morgan, wrote in an April client note following the acquisition.