While consultants may get paid big bucks for their advice, two consultancies’ merger dealings show judgment that is, at best, suspect.
Infosys, in announcing that it will buy Axon Group for $753 million, sees itself as making a small, logical step into an adjacent market. But our research found that such deals can be fraught with peril.
While Infosys has thrived as an outsourcer based in India, it’s looking to move into higher-level consulting, such as Axon does with its implementations of SAP software, which is used to control many functions at major corporations. Buying Axon also would expand Infosys’s roster of clients, especially in Europe, where Infosys has much less of a presence than it does in the U.S. and in India.
One red flag here is that Infosys is trying to move “upstream.” It is trying to go from operating computer centers and doing maintenance to doing software implementations that would take the company out of the data center and expose it to more parts of clients’ businesses, often at higher levels. Historically, consulting firms have found it easier to move downstream, leveraging high-level relationships built through strategy work to win less complicated, lower-level work. Another red flag is that the market for computer maintenance and running data centers doesn’t have much in common with the market for big software implementations like those Axon undertakes. In addition, the European market can be very different from Axon’s main market, the U.S., so Axon may have some serious adjusting to do. Among other things, European labor laws make it harder to reduce staff, which could pose problems for Infosys if the European economy continues to suffer. The final red flags are that Infosys has a strong, cohesive culture and has never done a major acquisition, so it may have a hard time retaining talent and, in general, absorbing Axon.
Beyond our research, there are figures in “Deals From Hell,” by Robert Bruner, that should give Infosys pause. He writes that acquisitions are much more likely to succeed when the strong company is buying the weaker one, and not the other way around. Infosys is certainly a strong company, but its consulting business had a $13 million loss last year. So, how are the consulting executives supposed to take over Axon and wring more profit out of it than Axon’s managers did?
Infosys has grand aspirations and probably can’t reach them without acquisitions, so it may be that buying Axon will be an important learning experience that will pay dividends down the road even if it hurts Infosys in the short term. Still, Infosys might do well to look at history and realize that it’s sometimes better to sit out the sort of consolidation that seems to be occurring in I/T consulting. Let the other guys overspend on acquisitions and wallow in the complexities of integration, while you benefit from the higher prices that can be had when big players are taken out of an industry.
Perhaps someone should have raised that issue, too, with Hewlett-Packard before it completed its acquisition of EDS for $13.25 billion, a deal that has its own share of red flags.
Again, the weaker, smaller consulting organization is doing the buying. HP has talked about potential cost synergies, but there is little available to the combined entity that wouldn’t have been available to EDS on its own. So it’s hard to see how HP can justify the 33% premium it offered over the price at which EDS was trading in May, right before the prospects of a deal became known. (The stock market has declined about 10% since then, so HP wound up paying some 50% more than the price at which EDS likely would have been trading on the day the deal closed.) HP is leaving EDS’ CEO in charge of the combined entity, so it’s not as though HP has some secret sauce to add to the deal. There are also potential revenue synergies, but they are minimal. Analysts sometimes assume that a big hardware manufacturer can use a services arm as a major buyer of its hardware, but customers resist being treated as a captive market. IBM saw so little value in the connection between its PC business and its services arm that IBM sold the PC business in 2005.
Hewlett-Packard almost blundered in the services space once before, but lucked out. It offered to buy PricewaterhouseCoopers in 2000 for $18 billion, but the Internet bubble burst before an agreement could be reached, and the stock market decline convinced Hewlett-Packard to reconsider. IBM bought PWC two years later for $3.5 billion, less than a fifth of what HP had been prepared to pay.
With the EDS deal now complete, HP apparently wasn’t so lucky this time.
