Wipro’s Capco Deal Can Boost BFSI Capabilities, But Valuation Woes Remain: Brokerages

Analysts see a successful completion of Wipro Ltd.'s acquisition of Capco as key to aid the software services provider's U.S. dollar revenue, create cross-selling opportunities and bolster BFSI capabilities. Yet, elevated deal valuation is a concern.

Wipro has agreed to acquire London-based consulting firm Capco for $1.45 billion, according to an exchange filing. The deal—that will help the IT company add 30 new clients from the banking, financial services and insurance segment—is its largest ever acquisition, and is likely to be completed during the quarter ending June 30, 2021.

While the deal will dilute Wipro's margins before interest and taxes by about 2% in the first year, it's expected to improve in the future due to revenue and cost synergies, Wipro said in a presentation accompanying the filing. It will also dilute earnings per share in the first year, and will start adding to it from the third year.

Shares of Wipro fell as much as 1.8% in opening trade on Friday to Rs 430.8 apiece. Of the 47 analysts tracking Wipro, 18 have a ‘buy' rating, 14 suggest a ‘hold' and 15 recommend a ‘sell', according to Bloomberg data. The average of the 12-month consensus price target implies an upside of 1.4%.

Here's what analysts have to say about Wipro's new acquisition...

Morgan Stanley

• Maintains underweight rating with a price target of Rs 410 apiece
• Large acquisitions by Indian I.T. companies have generally not yielded the desired results
• We think the market will wait to see a smooth integration to cheer this transaction
• Stocks have generally underperformed in the one month following the announcement of a large transaction
• Achieving some of the goals laid out in the strategy under new CEO, which could improve sentiment

Nomura

• Maintains ‘reduce' rating with a price target of Rs 410 apiece.
• Acquisition allows Wipro to scale its BFSI presence
• Adds presence in the consulting business which has typically been a less successful venture for Indian IT companies
• Valuations at 2x sales appear to be on the higher side for a consulting business
• Acquisition will be margin dilutive considering consulting and onsite-heavy presence
• Expects a 70-100-basis-points impact on overall EBIT margin for the company.

Investec

• Maintains ‘hold' rating; hikes price target to Rs 440 apiece from Rs 430.
• Success of the acquisition will depend on how well it is able to capture the downstream revenue opportunity.
• Downstream opportunity is typically two-thirds of the total spend, while consulting being one-third.
• With multiple bold decisions in place, execution remains the key
• Lowers FY22 EPS estimates by 2.6%, while FY23 estimates remain unchanged.

Motilal Oswal

• Maintains ‘neutral' rating with price target of Rs 450 apiece.
• Elevated valuation of the acquisition to require flawless execution.
• Sees significant risk on account of integration risk due to Wipro's weak track record, execution risk on challenges related to realising potential synergies.
• Execution risk further aggravated by a weak growth performance from Capco over the last two years.
• Wipro has paid a significant premium despite unexciting growth from Capco.
• Successful completion of acquisition will see the U.S. dollar revenue rise 700 basis points in FY22 and a negative impact of 6-7% on EPS.
• Wipro remains the least preferred name in the large-cap coverage universe.

Emkay

• Maintains ‘hold' rating; hikes price target to Rs 450 apiece from Rs 420.
• Capco acquisition to bolster BFSI capabilities.
• Acquisition to create significant cross-selling opportunities and aid wallet share expansion across existing clients.
• Integration of a low-margin business and higher non-cash charges are likely to impact EBIT margin by about 200 basis points in the first year.
• Margin will improve on revenue and cost synergies from second year.
• Acquisition expected to be EPS accretive in the third year.

Antique Stock Broking

• Maintains ‘hold' rating with a price target of Rs 450 apiece.
• Valuations of acquisition not cheap considering lower margin.
• Acquisition will dilute Wipro IT services EBIT margins by 2% in first year and improve thereon driven by revenue and cost synergies.
• Acquisition to provide cross-selling opportunities and access to 30 new large BFSI clients.