To buy or to be bought

Zensar is doing well for now, but it could face problems common to mid-tier IT companies in the future

Why should we talk to you?” was the ominous question Ganesh Natarajan faced at the start of a meeting with a very senior official of a large retail chain in England. Natarajan, vice chairman and CEO of Pune-headquartered Zensar Technologies, remembers the great lengths he travelled to get the appointment in 2004.

“I had almost anticipated the question,” he recalls. “I told him that all we wanted was a chance to provide them with IT solutions — we were even willing to offer our services for free. That client eventually did give us the chance and they are still with us.” 

Zensar is viewed more kindly by the international markets these days. After all, it has ramped up revenues to ₹1,782 crore in FY12, from a base of ₹606 crore five years ago. But then, that is still small when compared to the big three Indian software firms that clock an average revenue of ₹40,000 crore annually.

The aspiration for this RPG group company now is to get into the big league. Zensar hopes to become a billion-dollar entity — thrice as large as it is today — by FY16. To do that, Zensar will have to grow at a CAGR of 30% all the way, admits Natarajan. Zensar hopes to end this fiscal (FY13) with a growth of 20%. Which means, the company will have to look at acquisitions in the future.

“We plan to make a significant acquisition in the US market in 2015, and that should add $150-175 million to the topline.” The proposed acquisition aside, Zensar itself has been rumoured to be acquired several times in the past few years. It’s not happened yet. But with every passing year, the case is only getting stronger. Unlike a few years ago, growth for most companies is coming at a higher cost now. While there is cost push because of higher wages, clients are also driving down billing rates, thereby depressing margins. That is making it imperative for companies to scale up — and acquisitions are an easy solution — to better your odds in the dogfight for business. So will Zensar storm into the billion-dollar club, as Natarajan suggests, or will it get bought-over?


Being a mid-tier IT services operator is just not easy. “Of course, there are disadvantages about being a mid-tier IT firm,” says Natarajan candidly. “We don’t get invited to the large parties where deal sizes range between $50 to $75 million. Our sweet spot is the $3.5-4 million range”.

It’s already a slugfest for small contracts among mid-tier IT companies, where Zensar is up against the likes of Mindtree, Hexaware and Polaris (the larger contracts go to TCS, Infosys and Wipro). “For any mid-tier company, the challenge lies in scaling up the $7 million contract to $70 million,” says Jigar Shah, senior vice president and head of research, Kim Eng Securities. “That is not easy at all.”

A bigger headache for most companies is the drop in client spend, which is unlikely to change soon. Even the big boys in the sector are struggling. Nasscom’s own prediction is that the IT sector will grow by 11-14% — less than the 16.3% it forecast for FY12. Of course, there aren’t likely to be many $100 million projects. “If there is a possibility to defer a large capex, it will be deferred,” says Natarajan.

“There is no getting away from that.” This only means competition will get more intense with larger companies now forced to go after smaller deals they ignored till now. The pressure is being felt globally. “If you look at the US, there is just a small recovery and therefore there is protectionism. If Europe is a long way from recovery, Japan is not going anywhere either,” points out Natarajan.

Differentiate or perish

Even the most optimistic analysts agree that the IT sector is getting ruthlessly competitive with wafer-thin margins. So if you are a mid-tier IT company, who has lost the scale game to the biggies, you have no option but to differentiate yourself from competition.

“There has never been a greater need to have a unique business model,” says Kim Eng’s Shah. “A player like HCL Technologies has a niche in enterprise application and remote infrastructure management, KPIT Cummins has found its space in automobiles, CMC is big in embedded systems.” 

Zensar, too, is carving a niche for itself in infrastructure management. Shah feels Zensar’s preferred vertical (about 35% of revenues) is a good idea. The plan is to grow the infrastructure management segment to $400 million by FY16 — a hefty 40% of the billion-dollar target from $120 million now, if Zensar actually gets there. With the global infrastructure management space pegged at $370 billion and growing at 3-5%, there is enough room to grow.

Here’s where the 2010 buyout of US-headquartered Akibia for $66 million will prove handy — not only did it jumpstart the company’s infrastructure management foray, it also strengthened Zensar’s presence in these verticals for clients in America and Europe. “Akibia’s product offerings make our customer interactions much more richer,” says Zensar’s Ajay Bhandari, senior vice president and chief corporate development officer, who just returned from another trip to the US. “We already have very strong relationships in the American market.” 

What also works in Zensar’s favour is that it gets almost half its revenues from the manufacturing sector (see: Niche play) rather than the usual suspects — banking, financial services and insurance (BFSI). Not to say that getting business from the manufacturing industry is any easier, but the scope for Zensar to differentiate its offerings in this space is better given its deeper industry expertise. 

“The larger IT companies in India depend on BFSI to contribute as much as 40-45% of their revenues,” Bhandari says. “For us, it is a much smaller 15%.”  And Zensar is happy keeping it that way. In fact healthcare is the next chosen focus area for Zensar and not without enough reason. “The US government has been increasing its focus on healthcare and this could well be our fastest growing segment,” Bhandari points out. “Though it accounts for very little today, we are sure that we will grow in this space with a large chunk coming from the US.” 

Even today, a bulk of Zensar revenues (72%) come from the US (see: Moving away). “It is a little higher than we’d like — I would say 65% would be ideal,” says Natarajan. One example of a new market that could reduce the dependence on America is South Africa, which has been growing at 15% year-on-year. Zensar employs 200 people in this market (supported by another 250 in India) where Natarajan says success comes only if one is proudly African.

“People expect you to be there and it is necessary to have a healthy mix of the local population.” The consulting-driven South African market has been a runaway success for Zensar — it should pull in $120 million by FY16, up from $29 million now (or ₹142 crore in FY12). Up next could be Kenya and Tanzania.

Zensar is also moving towards Asia, which is gaining manufacturing market share from Europe. “Indonesia is one such opportunity where we expect manufacturing to take off,” says Natarajan. “It could become the hub in Asia and we need to find a partner there.” Latin America is another geography that’s already witnessing some activity with the entry of a large number of Indian IT companies. 

Grow or go

Zensar is probably the only mid-tier company to register a steady growth rate over the last 12 years, says a confident Natarajan. “To date, we have never lost a client,” he adds. “Our top ten clients account for 60% of our revenues; the top five bring in 51%.” That’s pretty much the norm for mid-tier companies — in large enterprises, 25-30% revenues come from the top 10 clients; the top 50 bring in 65-70%.

Among Zensar’s 400 clients include UBS, Credit Suisse, Cisco, Nomura and Federal Reserve Bank, but one thing analysts are worried about is Zensar’s over-dependence on Cisco. At one point, Cisco accounted for 38% of the company’s revenues though that’s dropped to a more comfortable 22-25% today.

A generally accepted problem area for the smaller players is that they have trouble attracting and retaining good talent. Large players recruit more than they need just to send out a message to their clients; it is a luxury the mid-tier players simply cannot afford. But Natarajan points out that attrition at Zensar has remained at a manageable 10%. “Of the 680 people that the company has identified as critical talent, only four have quit,” he says.

He agrees that it is important to demonstrate non-linearity in growth. “We cannot just move up from 7,000 to 21,000 employees without a sharp increase in productivity.” That said, rising employee costs have kept margins under pressure. However, Natarajan maintains, “We are committed to achieving a 15% margin at the pre-tax level.” Investors seem to be buying that promise. Even in the current market turmoil, the stock has held its ground and trades at a five-year high (see: Regained glory)

Zensar’s strategy might seem conservative given its billion-dollar target. But, the fact is that the global delivery model is growing and there’s an opportunity for everyone in the sector. “Demand exists — companies just need to manage their costs and keep exporting,” says Shah. The reality, though, is that the IT industry is becoming commoditised. The pie may be growing, but more and more players want a chunk of it and there is little that mid-tier companies can do despite their differentiation. The only hope is small accounts that don’t catch the fancy of large players. 

Of course, it will be a tall order for Zensar to break into the billion-dollar club within the stated timeframe. But it’s strategic thrust on new verticals and emerging markets makes it an alluring target for any potential acquirer. For Zensar, it could very well be the case of the hunter becoming the hunted and that is the biggest trigger to be bullish on the company.