Wipro, beware of integration / impairment risks! ICICI securities

Several earlier attempts by Indian IT (including Wipro) to buy or build sizeable consulting practices have not been successful. However, learning from HCLT’s then bold bet on software products (similarly adjacent to IT) suggests there can always be a first! Keeping Capco as a separate entity should address branding, GTM and culture conflict issues to an extent. Successful cross-selling / integration of offerings will likely depend on the incentive structure promoting the same. Capco’s revenue stagnancy is of concern as it can be a further drag on the already low growth of Wipro. Given its onsite / consulting heavy nature, the acquisition should weigh on IT services’ margins (by 110bps, proforma, excl. amortisation). Our IRR scenario analysis pegs best case / worst case IRR of +8% / -4%. Implied 1-year forward P/E for Capco could be 35-45x (vs 21x of Wipro). Given its large size and lofty valuations, risk of integration challenges / future impairments (e.g. in HPS) cannot be ruled out. As in HCLT, this bold bet should remain an overhang on multiples till the time street finds comfort in integration. Our FY22E-FY23E EPS witness 6%-8% downgrade as we adjust for the acquisition. We reduce our target multiple to 17x FY23E EPS (vs 19x earlier).

Large acquisition at lofty valuations! Wipro acquired Capco – a global management and technology consultancy – for a cash consideration of US$1.45bn. Capco provides consulting, digital and technology services to financial institutions in the Americas (55% of sales), Europe (41%) and the Asia-Pacific (4%). The transaction is expected to close by Jun’21. As part of the acquisition, Wipro will get access to 30 marquee BFSI clients and over 5k consultants of Capco. Post acquisition, Wipro plans to operate Capco as a separate entity.

Revenues of Capco have been largely stagnant for the previous three years. EBIT margins are hinted to be close to the onsite margin profile of Wipro. Including amortisation of the intangibles, Wipro expects its IT services margins to be diluted 2% in the first year with the acquisition turning EPS-accretive from third year.

Cautious on integration challenges / impairment risks. Based on a basket of such onsite / consulting heavy entities (e.g. Appirio etc), we assume PAT margins in the range of 4.5%-6.0%. We build-in stable margins for our IRR scenario analysis as he company is non-committal about a material margin expansion. Despite stagnant revenues over the previous three years, we build three scenarios of 0%/5%/10% CAGR each. Our scenario analysis suggests best case / worst case IRR of +8%/-4%. Implied 1-year forward P/E could be 35-45x (vs 21x of Wipro) – very much on the higher side as the timing is coinciding with lifetime peak valuations of technology assets!. Given its large size / lofty valuations, risk of integration challenges / future impairments (e.g. in HPS) cannot be ruled out. This should remain an overhang on multiples of Wipro.

Downgrade the near term-earnings / target multiple: As we adjust for FY22E-FY23E projections for Capco acquisition w.e.f. 1st Jul’21, earnings witness 6%-8% downgrade. To factor-in for the elevated risks, we reduce the target multiple to 17x FY23E EPS (vs 19x earlier). We downgrade the stock to SELL (from Reduce earlier).

Shares of WIPRO LTD. was last trading in BSE at Rs.420.4 as compared to the previous close of Rs. 438.85. The total number of shares traded during the day was 2173436 in over 39865 trades.

The stock hit an intraday high of Rs. 440 and intraday low of 417. The net turnover during the day was Rs. 925588902. Equity Bulls