Tech Mahindra London Limited (TECHM.NS) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Tech Mahindra Limited Conference Call to discuss the acquisition of CTC. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Vivek Agarwal, President of BFSI, HLS and Corporate Development. Thank you, and over to you, sir.

Thank you, [ Faizan ]. Good evening, everybody, and I appreciate joining this call on short notice. And I hope all of you had a chance to look at the investor deck, which should be available on our website and cost to have kindly arrange to send to all of you. I'm going to take a few minutes upfront to talk through some of the salient points in the deck, and then we'll open it up for questions. Just from a transaction perspective, this is -- 3 primary strategies and rationale of why we've done this investment. Firstly, we believe that the insurance industry is going through significant transformation. A lot of new emerging business models and a lot of it is being disrupted by technology. So this is about us doubling down with increased focus on scaling our insurance business over the coming years. Secondly, CTC brings in deep digital technology skills and capabilities. They've been involved in a number of marquee digital transformation work with their client base. And we think it's a very scalable capability, not only for servicing their existing client base, but also being able to cross-sell and take to a bunch of Tech Mahindra clients globally. And lastly, the business services clients in Europe and in the U.S., but the delivery centers for the company are based in Latvia and Belarus. Those countries and the region provides excellent technology capability and talent. And as part of our plans, we do think this is a very scalable talent base, with very high-quality talent availability, which you would expect to grow manifolds in the coming years. So that's the broad thinking around these investments. And just getting into some of the detail. So as you may have seen from the communication, this is a couple of transactions together. And the reason they are combined is they are owned by the same shareholder group and they're all very deeply focused on the insurance industry and financial services industry. The first is a core 100% acquisition of CTC, which is 100% services business. And we are acquiring the business for a total consideration of EUR 310 million. Out of this EUR 310 million, we will pay EUR 210 million upfront, and the balance of EUR 100 million is linked to the performance of the business over the next 4 years in the form of earnouts, as well as synergy linked payouts. And I think -- This is just to ensure that we drive the right levels of synergy and cross-sell, as we move forward in integrating this business with Tech Mahindra. The second part of the transaction is a minority investment into 2 InsurTech platforms. The 2 platforms have a proven technology stack, have a proven business model. They have active clients on the platform and they go to market in a SaaS business model, and helps customers address very specific needs in their business. We do believe that these are very scalable platforms. And with our participation, we would have the ability to take these wider into the global market as well as provide scalability to these platforms over the coming years. We've taken -- we're taking a 25% equity stake upfront in these platforms, with an option to subsequently increase our stake, add a predetermined valuation within the next 2 years if we wish to do so, at our choosing. Just a quick snapshot of the businesses. CT Co, which is the core services business, did about EUR 71 million in revenue for the full year calendar 2020. And for the first 9 months of 2021, the business turned over about EUR 59 million in revenue. 720 employees, and the business has seen significant growth rates over the last 3 years, a 40% CAGR on revenue. And on a consolidated basis, this business would deliver industry-leading EBIT margins to Tech Mahindra. The 2 insurance tech platforms, which we're looking at. The first one is SWFT, which essentially focuses on sales and distribution, helps set up digital broking capability price comparison websites and helps insurers launch new products go to market very quickly with an out-of-the-box solution. Currently runs with -- has a bunch of clients in Europe, but we do believe both added functionality as well as added go-to-market strengths will offer a significant upside to both the market we can address as well as the functionality we can offer clients. And the second InsurTech platform we've invested in is Surance. This is a very unique technology and platform, which was developed in Israel and helps insurers underwrite personal cyber insurance. And it helps collect information, data, helps with managing the risks for the insurer. So this is -- these are both B2B platforms, which help insurers or brokers develop and take new products to market. And these platforms will provide the technology backbone for those products. So on Surance, there are a number of leading global reinsurers who use the platform to underwrite cyber insurance. But we also see this as part of a bigger market, which is focused on data-driven insurance underwriting, and we see a big market opportunity out there. Just quickly -- and I touched upon this in the opening statement around the strategic rationale, but this is about high-quality digital engineering, a scalable talent pool and workforce in Europe and very, very deep domain expertise in insurance and reinsurance industry. And lastly, I'm going to touch upon how do we see value creation from this investment. I briefly said that the business has industry-leading margins and will be accretive to the tech and EBIT margins. And also, the transaction will be accretive across a bunch of financial parameters around EPS, free cash flow and ROCE. We will rebrand, co-brand the business segment of CTC from day 1, and this will become part of our overall operations. And we do have an integrated management team structure which has been set up and agreed with the management team and sellers of the business who will be responsible for the business, going forward. And they would also be focused on driving synergies, which has largely around cross-sell and scale-up of digital engineering capabilities, as well as the ability to sell the tech and service lines in the client base which comes in with the CTC acquisition. This is extremely important for us, and that's the reason why when we set up earnouts, it's not only earnouts on standards of performance of the business, but earnouts include -- earnouts also include payments linked to achieving the synergy goals for the combined business. And lastly, on the global insurance scaleup. I think, on the back of this transaction and these investments, we are very focused on creating a dedicated go-to-market for our insurance business. We think that the market is very attractive in the segment. If you look at spend data, the insurance industry spends on transformation and new business models is at least 2 percentage points to 3 percentage points more than the overall industry, and we see this as a great opportunity to play a disruptor in this industry. So we have geared up internally with the right alignment of management team, personnel to go after that opportunity, apart from growing the whole digital engineering practice on the back of this -- these investments. I'll take a pause here and open it up for questions and as the questions come in, happy to address as much as we can. Thank you.

[Operator Instructions] The first question is from the line of Mukul Garg from Motilal Oswal Financial Services.

I think, very interesting acquisition. Just a couple of clarifications, if I may. First, if you look at the 2 InsurTech platforms, can you help us, how old are the companies and what are their current revenue run rate?

So Mukul, the 2 companies are between 1.5 and 3 years old, okay? The -- I can give you the number of clients and where they are and their evolution rather than revenue numbers and the business model, if that helps understand a little bit more. So SWFT Online, works with insurers, brokers and currently has 2 live clients in Europe, and they get a percentage of the brokerage fee, which is generated out of on the platform. That's the business model they go out to, and there is an installed base, there is revenue, long-term SaaS contracts with digital brokers and online platforms, which use the SWFT technology to power their customer journeys and the sales and distribution process. On Surance, the model is slightly different. The platform works with insurers carriers as well as reinsurers to help assess, manage and then underwrite personal cybersecurity risk. This is on the basis of the technology and IT the company carries. They look at understanding the risk involved and then managing it, which is obviously of great value. Any of the data has upgrade value to the insurance companies. And that's what this platform provides.

Sure. And I just wanted to kind of touch upon the motivation for this transaction from the seller side. If you look at this particular acquisition, the valuation looks quite attractive for you guys, given that they are into digital engineering and development space, both of which are quite hot, but the valuation seems still fairly attractive. So after working for about 20 years in the space, what was the motivation for the seller to exit fully at this valuation? Obviously, the reason looks like that it was for the InsurTech platform. But again, they are giving you almost a 45% type of a stake over a few years if things goes well. So if you can just touch upon what was the factor which led them to do this transaction at these prices?

So I think, Mukul, firstly, a great bunch of entrepreneurs who built this business over the last few years. And a lot of the growth has been in the last 3 or 4 years. As I said, last 3 years CAGR is about 40% from a revenue perspective. What I would like to say is that this has been a bilateral deal. We've built a great relationship with the founders over a period of time. They mine into a larger vision of where this business and this entire capability can be as part of a larger organization. That's the reason why some of the earnouts and payouts are linked to synergy achievement because they do believe in the wider vision of what we have for the businesses. And I think, the second reason is that while the services business has its own momentum, the structure we have adopted is will also help fund the next phase of growth of the 2 InsurTech platforms, while the founders and the management can focus on building more functionality, taking it to market on a wider basis. And we would love to take them to market, to our client base, to different parts of the world and provide them with a global reach. So I think it's a holistic vision of what we think we can jointly build together. It's been the big driver for this.

Just 1 clarification. What's the current attrition rate of the companies you can share?

Again, a single-digit attrition rate. So very well-run, very tightly and well-managed business. And if I may say so, a little bit under the radar of how they've operated to get to this great success.

Congratulations, and I think it's a good acquisition from your side.

Thank you.

The next question is from the line of Ankur Rudra from JPMorgan.

So that looks like an interesting deal. Could you prefer this 40%, as you mentioned, to be entirely organic in the last 6 years?

Ankur, that's correct. It is all organic growth over the last few years. Absolutely.

It looks like it struggled to grow. I mean, it was a bit slower growth for a long time, and only picked up pace in the last, like you mentioned, in the last 2, 3 years. Any changes in the ownership or structure of focus, which is agreement?

So not -- so the short answer to those questions is no. It's been the same set of founders. I think, what's happened over the last few years is, they've built a great knowledge of their clients' understanding of deep business processes and understanding of the core of their clients. And as customers have undertaken large-scale digital transformation, they've looked at -- looked for people who understand their core business rather than trying to get horizontal skills and then helping people understand their business processes, et cetera. And what they found in CTC is already understanding of the core of their business as well as some top-notch technology talent. And I think, that combination is what's driven growth for them over the last few years.

Okay. And could you clarify how widely spread are the earnouts for the founders have been indiscernible]? And what is the duration?

So the duration is 4 years, including the calendar year we just finished, so there's 3 full years on this after this year. But it was in 4 parts, yes.

Okay. And [indiscernible], is there any layer of management in the senior management [indiscernible] also participating...

Sorry to interrupt you, Mr. Rudra, the audio is not clear from your line, sir. Please use the handset mode.

I was saying that, do you think the extent of lock-in is beyond to the founder? Can you elaborate this in the senior management team as well?

So there are a bunch of key personnel who do not have significant equity stakes, but we put them as part of a transaction on the retention plan for 3 or 4 years.

Okay. Understood. Just last question from my side. You had an interesting -- a quite a successful strategy in the last few years, which is, as you highlighted in a recent Analyst Day, a programmatic method of going at [indiscernible] bigger transaction in comparison to what you've done in recent years. Is this a slight change in approach? Or are you just a bit more confident in terms of the targets you're going after?

So Ankur, I think -- and you referred to the Analyst Day presentations where we did put out our strategy and how we're executing on it. And I do believe we are executing fairly well on our strategy of how we integrate, how we go after large deals on the back of acquisitions. So yes, absolutely, there is more confidence. I think, from a size perspective, as you would see from a revenue size perspective, this is very much in the sweet spot. We've always articulated this is about $100 million in revenue or $90-something million in revenue on an annualized basis. I think, from a valuation perspective, it is reflective of what we believe is the quality of the talent, the overall capability set, and as I said, industry-leading EBIT margins.

The next question is from the line of Kawaljeet Saluja from Kotak.

My question on the acquisition is twofold. One is, can you talk about your own insurance capabilities, which you can cross-sell to -- which can cross-sell and make the best use of the acquisition? When I look at your own financial services practice size, including banking, that's about $1 billion, which is modest. So kind of just detail the areas of synergies out.

So sorry, apologies. You said twofold, so is there a second part of the question? Or do you want me to go ahead with the first part only?

Okay. I'll go ahead. Now, the 2 -- the acquisitions, the investment that you have made in SaaS, right, was the investment coterminous with the overall acquisition? Or you had a choice of not making that investment?

The second one is an easy one, so I'll take it upfront. It was our choice. And as I responded to Mukul on the first question, we do believe that the combined vision for the industry and how we would work this together with the founders was critical. But it was at our choice.

Yes. So why is it compared to the 25% investment? Why not go the whole hog?

So I think, commonly, the structure is that we have an -- we have invested 25% and we have an option to buy another 20% again at [indiscernible]. We've just used a standard approach, and we do think that if we do exercise our option, it would give us a pretty significant stake as these develop to the next stage. And to your first part of your question around what is our capability set in BFSI and especially in insurance and how do I see synergies are working. As you rightly said, BFSI for us is now about $1 billion business. But if you look back on this, this has been high-teens growth over the last 5 years. We've had somewhere in the 17%, 18% CAGR in BFSI over the last 5 years. And I think, the way that business has been built over the last few years is around identifying specific trends and creating a right to win, following those trends. Because if you look at 5 years back, we were a 300 million business unit in BFSI and there was no differentiation. But I think, from a strategy and logic perspective, we are following the same that if we are going to create differentiation and a right to win, it gives us a better chance to be successful in the market. It gives us -- it does give us scalability. And when I look at where do we see synergies. I think there are 2 ways to look at this. This business largely works on helping insurers and financial institutions do digital engineering, digital transformation projects on the development side. So they, essentially, are an enterprise OPD shop, where they build next-generation digital products for their clients. So that capability and that skill set is very fungible to our clients. So that would be one part of the synergy. And I think, the second part of the synergy is going to be on our client base -- sorry, on their client base, where we do believe we should be able to sell horizontal service lines, scale service lines, which today, this business does not deliver. So they actually leave enough money on the table for some of the other players to come in and fulfill those capabilities. So it's a combination of the 2. And then, as we look at combining those sets of capabilities, we also believe that it will improve our chances of winning in the market for new clients, et cetera.

Got that. Just -- that's very helpful perspective Vivek. Just a question for Rohit or Milind. I don't know whether this question was asked or not, but is this -- what's the amortization charge from this acquisition? And will this transaction be EPS dilutive or accretive?

So Rohit, do you want to answer or I can answer the part of the amortization charge?

Go ahead, Vivek.

We've -- obviously, the accountants will ultimately finally opine on the quantum. But right now, we assume 1/3 of the transaction value will get amortized over 8 years linked to client contracts and client relationships.

I mean, but would there be amortization related to marketing intangibles, brand name or client contracts is the only thing amortized?

The client relationships and those are the ones which will get amortized, yes. So that's -- and our estimate is 1/3 of the value will get attributed to that amortization.

Kawaljeet, that is actually a group which will include customer contracts and customer relationship.

Okay. So the approximate charge will be around EUR 13 million, EUR 14 million Okay. And whether it's EPS accretive or not?

Yes, it is. Yes.

And on a GAAP basis?

That's correct. Yes.

The next question is from the line of Nitin Padmanabhan from Investec.

Congrats on the transaction, Vivek. On the -- I think, you mentioned that the annualized revenue was around EUR 90 million. Is that correct? And that would actually mean that the fourth quarter is like EUR 31 million. Is there so much seasonality in the business? How should we sort of understand it?

No, no. So Nitin, sorry. I did say $90 million because the question was on size. So it was EUR 90 million, okay. So -- and the business has no significant seasonality. Yes. So the numbers will be -- I'm not at a liberty to make a forward-looking statement of where the December quarter will close, so hence, we've given you 9 months revenue, but there's no seasonality. And again, just for good order, the 90 million was U.S. dollars and not euros, yes.

Understood. So if you look at the past 3 years, actually, the growth has sort of been decelerating. It's like almost 10% growth this year on an annualized basis, right? So what's happening within the business that's leading to this deceleration? And going forward, do you see -- or do you believe that it can get back to earlier growth rates?

So I think, Nitin, as the business has grown, and one of the reasons why this is attractive for us is because we think we can help add value to bring scalability in the business, yes? The business has become constrained in its private ownership for various reasons. And one of the opportunities for us here is being able to build more scalability, more robustness into the systems, processes for the business as we move forward. The opportunity is humongous. Obviously, I can't give you a forward guidance on what we expect here, from a numbers perspective. But directionally, if we fire on all levers around building scalability on the talent side, there is enough revenue opportunity in the sector, both from horizontal perspective as well as from industry perspective.

Understood. So what you're essentially saying is, the lower growth rate is because of underlying business constraints, which, as a group, together with Tech M, you should be able to harness synergies and sort of improve. And that's what they're targeting, and that's why you've announced. And that's why the valuations are where it is, is how I would understand. That's a fair assessment, right?