TCS has announced the acquisition of Citigroup Global Services (CGS), the captive BPO arm of Citigroup, for US$505m in an all-cash deal. As part of the deal, TCS gets assured process outsourcing business of US$2.5bn over 9.5 years. This is in addition to TCS's existing relationship with Citigroup for application development and maintenance, and infrastructure support services, currently at an annual run-rate of US$150m. We estimate the acquired business makes Citigroup TCS's top account. We view the transaction to be near-term EPS neutral. We estimate the transaction values CGS at 8.6x FY09F EBITDA, ahead of the current valuation of Genpact, the closest comparable (7x CY08F EBITDA, as per IBES consensus) and in line with 9x FY09F EBITDA for TCS at current levels.
TCS acquires Citigroup Global Services for US$505m
We estimate the transaction values CGS at 1.9x FY09F revenues or 8.6x FY09F EBITDA. According to management, CGS is projected to have revenues of US$278m for CY08 with about a 30% CAGR over the last three years. As part of the deal, TCS get assured “take-orpay” business at the current run-rate – translating to US$2.5bn – over 9.5 years. It also becomes the preferred vendor for incremental process outsourcing work from Citigroup.
We rate the transaction as EPS neutral in near term…
TCS aims to fund the transaction with internal cash reserves. We estimate the return on purchase consideration at 8.7% (assuming EBIT margins at 20%, 0 other income and effective tax rate at 18% for CGS for FY09), in line with the current effective post-tax yield on cash balance of about 8%. The transaction should thus be EPS neutral in the near term. Management expects it to turn EPS accretive over the next three years. We believe this would depend on incremental revenue flow; we see limited margin expansion potential, given CGS’s current margins (23.5%) are comparable to TCS’s (25.5% for FY08). Note, about 30% of revenues for CGS are from Citi’s India operations.
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