Kanbay’s sellout – A Mystery

Kanbay International Inc 

As I have written in my last Blog, I was supposed to write a comprehensive article on Indian Outsourcing Industry’s Q2 results, but anyways I am most interested in writing my view point on Kanbay in this Blog.

Kanbay (NASDAQ: KBAY) is one of the few pure play professional IT services firm operating thru global delivery model. They had a meaningful growth when compared to their peer group (they did not chase Y2K, they did not go after multiple verticals, their success in achieving high retention rates etc).Their blue chip client base in FSI vertical is second to none. It is also interesting to note that their operating margins for last few years are in the region of 15-19 % which is reasonably good given their operating structure (companies with similar structure have margins between 8 – 12%).The recent Kanbay’s acquisition of “Adjoined Consulting” was a major transformational event for Outsourcing industry. Also this was endorsed by leading analysts such as Forrester as a path breaking event.  Thus this firm had everything going good, leading towards a highly matured $ 1 billion organization by year 2010.

If everything is going good for Kanbay then why this sudden sellout to Cap Gemini? Raymond Spencer CEO of Kanbay in his email to Kanbay’s associates has said “bearing in mind the boards’ primary fiduciary responsibility is to its shareholders, we believe that an all cash deal at $29 per share and vested options is a deal that must be recommended to the shareholders“. Email also says that Kanbay will piggy ride Cap Gemini (CG) to transform existing client’s business and performance thru technology adoption. Lastly Raymond will be joining CG’s top management as Head of their FSI Practice directly reporting to CG’s CEO Paul Hermelin.

Given this background my take on this acquistion

1. Kanbay has been trading at low PE ( 28 before CG offer, a similar firm like IGate Corp is trading at 55 PE) made it attractive target
2. Lack of clarity in terms of 2007 and 2008 goals, lead to this sellout (just stating $ 1 billion revenue by 2010 is not good enough)
3. The very positioning of Kanbay is confusing (it not an Offshoring firm or a full fledged outsourcing company as per current positioning)
4. Lastly Kanbay is victim of its own success (successful IPO, some major client wins in North American Market)

All the above factors lead to Kanbay’s selling out but I felt $ 1.3 Billion (3 times 2006 annual earnings) is low, ideally Kanbay should have been valued at 5 times of 2006 earnings or $ 2.5 billion for this acquistion

What I did not understand is why Cap Gemini? Here are the few questions which remain unanswered  

1. It’s a known fact that Cap Gemini is struggling with their American operations including failed E&Y’s acquisition. They also sold their North American Healthcare practice couple of years back to Accenture. So why do another acquisition? I am sure this is will be as risky as E&Y transaction.
2. Why 100% cash deal?  If the idea of is to acquire Kanbay for their FSI expertise and domain experts then why not empower them with Stock and Cash deal? Like what Kanbay did with Adjoined Consulting (as per the available information Adjoined’s integration with Kanbay was highly successful)
3. North American economic growth rates especially housing sector is indicating possible slow down / moving towards recession in 2007 and 2008. So does this make sense for CG to acquire Kanbay at this point of time? (CG acquired E&Y’s consulting business at the height of Dot com boom)
4. Why should HSBC recommend that Kanbay should sell out to CG? (As reported by Economic Times FRIDAY, OCTOBER 27) was there a danger of Kanbay not renewing their $ 65 million outsourcing contact slated for 2007? I suspect this could be crucial missing piece in whole deal.  

Anyhow only time will tell if this acquisition is successful or not.