In a sign of growing consolidation in the outsourcing industry, two second-tier players with extensive Bay Area operations completed a merger Thursday, creating a combined company with annual revenues of nearly $1 billion that hopes to compete more directly with such software giants as Tata, Infosys and Wipro.
Fremont-based iGate acquired Patni Computer Systems in a deal valued at $1.2 billion. Patni, which has headquarters in Massachusetts and Mumbai and an office in Milpitas, is a pioneer in India’s IT industry.
The deal is the largest merger in the outsourcing industry, which includes companies with armies of engineers — mostly in India — who provide a host of services, from writing applications to providing business analytics and managing back-end tech systems for U.S. corporations, at relatively low costs. It is part of a wave of consolidations, said Phaneesh Murthy, CEO of iGate.
In the next decade, much of the growth in outsourcing will come from current clients, not new ones, giving large players a market advantage, he said. On average, U.S. corporations outsource 9 percent of their IT chores — a number that is expected to expand to 20 percent or more in the next 10 years, Murthy said. So software companies with the most clients stand to grab most of this new business, he said.
“More and more services are being executed by companies based in India,” Murthy said.
Another impetus to merge is the risk facing smaller outsource companies that rely on business from one particular industry. This was underscored when the financial services industry in the United States imploded during the economic crisis, which triggered a dramatic cutback in IT work assigned to Indian software companies, Murthy said.
“If you focus on one vertical and the vertical goes down, like what happened in the banking industry, it becomes a nasty surprise to you,” said Murthy, a former executive at Infosys. Large parts of iGate’s business comes from the U.S. banking industry, whereas Patni specializes in insurance and manufacturing sectors.
“The companies that were solely dependent on banking and financial services, they either went under or came close to it,” Forrester analyst Jan Erik Aase said. “The ones that had equally strong businesses, like retail or health care or energy — they can ride the various storms. Every industry will have a storm.”
After the economic downturn hit, the number of U.S. banks outsourcing significant work to India dropped from about 80 to 15, Murthy said. “When that happened, the smaller companies struggled more because the larger companies were swarming over these 15 companies,” he added.
The new company, called iGate Patni, has 26,000 employees, including 4,000 in the United States. Murthy expects to add as many as 1,000 new employees in the U.S. in coming months.
IGate, which reported revenues of $281 million last year, acquired the much larger but struggling Patni, which had sales of $689 million in 2010. Though its business is much smaller, iGate’s market value of $1 billion nearly matched that of Patni’s, which is $1.1 billion. In April, Patni reported a 20 percent drop in first-quarter profit.
Because of regulatory rules in India, the companies will remain separately listed entities for another 12 to 24 months, Murthy said.
While iGate Patni will be in a better position to compete with larger competitors, the company would be wise to ensure it does not lose the culture of a smaller operation, Aase said.
The large outsourcing companies are frequently viewed by clients as “too big, noncaring, too steeped in red tape,” he said. “Do you want to be associated with that? A lot of companies choose not to engage the tier-ones, ‘I am not a million-dollar-deal, so the chances that the tier one will pay attention to me are slim to none.’ ”