Afterthoughts - Axon and Infosys

If you read the full Stock Exchange announcement from Axon commenting on the Infosys deal you will come across the following Background to and reasons for the recommendation of the Acquisition by the Axon Directors:

Whilst the Axon Board is confident of Axon's ability to succeed in its global market, the industry in which Axon operates is subject to a number of challenges. Over recent years, the number of overseas new entrants with significant structural advantages has presented an increasing competitive threat to European and US service providers. The ongoing consolidation of the IT services sector has created a small number of major global service providers with considerable scale and breadth of offering. These companies are able to provide a more complete service offering compared to niche players like Axon, including large scale outsourcing and support for systems other than SAP, to large enterprise customers. In addition, IT services remains a highly cyclical industry and, although current trading remains resilient, the uncertain global macroeconomic environment represents a threat to Axon's future performance on a stand-alone basis.

Axon is facing two big problems. First, it's too small to go after the increasingly larger deals that are on the table and which are its key focus (50% of its revenues comes from its top 5 clients, 61% from the top 10). Infosys gives it both scale (customers will be dealing with a £2.5B revenue company, not a £200m revenue company) and "rampability", i.e. 'instant' access to a vast resource pool that can quickly be deployed on new projects. Secondly, despite having some one-third of its people in low-cost geographies, pricing competition is becoming more acute – not just from the Indians but from all around, especially the highly offshore-leveraged players like Accenture and IBM. Indeed, Steve Cardell made the point that competitors who were coming under pressure in their own core verticals are now encroaching into Axon's space looking for fertile new ground. Infosys gives Axon the low-cost delivery it needs to compete.

There's another reason too, not really evident yet, but clearly obvious to the Axon directors if you read the statement above. Axon's services cover the SAP application space but not infrastructure or business processes. So when clients want to outsource infrastructure management (IM) or BPO associated with their SAP applications, they have to go elsewhere. It's no secret that the Indian players see IM and BPO aas strategic services and use them to infiltrate new customers. This gives them a beachhead to move up the value chain into application management (still their heartland) and beyond. Axon would have no answer to this and would find themselves increasingly being squeezed once other players had foot-holds in their key accounts.

So the timing is right – do the deal while the business is still growing and profitable and get a reasonable (not stellar, but reasonable) price. Of course there are very clear lessons here for UK IT services companies that have not yet got the message. It's not that you have to go offshore to survive. That's a given. You also need to understand that the offshore (and offshore-enabled players) will attack your clients not just in your own service lines, but below and above you too. Mid-size IT services firms servicing large enterprise customers have little hope of being full-line services players; they should feel a strong sense of urgency to find benevolent partners, if not acquirers.

Footnote – Interestingly, Axon’s share price has currently (Tuesday 2.00pm) risen to 609p – ie above the offer price. Part of that is due to the dividend which will also be paid. But are investors really expecting a rival bid?

Update - The counter bid talk continues in the media this morning (Wednesday) with the FT - Axon rises 21% on persistent talk of did to counter Infosys - ending its report as follows:
"Steve Cardell, chief executive, said Axon had had "several chats around the coffee machine" with rivals but denied rumours that it had been talking to Fujitsu earlier this year over a deal at 700p per share."