MUMBAI: Until last week, the worry for investors in Mphasis Ltd was that Blackstone Group LP might sell a part of its stake in the company, which would put some pressure on the stock price. After all, its attempts to exit the investment through a deal with private equity (PE) firm, Carlyle Group, hadn’t worked out. With the stock soaring, it was believed that Blackstone may bring down its stake marginally from the 56% levels, and book some profit.
As it turns out, Blackstone is indeed selling down its stake, but not in the manner some investors had feared. Instead of selling in the secondary market, Blackstone has ended up placing a buy order for a 26% stake in the firm through an open offer to minority shareholders. This is part of a larger deal where a relatively new Blackstone fund will buy up to a 75% stake in the firm. Mphasis shares rose 1.4% on Monday, as investors were relieved at the change in tact.
The win-win deal has been made possible by a sort of a swap deal between two different funds managed by Blackstone. The fund that bought the stake initially in 2016 is selling its stake to another fund managed by Blackstone. What’s more, the special purpose vehicle that is being used for the transaction has raised funds from two sovereign wealth funds and one large pension fund, giving Blackstone a part exit in the process.
PE funds typically have a runway of about seven years before looking to exit an investment, and the Mphasis investment is already about five years old. By transferring the stake to another Blackstone fund, the PE firm is buying itself a lot of time to sell its stake in Mphasis. The new fund under which the stake will be held is relatively new, giving the PE much a much longer runway for planning its exit.
The other side of the coin, of course, is that this shows it isn’t easy to find a strategic buyer for mid-tier IT firms. Large global technology outsourcing firms either have captive units with immense scale, or have already gone ahead with acquisitions to gain scale. Baring Private Equity Asia has also struggled to find a buyer for its majority stake in Hexaware Ltd, and it ended up buying out minority shareholders and took the firm private. Valuations are also a bit of a sore point, in terms of concluding a deal with a strategic buyer or a PE firm. Note that the special purpose vehicle is buying the stake at close to a 15% discount to Mphasis’s stock price ahead of the announcement.
While Blackstone’s final exit has been postponed, in the meanwhile, Mphasis investors can hope that investee firms linked to the two sovereign wealth funds can be potential customers, and add value to the firm. The wait will also give the firm time to ride out the deterioration in the portfolio of clients linked to DXC. Mphasis’s direct core business has been far better than peers, although overall business has been pulled down to an extent by the DXC portfolio. DXC was formed through a merger of CSC and former Mphasis owner, Hewlett Packard Enterprise (HPE). As part of the Mphasis sale, HPE has given a minimum revenue commitment over a five-year period ending September 2021.
Most of all, Mphasis investors will be pleased that the deal brings stability and continuity for the firm. On the other hand, any hopes of a buyout or a delisting offer, like the one Hexaware investors got, can be put to rest. In this backdrop, and given Mphasis’s valuations of 23 times forward earnings, the firm would not only need to sustain its current momentum, but also improve on it for any re-rating to happen.