While the stock is almost sure to be hammered if the deal falls through, even otherwise, EDS' peculiar business model and its complete control over the Indian company after the acquisition may convert it into a high-turnover, low-profit sweat-shop being used mainly to save the parent company's bottom line from sagging.

Though most market participants seem to be in a mood to play the wait-and-watch game hoping EDS will revise the offer price upwards if it finds few takers, investors should guard themselves against missing the gravy train by tendering before the April 25 deadline.

In case the company is unable to get enough shares to meet its target and decides to hike the offer price, the same would apply to the initial applicants as well. The 8.3 crore shares sought to be acquired will constitute nearly 51.72 per cent of the total share capital of the 'second rung' IT services and business process outsourcing firm.

The deal, if it goes through, will effectively absorb and convert the Indian company into a low-cost, off-shore development and support centre for EDS' global operations and is likely to mark the end of the MphasiS brand.

For investors, the purchase offer is at a nearly 33 per cent premium to the stock's historic valuations of around 16 times its past four-quarter earnings.

Standing in the no man's land between India's first-rung IT services giants like Infosys [Get Quote] and TCS [Get Quote] and the specialised niche Indian software companies, MphasiS has always been valued at a discount, not just to its bigger peers but also to small, aggressively growing specialists like Aztec.

While the top-rung players are valued at 25-40 times their trailing earnings, Mphasis has stagnated at 14-17 times its trailing one-year earnings for the last two years, until the markets got wind of a probable takeover.

After adjusting for the stock splits, the scrip's value has remained steady at the Rs 120-130 price band for the last two years even as the company's revenues nearly doubled from Rs 500 crore (Rs 5 billion) to almost Rs 900 crore (Rs 9 billion).

Profits too kept track, taking its earnings per share from nearly Rs 7 a share in March 2004 to the current Rs 9. Yet, with a static stock price, its valuation fell steadily from nearly 17 times its earnings two years ago to nearly 15 times at the start of November last year.

In comparison, EDS' offer values the company at 22.7 times trailing earnings.

MphasiS gets nearly 60 per cent of its revenues from IT services spanning a variety of verticals, but mainly from the banking and finance industry, and the rest from BPO activities.

Over the past four quarters, its revenues grew 24 per cent to nearly Rs 895 crore (Rs 8.95 billion) and net profit 22.6 per cent to Rs 145.66 crore (Rs 1.45 billion), showing a decline in net margin from 17 to 16 per cent.

"The challenge for smaller companies is that the tier-1 vendors are bigger and have the scale," says Alok Shende, director of Frost & Sullivan's ICT practice in India, on the hazards of being small in an industry dominated by biggies.

"In the IT services business, where customers, especially global, like the scale offered by a TCS or an Infosys or a Wipro [Get Quote], small and mid players had to play the differentiation game and turn specialists," he adds.

But while that may explain some of the past investor disinterest, many of those who own the stock are looking at the present acquisition to fix the 'scale problem' for MphasiS and are disinclined to sell their shares at current prices.

Fuelling their ambitions are the rather widely known reasons for EDS to come up with the present offer, and to insist on a more than 50 per cent share.

Santosh Kotnis, a product lifecycle management consultant, based in the US for the last four years, says, "In the last few years, EDS has been finding it very hard to compete with rivals like IBM and HP, and its financials have been under increasing pressure (see figure).

IBM and HP have exploited the global delivery model much more effectively than EDS. These players are able to off-shore most of their development work to cheaper destinations like India."

Indeed, while EDS and its biggest competitor IBM have both been in India for over a decade, the latter employs more than 50,000 people here, while EDS has found it hard to populate its India office with even 3,000-plus engineers.

"Using its back office in India, IBM has been able to offer much more competitive rates to its customers than some of its competitors," Kotnis points out, "to the extent that some of the clients now positively demand that the job be done in India".

He points out that while EDS desperately needs a large engineer base in India to off-shore the development work associated with its service contracts, the 11,000 MphasiS employees, too, can look forward to an assured work flow from the US company.

But while the deal may indeed be a blessing to the MphasiS employees, it may not turn out to be so for minority investors who let go of the current offer in the hope of riding piggy-back on an EDS-induced growth story for MphasiS.

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