Following the acquisition of CTC, a European IT firm, Tech Mahindra is on shaky ground

In Tuesday's intra-day trade on the BSE, Tech Mahindra's stock fell 2% to Rs 1,686.35 after the company announced the acquisition of a 100% ownership in Europe-based Com Tec Co IT (CTC) and a 25% investment in two insurtech platforms for a total of EUR 330 million (about Rs 2,800 crore).

Tech Mahindra announced after market hours on Monday that it had authorised a proposal to buy a 100% share in CTC for €310 million (3.8x price to CY21 sales), with €210 million paid upfront and the remaining €100 million paid over the next four years based on synergy achievements.

CTC focuses on product development in the insurance and reinsurance industries. CTC sales expanded at a 40 percent compound annual growth rate (CAGR) from CY18 to CY20, it has industry-leading EBIT margins, and management expects the acquisition to be EPS accretive.

Tech Mahindra is also purchasing a 25% share in two CTC platforms, SWIFT and SURANCE, for €20 million, with an option to purchase a further 20% stake in the platforms over the next two years.

SWIFT is a software-as-a-service (SaaS)-based digital consumer engagement tool. SURANCE is an end-to-end personal cyber insurance solution that focuses on vulnerability assessment, cyber defence, and cyber insurance coverage. It includes different features for insurance sales and distribution.

The acquisitions will bolster Tech Mahindra's digital engineering and insurance technology businesses, according to the company. In an exchange filing, Tech Mahindra stated, "The acquisition will enable Tech Mahindra to tap into the potential industry disruption in the Insurance sector, expand its offerings to high-end digital engineering services for some of the largest insurance, reinsurance, and financial services organisations globally, and scale its nearshore delivery presence."

In the meantime, Tech Mahindra has been underperforming the market ahead of its December quarter (Q3FY22), with the stock down 3% in the last week vs a 0.83 percent rise in the S&P BSE Sensex. The stock has gained 3% in the last month, compared to a 7% increase in the benchmark index. The date for the company's Q3FY22 earnings has yet to be announced. The stock has increased by 53% in the last six months, compared to a 15% rise in the Sensex.

Because a bigger 5G deployment can lead to a new expenditure cycle in this domain, Tech Mahindra's higher exposure to the communications vertical remains a possible possibility. 5G initiatives are gaining momentum for the corporation. "Given the levers around productivity and cost efficiency, we foresee a modest improvement in EBIT margin." In a stock update, Motilal Oswal Financial Services said, "Elevated operating metrics and supply side pressure remain a risk to our margin forecasts." The stock has a "Neutral" rating from the brokerage company, with a target price of Rs 1,910 per share.