The Polaris - Orbitech Merger

Abstract:

The case describes in detail, the merger of India-based Polaris Software Lab with the US-based
OrbiTech Solutions, owned by the Citi Group.

The case describes the rationale for the merger on the basis of key financial data. It also
examines the reasons for revising the swap ratio of the merger.

Finally, the case discusses the future prospects of the merged entity.

Issues:

» The concept of the swap ratio and study the way it is computed. The different problems
associated with the merger of cross-border IT software companies

» The valuation of a firm using the 'Free Cash Flow to Firm' model
Introduction

On May 22, 2002, India-based Polaris Software Labs (Polaris)2 announced its merger with OrbiTech
Solutions (OrbiTech), owned by the Citigroup3 in the US.

This was one of the largest mergers in the software industry in the Asia-Pacific region; the combined
valuation of the merged entity exceeded Rs.27 billion (bn). It was also one of the biggest acquisitions in
terms of Intellectual Property Rights (IPRs).4 The merged entity would have 3,800 employees and
combined revenues of over Rs.6 bn. The merger was expected to result in significant operational synergies,
with significant cost savings through streamlining of infrastructure and rationalization of vendors. Analysts
felt that the merger was beneficial for both Polaris and OrbiTech. Polaris gained by acquiring IPRs from
OrbiTech, OrbiTech gained the wide marketing network of Polaris.

Prior to the merger, Citigroup was the only customer for OrbiTech products, as OrbiTech was not supposed
to render services to other customers.

After the merger was announced in May 2002, there were several rounds of negotiations between Polaris
and Citigroup. The final agreement was signed in October 2002 under new terms and conditions.

The merged entity continued to be known as Polaris. Arun Jain (Jain), chairman & managing director and
the CEO of Polaris, retained his designation while Ram Bhagwat, managing director of Orbitech became
the president of the merged entity.

The merged entity had a 12-member board - seven directors from Polaris, three from Citigroup and two
independent directors proposed by Jain

Background Note

Polaris was established in January 1993 by Jain and his associates with headquarters at Chennai.

Polaris' businesses could be broadly divided into software development, migration and re-engineering services,
maintenance, product enhancement and enterprise resource planning (ERP) solutions.

In 1994, Polaris developed an end-to-end retail banking solution for Citibank India. In April 1996, the company
established another development center at Noida (India) and in the same year, it also established a wholly owned
subsidiary in New Jersey, USA.

In 1997, Polaris established a wholly-owned subsidiary in Singapore and the first Polaris' businesses could be broadly
divided into software development, migration and re-engineering services, maintenance, product enhancement and
enterprise resource planning (ERP) solutions.

In 1994, Polaris developed an end-to-end retail banking solution for Citibank India. In April 1996, the company
established another development center at Noida (India) and in the same year, it also established a wholly owned
subsidiary in New Jersey, USA.
In 1997, Polaris established a wholly-owned subsidiary in Singapore and the first overseas development center for
Citibank in Los Angeles.

The company also provided niche software services along with related consulting & support services in more than ten
countries around the world.

By the late 1990s, Polaris had established two subsidiaries in the UK to cover the European region, and one in
Singapore to cover the Asia Pacific Region.

Polaris sold network services in the US, Gulf and Australia, from its offices in Atlanta (Georgia), Fremont (California)
& New Jersey in the US, Riyadh, Bahrain, Abu Dhabi, Dubai and Sydney. In 1998, the company obtained the ISO
90015 certification.

In August 1999, Polaris floated an initial public offering (IPO)6 at a price of Rs.210 (Rs.200 premium on a face value of
Rs.10), and was subsequently listed on the Bombay and National stock exchanges.

The Merger

Under the terms of the merger, the shareholders of OrbiTech were to receive 14 newly issued equity shares of Polaris
(face value of Rs 5) each, for every 25 OrbiTech shares (face value of Rs 2) held by them.

The swap ratio was arrived at on the basis of the enterprise value of the two companies, valued by Ernst & Young.
While Polaris was valued at $210 mn, OrbiTech was valued at $246.75 mn, 17.5 percent higher than Polaris. Polaris
shareholders would hold 46 percent while OrbiTech shareholders would hold 54 percent in the merged entity. Kotak
Mahindra Capital Company and Enam Financial Consultants were the advisors for Polaris in the deal, while Salomon
Smith Barney was the sole advisor for OrbiTech. The valuation favored Polaris shareholders. While OrbiTech's post tax
earnings in the financial year 2001-02 were over 1.83 times Polaris' earnings of $12 mn for the same period, it was
valued at only 1.17 times the valuation of Polaris.

The Revised Terms

As per the new scheme of amalgamation, the merger was to take effect from November 01, 2002.

Ernst and Young revalued OrbiTech, estimating its enterprise value at $188.1 mn compared to the earlier valuation of
$246.75 mn.

Under the revised agreement, the shareholders of OrbiTech received 10.6 newly issued Polaris shares (with a face value
of Rs 5), for every 25 shares (face value of Rs. 2) held in OrbiTech.

The total enhanced share capital of the merged entity would be approximately 97 million (mn) shares. Polaris
shareholders would hold about 51 mn and OrbiTech shareholders will hold around 46 mn shares. In this deal, Citigroup
got 6.57 mn shares less, when compared to the previous deal.

Benefits of the Merger

Analysts felt that the merged entity was better positioned to capitalize on new opportunities by acquiring new
customers and enhancing existing relationships.

The merger provided OrbiTech with a better platform to deliver its products in the market; it gave OrbiTech access to
96 new clients and operational geographies, access to a strong sales and distribution network, and exposure to areas
other than banking. On the other hand, Polaris got access to 57 IPRs of OrbiTech corresponding to 10 product lines,
with a couple of new products in each product line. Each product line had an estimated potential of building a $20 mn
business over a five-year period. Thus, a $200 mn increase in revenues was expected from this source. The merger
strengthened Polaris' position in the BFSI software segment, giving it higher profit margins and reduced sales cycle
time.
The Journey Ahead

Like any other merger, the Polaris-Orbitech merger also had to overcome the initial integration hurdles and had to
focus on leveraging its strengths.

One significant advantage of the merger for Polaris was the increase in size. The company emerged one of the fastest
growing companies in the Indian software industry with revenues from its top-line products increasing from Rs 150 mn
in 1996 to over Rs 6 bn in 2003.

After the merger, the company also focused on increasing its presence in the BFSI products market. It had split the
BFSI segment into six spaces - wholesale banking, retail banking, investment banking, brokerage, securities and
insurance and focused on each of these segments to increase revenues.

The company also hoped to increase profit margins by reducing costs.