Indian IT services companies, including Persistent Systems and Coforge, are increasingly using debt to fund large acquisitions. This marks a significant change for the traditionally cash-rich, debt-free sector. While the strategy aims to rapidly gain AI capabilities and expand, it also introduces new risks like interest costs and integration challenges that investors should monitor closely.
What Happened
The Indian IT services sector is undergoing a structural change as major players move away from their traditional debt-free approach. Persistent Systems recently secured a $1.5 billion bridge financing facility, supported by a corporate guarantee, to help fund its acquisition of the German IT firm Nagarro. This is not an isolated event; it reflects a broader industry trend where companies are using external borrowing to fuel growth rather than relying solely on internally generated cash.
Other notable examples include Coforge, which arranged a $550 million term loan to help finance its $2.3 billion acquisition of Encora. Similarly, Cognizant has used debt for its $1.3 billion acquisition of Belcan and to fund share buybacks, a practice that was previously uncommon among large IT service providers.
Why This Matters For Investors
For decades, Indian IT companies were known for being "debt-free" or having very strong cash balances. This allowed them to withstand market downturns and weather economic cycles without the pressure of repayment schedules. The shift to debt financing signifies that these companies are prioritizing speed over financial conservatism.
The main driver is the race for artificial intelligence (AI) capabilities. With organic growth—growing from within—proving difficult in the current environment, companies are choosing to buy expertise, specialized talent, and new markets through acquisitions. By borrowing money, they aim to secure these competitive advantages faster than they could by building them from scratch.
The Growth vs. Risk Trade-off
While borrowing can act as a lever to boost revenue and earnings per share, it also fundamentally changes the risk profile for shareholders. Traditionally, IT firms did not have to worry about interest payments eating into their profit margins.
Now, these companies must ensure that the businesses they acquire generate enough profit to cover both the acquisition cost and the interest expenses on the debt. If the acquired business underperforms or if the integration takes longer than expected, the added financial obligation could put pressure on the company’s bottom line.
What Could Pressure Earnings
Investors should be aware of a few specific risks associated with this shift. First is integration risk; bringing a large company into an existing organizational structure is complex and often leads to higher-than-expected costs. Second is the cost of capital. With debt on the books, any delay in realizing the expected benefits from the acquisition could hurt the company’s return ratios, such as Return on Equity (ROE) and Return on Capital Employed (ROCE).
Additionally, if a company takes on significant debt, its financial flexibility decreases. In periods of weak demand, having high debt can become a burden, unlike a cash-rich balance sheet which provides a cushion during tough times.
What Investors Should Track
Moving forward, investors may want to monitor a few key items in the company's financial filings.
First, track the debt-to-equity ratio to see how much leverage the company is adding. Second, look at the interest coverage ratio, which indicates the company's ability to pay interest on its debt from its operating profit. Third, pay attention to management commentary regarding synergy realization—essentially, how well they are combining the two companies to reduce costs and increase revenue. Finally, keep an eye on project timelines and integration updates to see if the acquisition is delivering the promised results.