Pactera Joins Privatization Queue

Pactera gets privatization offer

Anyone looking to invest in the China IT outsourcing story will be disappointed to learn that Pactera (Nasdaq: PACT), the sector’s biggest publicly listed player, has just announced a plan to privatize at a nice premium to its last share price. If the privatization succeeds, Pactera would join rival Camelot Information Systems (NYSE: CIS), which is engaged in a similar de-listing, removing what were once 2 of China’s most exciting tech companies from the publicly listed realm for international investors. While the Pactera move reflects a broader privatization trend among US-listed Chinese companies, it also reflects the failure of Chinese IT outsourcing firms to realize the big hopes that many once held for them.This latest news has a management-led group at Pactera offering $7.50 for each of the company’s American Depositary Shares, representing a hefty 43 percent premium over its last closing price. (company announcement; Chinese article) The buyout group includes private equity giant Blackstone (NYSE: BX) as one of its major backers, again reflecting a trend that has seen big private equity firms back many of the recent wave of privatization offers for companies that believe their shares are undervalued.

Pactera’s privatization bid comes just 2 months after Camelot, its only other major US-listed rival, announced a similar management-led buyout bid at a more modest 23 percent premium to its last close price. (previous post) Investors and observers like myself were full of hope for Pactera when the company was formed late last year through a merger of China’s 2 largest US-listed IT outsourcing firms, HiSoft and VanceInfo. But despite an initial rally in its shares after the new company was formed, Pactera’s stock has moved steadily downward this year, losing about 40 percent of its value since January.

So what happened? As a veteran China tech watcher, I suspect investors got tired of waiting for China to produce its first big IT outsourcing firm that could compete with Indian giants like Infosys (Mumbai: INFY) and western names like IBM (NYSE: IBM). Pactera posted 36 percent pro forma profit growth in the third quarter, but then slipped into the loss column in the fourth. At the same time, its fourth quarter pro forma revenue grew just a tepid 18 percent — hardly exciting for a company that is still a fraction of the size of names like IBM and Infoysis.

I have visited quite a number of Chinese IT outsourcing start-ups over the last decade, and many were full of hope at the time and had big expansion plans for the future. But most of those companies failed to realize their big plans. That failure may be partly due to lack of consolidation, but I suspect a big reason is also that many failed to realize that many major western players like IBM, Hewlett-Packard (NYSE: HPQ) and Accenture (NYSE: ACN) would also move aggressively into the lucrative area.

So now the question becomes: What’s next for these companies? Even at their current levels, Pactera and Camelot are still relatively small. Combining the pair would create a company with a market capitalization of less than $700 million — not a very impressive level compared to some of the global players they hope to someday compete with. I suspect that after these current privatizations are finished, we’ll see these companies’ managers and their new private equity owners try to force some consolidation to build 1 or 2 major players that really can compete on the global stage.  After that we may see perhaps see some of those companies attempt to re-list in the US, Hong Kong or China, providing a more exciting option for investors looking to buy into the sector.

Bottom line: The proposed privatization of Pactera could be followed by a behind-the-scenes consolidation for China’s IT services sector.

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