The opportunity in ER&D services segment
TCS is looking to scale up its engineering and industrial services clients to $100m. The company has recently won large deals in the space and expects this trend to continue. Last year, it won a digital deal with Rolls Royce worth $50m. Many other firms in the space have also won large deals over the last year. L&T Technology Services (LTTS) secured 10 multi-million dollar contracts – each about $5m on an average – across automotive, aerospace, and oil and gas verticals. GlobalLogic also won three multi-year digital transformation deals. According to Keshab Panda, CEO of LTTS, adoption of digital technologies is driving the deals in this space. While previously the talks were around developing proof of concepts, the discussions are now moving forward to implementation of mature solutions on a large scale.
NASSCOM expects the Engineering Research and Development (ER&D) market in India to grow to $42bn by FY22 from current $28bn – representing a growth rate of around 11% per year. In comparison, the overall tech services growth rate has been estimated to remain around 7-9% per year. The growth in the ER&D segment will be driven by the adoption of IoT, big data analytics, AI and ML, cybersecurity, and other emerging technologies.
According to a report, the rollout of 5G or fifth-generation wireless technology by telecom companies globally will translate into at least $10bn business opportunity for the Indian IT services companies over the next six years. Also, the demand for digital technologies by automotive companies, especially in the areas of ADAS (Advanced Driver Assistance System), electric vehicles, and body electronics has been growing tremendously. There has been demand in medical devices and semiconductor verticals as well. All these points reinforce the growth expectations of ER&D segment in India.
On a global level, the spends on ER&D reached $1.2 trillion in 2018 and are expected to grow to $1.7 trillion by 2023. Digital Engineering accounted for 24% of the ER&D spends at $293bn in 2018, this is expected to grow to $642bn by 2023 at a CAGR of c.17%. The reason for this exponential growth in the Digital Engineering space is the demand for solutions in the automotive, aerospace, medical devices, and industrial verticals to drive operational efficiencies and enhance customer experience.
The space has also seen several large M&A deals over the past year, perhaps buoyed by the growth prospects of the segment. The French engineering services company Altran acquired Aricent from KKR at 2.9x sales multiple; Arrow electronics acquired eInfoChips at 3.5x sales multiple; Partners Group acquired GlobalLogic from Apax Partners in a deal that valued the company at 4.0x sales multiple. The deal also saw Apax Partners generate around 40% IRR on its investment in the company; Cognizant acquired Softvision for over $500m. There have been other acquisitions as well – Quest Global services acquired Exilant Technologies and Mobiliya; Accenture acquired Pillar Technology and Mindtribe Product Engineering; and HCL Technologies acquired H&D International.
Transformation through ER&D and specifically Digital Engineering is expected to be challenging due to legacy complexities and change management issues. However, these challenges are translating into sizeable opportunities for the ER&D services provider community.