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Morningstar | DXC Acquires Luxoft for $2 Billion; Deal Bolsters DXC’s Digital Portfolio; Shares a Sizable Discount

DXC Technology announced that it will acquire global IT services provider Luxoft for $2 billion. The purchase price, in which Luxoft shareholders will receive $59 per share, represents an 86% premium to Friday’s closing price, although it’s only a 48% premium to Luxoft’s average closing price over the last 90 days. Based on fiscal 2019 consensus estimates, the deal implies an adjusted price/earnings ratio of approximately 24.6 times and a price/sales ratio of 2.2 times. Based on IT services multiples for higher growth digital transformation providers, we don’t see DXC as paying an exorbitant amount for Luxoft. With the deal expected to close at the end of June, pending regulatory approval, we reiterate our $91 fair value estimate and economic moat rating of none. We think DXC is trading at a considerable discount to our fair value estimate, and the stock would suit risk-seeking investors looking for exposure to a beat-down global IT services provider.

The strategic rationale for the acquisition makes sense, and we believe that DXC needs to bolster its digital offerings globally to compete with the likes of Accenture or Cognizant. Namely, we think Luxoft’s engineering, cloud, and DevOps services will help make DXC a more attractive vendor to the world’s largest multinational firms. Luxoft’s presence within the larger C-suite (not just IT professionals) will also help DXC broaden and deepen its relationships with clients, which is a highly valued asset in the IT services industry. Still, there remains an element of integration and cultural risk as DXC stitches together its sum of parts after multiple years of spin-offs and acquisitions. We think DXC’s strategy to let Luxoft run more independently under the moniker “A DXC Technology Company” may help, though.

DXC remains our only no-moat IT services provider, and we see a high degree of risk with the firm as it rebuilds after spinning off from Computer Sciences Corporation (or CSC), continues to integrate HPE’s Enterprise Services business, and recently removes its U.S. Public Sector (or USPS) business. CEO Mike Lawrie has a lot of work to do in order to consolidate and grow from here, but he has proven himself before with the turnaround of CSC. We give Lawrie credit but see a high degree of near-term volatility as DXC looks to establish itself in the upper echelons of the IT services market. For the time being, we remain comfortable with our no-moat rating for the firm.