Virtusa’s listing on New York’s NASDAQ came on the eve of disruption for some of its most important customers; banks. US system-wide liquidity dried up after an investment bank, Lehman Brothers collapsed and it took a massive liquidity injection from the US central bank, The Federal Reserve, to give the rest of the industry the confidence to continue doing business. The crisis exposed many shortfalls that governments all over the rich world have been trying to fix with more regulations, controls and oversight.

Soon after its listing, Virtusa’s senior team had to figure how they were going to manage the fallout from their biggest customers trepidation about the future and an unwillingness to invest in woozy technology their boards – who were busy fire fighting – no longer had the time to discuss.

Virtusa had been making money helping global banks deal with growth by helping deploy better systems, integrate ones they already had and remove layers of unnecessarily complicated IT. Its focus has been more about helping clients rationalise their existing IT than trying to sell them some more software, which may end up complicating their processes even more.

What the firm – which was concurrently started in a Boston basement and the garage of its founder’s home in Colombo in 1996 – didn’t then realise was how quickly the global banking crisis would be lucrative for the firm. Banking clients were generating a significant chunk of revenue for Virtusa by 2007 and the firm was catapulted to its NASDAQ listing because of its ability to help businesses, which included banks, cut layers of costs in core operational areas. Once the dust started settling after the 2007 banking crisis it became apparent there was a bigger opportunity, in helping banks deal with the new regulations that were slapped on them. New requirements included banks to have more equity, complex rules around liquidity and onerous oversight requirements on the biggest ones classified as too big to fail.

Soon Virtusa had pivoted its business model to start help banks develop new systems to deal with complex regulations and minimise costs of compliance. Throughout this difficult period, Sri Lankan software engineers at Virtusa were writing code that helped big US and European firms reduce costs by rationalising heavy technology spending. “We have been able to clearly demonstrate a sizable 30% cost reduction. This is where we are making a big difference,” says Virtusa Corporation’s Sri Lankan-born founder, Chairman and Chief executive Kris Canekeratne.

The firm’s revenue grew 23% annually over the last decade; a rate twice as fast as its competitors. Around half its revenue now comes from banks. Virtusa provides IT services to the banking, financial services, insurance and healthcare sectors, all heavily regulated in the US and Europe. Communications and media are other sectors it services. Founded by Kris Canekeratne and his wife Tushara, the firm is headquartered in Westborough, Massachusetts, USA.

Virtusa engineers write code that bring various IT software applications across retail and consumer banking into one manageable platform which can also support future technology changes. In 2014, global banks spent nearly $200 billion on IT, a staggering amount. Virtusa tries to help banks bring down these costs. The platform also builds in the complex regulatory requirements, helping banks shed additional compliant costs.

Growing twice as fast as its competitors, Virtusa’s chief executive says it is taking away market share from its competitors like Cognizant Technology Solutions, HCL Technologies, Infosys, iGATE Corporation, Tata Consultancy Services, Tech Mahindra, Wipro Limited, Accenture, Cap Gemini S.A., Computer Sciences Corporation, Deloitte Consulting LLP and IBM Global Services Consulting.

Some of these firms are much larger with clear advantage of scale over Virtusa. The company is driving its success on the high-level of technical expertise and the ability to provide quality one-stop-shop IT services to its clients. In tackling complex regulations, Virtusa has developed a client lifecycle management system, which helps retail banks comply with regulations every step of the way from when new customers open accounts, conduct complex transactions and when they close accounts.

Now, global banks are facing more threats. Digital disruption is threatening to make retail banking irrelevant and opening the investment banking industry to increasing competition from new firms.

Virtusa sees an opportunity here. With its success over the past twenty years, the firm has amassed a $200 million war chest from profits in operations in the US, UK, Germany, Sweden, Austria and its delivery centres in India, Sri Lanka, Hungary, Singapore and Malaysia. It will use these funds to fund its biggest acquisition to date to increase its client-base of global banks and double revenue.

Virtusa will spend $180 million to purchase a 51% controlling stake in Mumbai Stock Exchange listed Polaris Consulting and Services which employs 7,650 people and specialises in investment banking related IT services. With Virtusa strong on retail and consumer banking, the firm can now cover a wider range within banking which could improve the firm’s revenue flow which will be amplified by Polaris’ larger banking client base.

Morningstar, an investment research and investment management firm in Chicago USA, says the revenue of the information technology services industry grew 8% over the last five years. On the other hand, Virtusa has grown 23% on average each year for the last ten years.

With a book value of $439 million, Virtusa is one of the smallest of the listed information technology services firms listed on NASDAQ with a market cap at $ 1.5 billion, almost the same market cap size as Sri Lanka’s largest listed company John Keells Holdings. The largest of the IT firms on NASDAQ is International Business Machines Corp (IBM) with a market cap of $ 131 billion.

What it doesn’t have in size it makes up for in its attitude.

Virtusa is feisty for its size, reporting earnings growth impressing investors. IBM’s PE ratio (share price, over earnings per share) was 9.3 early November but Virtusa’s was 35.2; higher than the industry average of 17.7 and still higher than the top 500 largest market cap firms in the US tracked by ratings agency Standard and Poor’s. Sri Lanka’s largest market cap firm John Keells Holdings had a PE of 15% at the end of the 2015 financial year.

A higher PE ratio could indicate that a company is over-priced but it is also an indication of investor faith in a company’s ability to grow their returns. In Virtusa’s case it’s not a bubble: revenue has been growing quarter-over-quarter in succession for the past eight years.

Its share price, trading at under $18 in August 2007, has grown steadily over the years and traded at $52 in October 2015 after the Polaris Consulting acquisition was announced.

The takeover comprises buying all of the outstanding shares held by Arun Jain, founder and chairman of Polaris. A share will be purchased at $3.38 or 220.7 Indian rupees. The share was trading at 202 Indian rupees on 23 November. Its PE ratio was near 17%.

The new entity will be called Virtusa Polaris. Regulatory approval from the US and India are expected to come through before the end of the 2016 fiscal year next March. Virtusa will then bid to buy more shares to take its stake up to 75%, which will cost the firm a total of $270 million.

Canekeratne is not ruling out a full buyout of Polaris Consulting which will cost $348 million. The company already has a war chest of $200 million. This cash will be leveraged and an agreement has been reached with JP Morgan Chase and Bank of America for a $300 million five year loan. The acquisition will also give Virtusa more long term revenue generating work, rather than one-off consultation projects. Before the acquisition 45% of Virtusa’s revenue came from outsourcing work which generated revenue streams over a year. The acquisition of Polaris Consulting will take this up to 56%.

“This is strategically important to us because as we grow and scale, we want a larger percentage of our revenue to be recurring and outsourcing related. This helps us be more where we want to be than where we are now,” Canekeratne says.

Almost immediately the possibilities became manifest.

Virtusa was engaged by Citi Group to develop and implement a cost reduction programme for the bank, one of the largest in the world which saw profits rise 51% to $4.3 billion during the third quarter of 2015. Despite falling incomes, the growth in profits was driven by falling costs, the bank said in an announcement.

Polaris was on the Citi Bank payroll too providing tech services across its investment and corporate banking units.

As a result of the acquisition Citi Group had entered into a long term deal with Virtusa, which includes preferential treatment for two years when new IT contracts are announced.

Informal talks between Canekeratne and Polaris Consulting and Services Chairman Arun Jain began three years ago.

Negotiations intensified last March. “It was a very complex transaction: on one side we had to negotiate with the founders and stakeholders of Polaris, on another side we had to negotiate with the regulators and also with the Citi Group,” he says.

He expects profit growth to slow down until the 2018 financial year as a result of the acquisition. The current CEO of Polaris Consulting and Services Jitin Goyal will head the combined banking and financial services segment of Virtusa and Virtusa-Polaris while the insurance, healthcare, media and information technology sectors will be run by Virtusa.

“We will continue to operate two listed companies, one in the US and one in India, Canekeratne says. Now that Virtusa has widened its geographical reach and deepened its expertise in banking related IT services, it’s ready to make money, helping banks deal with the biggest challenge the industry is facing today, digital disruption.

The rapid development in financial services technology is threatening to make retail and consumer banking irrelevant and large investment banks redundant.

In the retail banking front, a recent Viacom study reported by Forbes magazine, said 73% of millennials (people born after 1984) would rather handle their financial services needs with Google, Amazon, Apple, PayPal or Square than with a bank. Goldman Sachs Global Investment Research’s Future of Finance report says 33% of millennials believe they will not need a bank in the near future.

Global investments in financial technology ventures, called FinTechs, have soared from $4 billion in 2013 to $12 billion in 2014, global consulting firm Accenture said in a 2015 report, with growth rocketing to 200% in 2014 from 63% in 2013.

A FinTech called Lending Club, an online lending service provider raised $865 million on the New York Stock Exchange in 2014. It was valued at $8.5 billion and the IPO was the biggest for a technology company that year. Companies like these are raising questions for banks.

Analysts are unclear whether this presents more of a challenge or an opportunity for the (banking) industry. But established financial services players are starting to take bold steps to engage with emerging innovations. Big global banks like Bank of America, Barclays, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, Intesa Sanpaolo, JP Morgan, Lloyds Banking Group, Morgan Stanley, Nationwide, RBS, Santander and UBS have invested in FinTechs in order to adapt to new technologies.

“This is a very big part of Virtusa’s strengths which I normally couch under reinventing and reimagining the digital storefront,” Canekeratne says. Big firms are using the internet and sensors on mobile devices (both inbuilt and downloaded applications) to create information, insights and analytics about individual people. “Banks and other consumer industries that do a better job of this will create competitive differentiations,” he says.

According to consultant firm Accenture, big data analytics and digital technology are challenges facing investment banks as well. Investment banks will have to change the way they interact with capital markets and provide clear, transparent market information in a complex regulatory environment better than their competitors if they want to stay profitable.

Most investment banks are realising that their trading houses need to go high tech, but they are stuck with costly legacy infrastructure where each unit has its own IT department, trading platforms and back office infrastructure. According to Accenture, the digital revolution is driven by customers and investment banks are increasingly facing competition from online trading portals.

Well-managed IT platforms result in better bottomlines for banks, a 2007 McKinsey report says, but it doesn’t mean spending more on IT improves profitability, in most instance the opposite is the case. Banks that invest heavily on IT spend a lot just to run their systems, leaving little room for innovation. IT spending needs to translateinto real business value and create competitive advantage.

Virtusa’s acquisition of Polaris Consulting will now give the company an opportunity to bring its retail banking expertise on creating unique customer experiences to the investment banking sector as well.

“Most of our clients are spending to reimagine, invent and reinvent how they transact with consumers and that landscape has changed dramatically. This is where Virtusa is making a big difference and we are working with some of the large banks to help them develop digital store fronts. This is why we continued to grow during somewhat difficult times,” he says.

[pullquote]”Most of our clients are spending to reimagine, invent and reinvent how they transact with consumers, and that landscape has changed dramatically[/pullquote]

Firms struggle choosing between faster growth rates and sustainable growth. Virtusa realised early that some clients gave them short term work for a windfall, whereas others would have them engaged for a longer period. Six years ago, Virtusa formalized its client acquisition protocols and developed a procedure called DRP, or Deal Review Process.

Ninety per cent of Virtusa’s revenue comes from existing clients engaged for more than 12 months.

“It is not a new client at any cost but the right client. For example we may have many clients a given year and the revenue will only apply to that year, so this kind of investment is costly to us. We have 125 clients generating 588 million dollars of revenue. It was a strategic decision to grow this way,” Canekeratne said.

With the DRP, Virtusa became better at identifying these clients and now the firm works mostly with Global 2000 companies, top public companies in the world rated by Forbes magazine.

With everyone looking east towards China these days, Virtusa is not interested.

“The US economy has done quite well over the last few years, 60% of our revenue comes from the US market. EU is seeing the lower end of the trough and we may see some slight levelling and some growth. We believe we will see strong growth that will enable us to create a significant number of Jobs in India and Sri Lanka. We believe our opportunities lie with large enterprises and our ROEs will be in the US and Europe, India, Singapore, Malaysia and now with the Polaris acquisition, Australia and Japan,” Canekeratne says.

He is excited that Virtusa will be transformed from a half-a-billion dollar revenue company to touching distance to a billion. Virtusa’s revenue for the 2016 fiscal year is forecast at $588 million and Polaris at $310 million, half the combined revenue coming from the banking and financial services sector. The synergies of the two firms is expected to generate additional revenue exceeding $100 million over the next
couple of years.

“Polaris has more banking clients than we do. We can pursue larger opportunities and larger outsourcing engagements and also enter the
markets in Australia and Japan where we’ve always wanted to go but couldn’t,” Canekeratne says.

“We intend to invest in creating synergies between the teams at Virtusa and Polaris Consulting. There will be more exciting opportunities for our teams in India and Sri Lanka. After 2017 we will see growth outpace the industry again,” he says.