Sourcing growth

IPO REVIEW

Firstsource Solutions is getting ready for acquisitions by raising cash from the public.

The Indian outsourcing saga is not new to the world. An industry that has grown leaps and bounds over the past decade and continues to scale new heights, is now set to see some action as large players like Firstsource Solutions, the erstwhile ICICI OneSource, adopt an expansive stance.

According to a Nasscom study, the information technology enabled services"�business process outsourcing (ITES-BPO) business makes up for 20 per cent of the total information technology industry, and has grown at 38.5 per cent year on year amounting to $7.2 billion in FY06.

The number of people employed in the industry exceeds 410,000, adding almost 100,000 people a year to the count.

A leaping industry
In 2005, the global BPO industry was estimated to be worth $120-150 billion, according to a Nasscom-McKinsey Report. The offshore BPO industry segment accounted only for about 10 per cent, at $11.4 billion and is expected to grow at a compound rate of 37 per cent, sizing up to $55 billion by 2010.

Companies based in India took a dominant 46 per cent share of this market, amounting to revenues of $5.2 billion, which are expected to grow to $25 billion by the year 2010.

The Indian offshore BPO industry comprises of large players like Genpact, WNS, Wipro BPO, HCL Technologies BPO and Firstsource, in that order according to rankings assigned to BPO companies in terms of revenues by the Nasscom study.

Among these, Genpact, WNS and Firstsource are pure-play BPO players, without any forays in the IT industry. Firstsource is thus the third largest pure-play BPO company.

Grow to serve
While a number of players in this space have turned to private equity funds for their capital needs and two domestic BPOs have gone public in the US, Firstsource, is looking to grow aggressively via raising capital from the domestic public.

The company has announced an initial public offering of 69.30 million equity shares of Rs 10 each.

The offer comprises of a fresh issue of 60 million shares and an offer for the sale of 9.3 million equity shares by the ICICI Group in the price band of Rs 54 and Rs 64. The issue will constitute 16.65 per cent of the fully diluted post-issue equity share capital of Firstsource.

This would be the first public offering of a large scale pure-play BPO company in India, barring a few players like Allsec Technologies and Tricom India listed earlier.

An array of strategic investments have been made in the company by Sequoia Capital, Temasek and Metavante, a US based technology platform provider to banks, apart from the promoter group ICICI.

The company currently has about 10,000 employees at its 20 delivery centres in India, the US, the UK, Argentina, and the Philippines (under development).

"We have developed a multi-shore delivery capability along with a client base which is distributed almost equally across geographies, thus neutralising the risks of downturn in any individual markets," claims Ananda Mukerjee, chief executive officer, Firstsource Solutions.

The company grew at a compound rate of about 74.4 per cent a year in its total income, from Rs 180.8 crore in 2004 to Rs 549.9 crore in 2006. The corresponding net profit has grown at a compound rate of a whopping 536 per cent from Rs 0.61 crore to Rs 24.7 crore.

For the same period, the number of clients has grown from 21 to 74. Firstsource boasts of an attractive clientele including six Fortune 500 banks, two Fortune 500 telecommunications companies and three Fortune 100 healthcare companies.

Using the proceeds of the public offer, the company plans to acquire other BPO companies in order to expand its service offerings into new industry sectors. "We look for enhancing our skill-sets and domain expertise when we hunt for targets for our acquisitions," says Mukerjee.

Serve to grow
In order to enhance its skill-sets in different industry verticals, the company has carried out an acquisition a year right since its inception in 2001, the first being CustomerAsset, followed by FirstRing, Account Solutions Group (ASG) of the US, Rev IT Systems, a Chennai-based BPO company along with its US subsidiary Sherpa Business Solutions and BPM Inc, a Delaware-based healthcare claims outsourcing company along with its subsidiaries MedPlans 2000 Inc and MedPlans Partners.

These acquisitions have added to the company's capabilities to provide services to its clients in different verticals.

"We have taken over profitable businesses with strong operational bases and process expertise in the respective industry verticals while avoiding turnaround situations, which has helped us keep up our momentum," contends Rajesh Subramaniam, chief financial officer, Firstsource Solutions.

In March 2006, a strategic partnership deal was inked by Firstsource with Metavante Inc of the US, in which the latter picked up a 20 per cent stake in the company.

Metavante is a financial technology provider, and figures among the top three bank technology and payment processors in the US.

Owing to the deal, the company has access to Metavante's technology expertise, as well as a number of super-regional, regional and local banks and financial institutions in the US markets, which are beyond the company's traditional customer base of national and international banks and financial institutions.

Valuations
Although the company benchmarks itself against its peers listed overseas, such as WNS Global and EXL Services which currently trade at over 40 times their estimated earnings, analysts feel the issue price is fixed on steep valuations.

Taking a conservative growth rate in revenues of about 37 per cent a year, at which the industry is expected to grow, the stock is valued at about 45 times its estimated FY07 earnings and 28.4 times FY08 earnings at the lower band, and about 53 times estimated FY07 earnings and 34 times FY08 earnings at the upper band of the price. 
 

RAISING THE BAR
Rs crore	FY06	FY07E	FY08E
Revenues	549.90	749.50	1027.00
Net profit	24.70	52.50	82.20
EPS (Rs)	0.80	1.20	1.90
P/E @ Rs 54 per share		45.00	28.40
P/E @ Rs 64 per share		53.30	34.00

The potential short term growth of the company imminent from the accrued economies of scale realised from repeat orders of existing clients as well as an order backlog of about $14 million appears to be factored-in in the valuation.

In FY06, 87 per cent of the business was generated from existing clients, according to the management.

Also, the company aims to sustain the high growth both organically and inorganically and outperform the industry, which would justify the valuations.

However, concerns over sustainability of margins, the capability to add new clients once the capacity utilisation reaches its peak and the extent of renewal of orders from the company's existing clients, could arise.

To compare valuation of Firstsource, a fair benchmark is difficult to arrive at, since the key peers "� pure-play BPO players like WNS and EXL Services are listed in the US, while others like Wipro and HCL are not pure-play BPO companies.

Therefore, the issue looks more attractive over the longer term, given the future outlook of the company and the pace in which it has grown in the past.

Issue Opens: January 29
Issue Closes: February 2