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Private Equity investors are playing a key role in consolidation in IT Services and BPO sector. In 2013 so far, there have been five deals worth $1,132.87 million against one deal each in 2012 and 2011 worth little over $1,122 million. The space could see few more big ticket deals in the coming years as the BPO sector expects to touch $50 billion revenue by 2020.
PE firms have bought majority stakes in five companies, including in two significant mid-sized players -- Baring Asia invested $260 million in listed firm Hexaware Technologies while the Partners Group invested $270 million in privately- held CSS Group, according to Venture Intelligence.
In 2012, JP Morgan's PE arm One Equity Partners took control of medical transcription BPO M*Modal (formerly CBay Systems) in a $1.1-billion deal. Aman Kumar, who founded CBay in 1998 and is a partner at PE firm at Siris Capital, believes that the business process management (BPM) and IT services sector will continue to attract PE players.
"PE players are looking to acquire assets that can allow them to build an integrated company providing end-to-end services," he says. As the industry matured there was a phase where India was losing its cost arbitrage. Salaries were touching sky high especially in the mid to senior level. But a recession brought in a lot of correction, salaries came down, companies managed to reduce costs by expanding into tier-II and tier-III towns.
?One of the key reasons making the sector attractive to the PE investors is that the improvement it could make on the financial assets lying without optimal utilisation in the top IT firms, says Amit Chander, partner at Baring Private Equity Partners India.
He says that if you look at the balance sheet of any of the top 20 IT firms in the country today, almost 50 per cent of the balance sheet comprises of financial assets, which is either surplus cash they have with them or have deployed in financial investments like mutual funds or other securities.
While the existing management has proven expertise in growing the operational part of the company, the financial assets lying like this would not be making much of a return. "This is where the financial investors are standing up and saying that there is large part of capital that they can manage because the financial investor knows how to manage money."
"For instance, if an IT company has 50 per cent of the capital lying as cash or liquid investments, most of these companies have a return on capital of 25-30 per cent. If you look at the return on the cash that is sitting on the balance sheet, that is anywhere from 7-9 per cent. When a PE investor comes on board, his thought is that let the current management continue to generate good returns from the operations while the investor can look at increasing the returns from this cash out of the balance sheet, improving the overall business," he added.
Experts feel the maturity of the industry is fuelling big ticket transactions. Some of the large PE players could not enter the sector as these firms were small. But now with ticket size going up to $500 million to $1 billion they can invest in them. Sandeep Ladda, Leader, Technology, PwC said, “The sector has remained fragmented over the last few years, and so has the inflow of investments. Hence, consolidation may be in the offing in the near future." The rupee's depreciation will also help IT and the ITeS segment.
Besides, some of the recent exits have also attracted the PE firms. Temasek Holdings and One Equity Partners exited from Apollo Health Street (AHS), a BPO arm of Apollo Hospitals. According to sources, Temasek exited with 3X (three times returns) it had invested, around Rs 16.32 crore in 2005 and sold its stake for Rs 51 crore after seven years. The acquirer, Sutherland Global Services, bought the entire stake of AHS for an enterprise valuation of around Rs 1,000 crore.
One of the earliest PE investors in India was Citicorp, which in 2001, invested $6 million in Daksh eServices. Capital-raising avenues were limited, and PEs provided promoters with much-needed initial capital. In some cases, like the Blackstone-funded Intelenet Global Services, the PE firm provided value addition through access to its portfolio companies.
PEs have become an integral part of the BPO industry,” said a senior executive a PE firm. Since 2010, PE firms have become the key drivers of change in the BPO sector. As the industry is a highly fragmented, a number of PE buyers have recognised the substantial upside to be gained from buy-and-build plays. Many BPO firms were launched as captive arms of global corporations such as GE, British Airways and Citibank. After their initial five or six years, it was felt that these captives had hit a wall and needed to look outside their parent firms to expand. The parent firms also felt they could achieve attractive valuations due to the rapidly expanding off-shoring industry during 2004–07. PE firms emerged as buyers of these captives, and one of the major deals of this period was General Atlantic/Oak Hill Partner acquiring GE’s 60 percent stake in GE Capital Information Services (GECIS) for $ 500 million in 2004.
