CESC's Firstsource investment starts to pay off

With Firstsource Solutions turning around, the Sanjiv Goenka company is looking for better growth in the coming years

Backed by a strong performance of Firstsource Solutions, an IT BPO firm, in the quarter ended March, CESC has seen improvement in its outlook. When CESC acquired 56.9 per cent stake in Firstsource in October 2012, everybody was concerned about its unrelated diversification, which had a negative impact on its share prices.

Investors were already worried about its retail business - Spencer's, which was eating into company's profits. In the quarter ended March, Firstsource reported 14 per cent growth in revenue and 74.2 per cent growth in net profit, backed by 300-basis-point improvement in margins compared to the corresponding quarter last year. This was ahead of analysts' expectation and had a positive rub-off on the share prices of CESC, which rose five per cent after the IT company's results.

CESC has so far invested about Rs 450 crore to acquire 56.9 per cent stake in Firstsource. It is considered risky, given its huge debt of about Rs 2,179 crore as of March 2012 (on an equity of Rs 1,430 crore). However, this could also become a game changer if the company is able to turn it around successfully.

Firstsource, on a turnover of Rs 2,000 crore, has a market capitalisation of only Rs 700 crore, attributed to debt. Nevertheless, at Firstsource, the run rate of profits has improved from Rs 20 crore in the March and June 2012 quarters to its current level of Rs 40 crore. If analysts and management's views are to be believed, in FY14 it is expected to make a profit of Rs 180 crore as against Rs 62 crore in FY12.

  Things are changing for the better; thankfully, the worries on debt front, too, are easing. The current debt of Firstsource is considered to be half of what it was in March 2012, say analysts. That apart, improvement in its own profitability and support from CESC lightens concerns over its debt. It is in CESC's interest as well as that will lead to higher value for its investments and over a period of time start reflecting in its consolidated financial performance.

If Firstsource can make Rs 180 crore net profit in FY14, effectively factoring a 56.9 per cent stake, that will be almost 50 per cent of CESC's net profit in FY12. But this does not include interest on the loan taken for the acquisition of Firstsource. "We expect FSL to contribute 5-15 per cent of CESC's consolidated profits over FY13-15 post acquisition interest cost, and should generate a return on investment of 18-20 per cent from FY14 onwards," said Venkatesh Balasubramaniam of Citigroup Global Markets in a recent research note.

Core business growth
In the power space, CESC is well established, with a generation capacity of about 1,225 Mw. On an average the standalone business (captures the power business) has been generating Rs 800-1,000 crore annually. However, a large part of this cash is deployed in its expansion and businesses like retail and Firstsource.

But, the IT BPO firm will need less cash, unlike the retail business (CESC holds 94.71 per cent stake in Spencer's). This has been a cause of worry, given that it has been contributing losses at the consolidated level. In FY12, Spencer's reported a Rs 255-crore loss on a turnover of Rs 1,210 crore, impacting the consolidated financials of the company. CESC on a standalone basis made a net profit of Rs 554 crore in FY12 but on a consolidated basis its profit stood at less than half (Rs 236 crore).

On account of these losses in Spencer's, CESC had to infuse funds to keep it running. Thankfully, Spencer's has seen some traction. Average sales have increased to Rs 1,230 per sq ft in the nine months ending December 2012, compared to Rs 1,087 per sq ft in the corresponding period last year. The management is expecting Spencer's to break even in a year. This will be the key issue to watch, not only in terms of breakeven but also future cash flows from the business, considering its impact on consolidated performance. Meanwhile, its core business could add to growth. Over the next two years, the company is likely to almost double its generation capacity to 2,425 Mw. Effectively, the growth will also be driven over the next two years from these new capacities leading to higher visibility at consolidated levels.