EXL-lent flotation

The first Indian BPO's public issue marks another milestone in the outsourcing story

ExlService Holdings could soon be the first Indian BPO company to list abroad. The company started by mainly catering to the business processing needs of financial services company Conseco, operating as a wholly owned subsidiary of Conseco from August 2001 to mid-November 2002.

In November 2002, EXL's founders, along with two venture capital companies and some other members of its senior management team, bought the company.

But soon Conseco filed for bankruptcy, forcing EXL to find new clients. So far, EXL has done a good job of it. It added four clients in 2003 and seven new clients in the nine months till September 2004. Meanwhile, revenues from Conseco have fallen to just 3 per cent.

Revenues in the nine months till September this year grew 127 per cent, while gross profit jumped by 148 per cent. At the operating level, EXL reported a profit of $4 million, or 10.2 per cent of revenues, compared to a loss of $0.4 million in the same period last year.

Notably, the improvement in profitability was despite a jump in depreciation by over 5 percentage points as a percentage of sales, which talks of the extent to which economies of scale have kicked in.

But although the dependence on Conseco has fallen, EXL instead relies on just two clients for 77.4 per cent of its revenues currently.

In sum, EXLService's story is not very different from the stories of several Indian BPO companies. While the performance record will determine the price, EXL's trailblazing IPO is likely to set the pace for unlocking value in other BPO companies. Given the increasing competition, the sooner they list, the better.

Sintex

After gorging themselves on Sensex stocks, FIIs have developed an appetite for stakes in mid-cap companies. The latest in that trend is Warburg Pincus' acquisition of 26 per cent stake in Sintex Industries Ltd (SIL).

Warburg will be picking up the stake at Rs 280.10 a share, 12.65 times trailing 12 months P/E and at a discount of approximately 12 per cent to Tuesday's market price. It's also expected to make an open offer. Other plastic companies like Nilkamal Plastics and Plastiblend trade at a 12 month trailing P/E of around 4.7 and 5.7, respectively.

But Sintex is in a different league. SIL has two divisions""plastics and textile""-with the plastic division accounting for the bulk of the business.

Its textile business has been the star performer in the last quarter, and segment profit grew 129 per cent to Rs 6.52 crore. This division has helped the company get a better valuation (Textile valuations are much higher than those for plastics companies, with the post-quota textile story in full flow).

The company's plastics business is also well-established. It has been a pioneer in the water storage tank business "" Sintex water storage tanks are a household name and it has an estimated 65 per cent market share in this segment. The plastic division's profit grew 25.1 per cent to Rs 12.56 crore in Q2 FY05.

The preferential allotments of equity and warrants will dilute the company's equity by 50 per cent, but this dilution will happen over three years, as the warrants get converted.

The market has been unperturbed by the prospect of dilution, because of the strong growth prospects of the company, which make current valuations attractive despite the sharp run-up in the price.

What's more, the recently announced cut in polymer prices should help improve the profitability of the plastic division, while the planned demerger of the textile business into a separate entity would unlock value.

The strangeness of Chinese stocks

Emerging market indices from India and Singapore to Brazil and Mexico have been hitting new highs recently. And the giant among emerging markets is unquestionably China.

It's the fastest-growing economy in the world, it attracts the largest amount of foreign direct investment, and its huge investment boom has raised commodity prices across the world. With this kind of track record, one would have expected China's stock market to be right at the front of the rally.

Unfortunately for Chinese investors, the reality is very different. As the table shows, the Shanghai Composite Index is currently well below its average for September, and more than 20 per cent below its March average. Sentiment is so bad that the index hovers above multi-year lows. It's starkly different from other emerging markets.

There are many reasons for the underperformance. China has a two-tier stock market, with investment in some shares limited to domestic investors. The Shanghai Composite index does track both classes of shares, but foreign investment is often through the Hong Kong market.

The heavy hand of the Chinese government is another factor, and the market regulator has been accused of talking up stock prices and favouring state firms. Many securities companies have been plagued by scandal. IPO prices are decided not by the market but by government fiat.

But perhaps the most important reason for the Shanghai Composite's dismal performance lies in its astronomical price-earnings ratio, which is near 30. No wonder foreign investors prefer the far cheaper, and far more open, Hong Kong market.

With contributions from Mobis Philipose and Amriteshwar Mathur