The Hindu Business Line : Firstsource Solutions: Invest at cut-off

The diversified business model, strong relationships and aggressive acquisition strategy lend confidence to the offer. However, competition and integration risks remain.

MR ANANDA MUKERJI, MD and CEO.

Investors with a penchant for high risk can consider taking exposure in the initial public offering of Firstsource Solutions (formerly ICICI OneSource). The price band for the offer is Rs 54-64 per share. As the third largest pure play BPO service provider in terms of revenue, the positives linked to this offer are its diversified business model catering to three key verticals (banking, telecom and healthcare), strong relationships with established global clients, aggressive acquisition strategy, and broad global delivery base. However, it will remain exposed to key challenges stemming from intense competition from a multitude of players, high client concentration and employee attrition, apart from risks arising from integration of large acquisitions.

At the announced price band, the price-earnings multiple works out to 27- 32 times the annualised per share earnings for 2006-07 on an expanded equity base, post-offer. At the upper end of the price band, the offer is aggressively priced, practically in line with its frontline software service peers. The PEM, however, is lower than the multiple commanded by WNS Global and EXL Services, its BPO peers listed in the US over the past year.

As this IPO is a play on the robust growth potential for BPO, investing at cut-off price makes sense as investors will remain eligible to participate even if the offer price if fixed at a lower level. However, our comfort will be greater if the final offer price is fixed at the lower end of the price band.

Positive signals

The business model employed by Firstsource Solutions as a pure play BPO with vertical expertise is encouraging. It has derisked its model to some extent by focussing on banking and telecom as its key verticals and the US and the UK as its principal markets. Its global delivery infrastructure is also fairly widespread, with its 20 centres including 11 in seven cities in India, six in the US, two in the UK and one in Argentina. It is also in the process of developing a centre in the Philippines. It enjoys a fairly stable client base. As of December 31, 2006, it had 74 clients. Its top five clients are BSkyB, CapitalOne, Lloyds TSB, a large telecom firm in UK, and a Fortune 50 telecom company. And the top five clients accounted for 53.6 per cent of revenues in the nine months ended December 31, 2006. Its largest client accounted for 14.3 per cent of revenues, with one more contributing more than 10 per cent.

The company also entered into a strategic relationship in March 2006 with Metavante, a subsidiary of Marshall & Illsley Corporation, which is the third largest provider of products and services to the financial services industry. It has relationship with over 1,000 banks, including 91 of the top 100 US banks. Metavante has also taken a 24.07 per cent equity holding in Firstsource, which will come down to 20.6 per cent following this offer. The company's ability to leverage this relationship is fairly strong.

Its track record for integrating acquisitions has also been fairly good, having put through six acquisitions. It started its string of acquisitions with CustomerAsset in 2002, FirstRing in 2003 for credit card capabilities, majority stake in Pipal for research and analytics, and ASG for collections and receivables management in 2004, RevIT to enter the healthcare industry in 2005, and BPM to enhance capabilities in the healthcare sector.

On the financial front too, it has been a consistent performer, though in the first nine months, this has jumped significantly. On a consolidated basis, it reported revenues of Rs 548.46 crore for the nine months ended December 31, 2006, in line with the revenues clocked for the full year. Over this period, with a sharp improvement in operating profit margins to 19 per cent, the company recorded post-tax earnings of Rs 62.3 crore, up sharply from Rs 24.7 crore.

Risks and challenges

The competition in the BPO sector is likely to get fairly intense, with practically all vendors — multinational, domestic, captive and standalone — focussed on enhancing the non-voice segment of their operations. Though its client base is stable, Firstsource still has to contend with high client concentration. Its ability to retain employees and manage wage inflation will be one of the key challenges. Since a chunk of the proceeds is intended to finance acquisitions, the ability to integrate them smoothly also remains a key risk.

Offer details: Firstsource Solutions is making this IPO to part-finance acquisitions of Rs 180 crore, to set up new facilities for Rs 46 crore, and repay loans of Rs 45 crore. In the stated price band, the company is expected to raise Rs 374-443 crore, leaving a lot of leeway to deploy the balance for general corporate purposes. The offer constitutes a fresh issue of six crore shares and offer-for-sale of 0.93 crore shares. Post-issue, ICICI Bank (25.5 per cent stake), strategic investors such as Aranda Investments, affiliate of Temasek Holdings (22.08 per cent), Metavante (20.60 per cent) and Westbridge, now managed by Sequoia Capital (9.37 per cent), will be the key shareholders of the company. The offer opens on January 29 and closes on February 2.

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