The Hindu Business Line : ‘Indian BPOs may be target of acquisitions’

The Indian outsourcing sector is amongst the worst hit by the rising rupee with most of the companies showing a slump in growth and profitability. Valuations too have fallen. However, this situation not only reflects the ‘deteriorated revenue growth expectation’ of investors, but also makes the domestic BPO (business process outsourcing) space ripe for heightened M&A (merger and acquisition) activity. “…M&A activities triggered by low interest rate regime in the US might surprise the sector with valuation multiple reaching the early 2007 levels,” claimed Mr Manoj Bothra, Senior Associate with Ernst & Young.

Driving the M&A wheel in search of possible acquisition targets could be PE (private equity) players. In the past week, PE fund Nalanda India has picked up a 5.25 per cent stake in the US-listed BPO firm WNS Holdings. But even the US listed but the India-based BPO companies could themselves look at acquiring stakes in India-listed counterparts. Genpact is reportedly looking at adding more domestic clients in regions like Asia such as India and China. Select Indian BPOs, if acquired, may help them enter these markets quickly.

So, who could be on the radar? Without pointing fingers at anyone, Mr Bothra gives examples of some India-listed BPO companies. “Allsec Technologies has been the worst hit, as the market capitalisation of the company fell by 70 per cent in March 2008 as compared to March 2007. Datamatics and HOV Services also saw their market capitalisation reduce by 40 per cent and 60 per cent respectively,” he said, during the course of an e-mail interaction with Business Line.

While the rupee appreciation has been too quick for the companies to react with appropriate measures that offset the currency fluctuation, curiously the US-listed counterparts have fared well on the margins front, even though their cost structure is almost the same as that of the Indian-listed entities.

Convergys, Syntel, WNS and EXLServices, the top four India-based BPO firms listed on Nasdaq have been able to maintain their EBITDA (earnings before interest, taxes, depreciation and amortisation) margins to a greater extent due to prudent foreign exchange hedging policies, Mr Bothra said.

While valuation metrics like enterprise value (EV) to sales multiple, and the EV/EBITDA multiple bands have more than halved for the sector as a whole, prudent forex hedging policies and cost management through operational efficiencies will be the key factors effecting the valuation of the BPO companies, he added.

Any hopes of a turnaround in fortunes? “For the multiples to stay at higher levels over a sustained period, the BPO companies will have to ensure healthy topline growth and diversification seems to be the only mantra, diversification to non-financial sector in the US and, if opportunity strikes, to non-US markets, too,” Mr Bothra predicted.

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