The Hindu Business Line : Debt spells no dent

3i Infotech has been aggressive in acquisitions. Its latest in a string of acquisitions is US-based Regulus, which provides bill presentment and remittance processing services, for a total price of $100 million. 3i Infotech has also been aggressive in using debt to fund its acquisitions as well as working capital requirements. Industry observers have both commended and questioned this aggression. Its CFO, Amar Chintopanth, explains the thought behind the strategy to eWorld . Excerpts from the chat:

With regard to your Regulus acquisition completed in June, what ruled your decision to acquire it at 0.66 times its annual revenues? Isn’t 0.9x to 1.1x the typical range?

Regulus has revenues of $150 million or in excess of Rs 600 crore. This year, about Rs 500 crore of revenue would accrue to us.

As to the price, we went by EBITDA (Earnings before Interest, taxation, depreciation and amortisation) of $20 million. So four times EBITDA in the current market condition is appropriate. (The cost of acquisition is $80 million with another $20 million coming as earn-out over two years.)

Had you waited three months, you would have got it cheaper.

Even as we were talking to them, it came down from 5 x ebitda to 4x.

What is your approach to acquired companies? Regulus has about 235 clients. Do you rationalise client base, since some clients need not be worthwhile servicing?

In none of our acquisitions did we feel the need. We have three categories of acquisitions. First, the product category. Here, the domain expertise and reference clients are important. We use these client to grow our businesses. The second kind is the BPO in India. We have acquired five-six small companies here. Each had a common set of clients but with different offerings. So, we actually scaled up per client. There was hence no need to send away clients. The acquisition of UK-based Rank Systems is an example of the third kind of acquisition. It had a new set of good, marquee clients. There was again no need to rationalise. The last is Regulus — it is a business we want to grow and in which we are not present, in the US.

Do you see increased offshoring from Regulus’ existing business?

The main advantage there is the opportunity to offer technology services to existing clients rather than just transaction processing. Regulus anyway offshores work worth between $8 million and $10 million a year to companies in India and China.

Regulus also outsources some services in the US. Remote network management is an example, for which vendors use between 200 and 250 people to service Regulus. Both these kinds of work could come into our fold. We have the capability here. Our margins would improve.

As CFO, how have you cut costs given the current economic environment?

There has been cost rationalisation, rather than cost-cutting. Our productivity is increasing. Since we have not been in mass recruitment, we never carried a bench. Because we did not have huge margins, it did not make sense for us to carry a bench. We also look at how much work we should do ourselves versus outsourcing that. In the BPO business, we do outsource a bit.

On the products side, we have been spending a bit on product management and componentising our products. Even in our services offering, we see where our frameworks could be sold (instead of re-inventing the wheel). In large contracts, we try and change fixed pricing to pricing based on time and material used.

Why is that? Isn’t the reverse true, to improve margins?

In very large deals, of the order of $6-7 million and above, if customisation requirements are large, then we would benefit by having a T&M pricing structure. Licence and AMC (annual maintenance contract) revenues would all remain. Only customisation would be in T&M mode, in the western markets.

Change requests keep coming in from clients and in fixed price mode, we would not charge the customer for that. Customisation would need a certain number of hours, irrespective of whether it is Fixed price or T&M. So, more revenues per hour are always welcome.

For software products, we are looking to convert them into Software as a Service (SaaS) offering. It need not be in all markets. If products’ licence revenues give you revenues of X in India, going the SaaS way would give you higher revenues. In markets where revenues are not substantial, such as in African markets, we are exploring this.

For the same investment, our revenue streams would be higher using SaaS. We are doing it in India.

We see that you have been raising loans, through term loans, Foreign Currency Convertible Bonds. Please explain the rationale.

End June 2008, our net worth was Rs 800 crore and our total debt was Rs 1,862 crore. I agree that the debt to equity ratio looks skewed — comes to 2.1.

We look at it as three components.

First is the roughly Rs 750 crore of cash-flow based, term loan debt. Of this, Rs 100 crore would be cash credit and Rs 650 crore would be working capital loans. These would get serviced on a month-on-month basis from the traditional business of 3i Infotech.

The second is the Rs 720 crore of FCCBs. Here, there is no cash flow impact today. There is still an average of 3- 3.5 years to go before they become convertible

Conversion prices for these are not too far off from current prices. For roughly $20 million or in excess of Rs 100 crore, the conversion price is price is Rs 115 — this has another three years to go. For another $40 million or Rs 170 crore, the conversion price is Rs 154 — we have another four years to go for this. (The current price is about Rs 85.) The last is the $100 million FCCB for which the conversion price is Rs 166.

These were at premia of between 10 and 20 per cent on the date of issue. We have not had high premia since this was always meant to be equity for us. Three-and-a-half to four years from now is a fairly long period and things would change. There is hence no cash flow concern, it is not affecting our daily operations in anyway.

The third component of debt is Rs 350 crore for the Regulus acquisition. That is serviced from cash flows of Regulus itself. It is a loan on the target. If the new stream of cash flows from Regulus were not there, then the debt itself would not be there.

So, these are not impairing the regular businesses of 3i Infotech.

As to the Rs 750 crore of term loans, if you see our business model, our products is business milestone based. Also, roughly 40 per cent of our services business is also milestone or payments based. We have to invest upfront, all our costs are people and space costs, with payments coming over time. We need working capital.

Then, for acquisitions made in India, we have used internal accruals, hence the working capital strain where term loans help. Also, as of June 30 this year, we also had Rs 280 crore of cash on the balance sheet.

How much head room do you have — if you acquire another company, would you use the cash flows of the target company to raise debt?

For very small companies, you may not look at such structured funding. For large acquisitions — in the region of $50 million — either debt or stock swap would work.

Where we would need more debt is for our citizen services centres business. Our total investment would be between Rs 150 crore and Rs 200 crore, for about 12,000 centres over an 18-month period.

At least 30 per cent of this would be from cash chest. The balance would be from debt.

How badly is the turmoil in the West affecting you?

Our exposure to the US banking industry is not significant. We are more into the payments processing side. Our services are to do with day-to-day activities of banking. Even with Regulus, in addition to servicing banks, we service clients who use banking operations but are not necessarily banks. We may not see significant growth but there is no significant slowdown either.

Most problems today are to do with investment banks, to which sector we have no exposure.

What is your exposure to the US now?

Currently 25 per cent, but with Regulus it should touch 50 per cent by the end of year.

But as a vertical, BFSI (Banking, financial services and Insurance) contributes to 70 per cent of total revenues for you…?

True, but it’s not only banking. We also address capital markets, insurance. Growth from emerging markets is good for us. Russia has opened up its insurance and we fancy our chances there. We have a joint venture in China. In West Asia, India and Far East, we are doing all right.

Because of the uncertainty in the West and we don’t know how that could spread, are decision makers in other markets holding back decisions?

Not yet — but if this continues for another year, they could clam up. But for now, optimism is still there. Reports say that by March ‘09, our own inflation would go down, and that things would be better. Fundamentals are still strong and we are a growing economy.

bharatk@thehindu.co.in

Related Stories:
3i Infotech raises Rs 500-cr debt to fund domestic buys
3i posts 44% rise in net

More Stories on : Interview | Outsourcing | Financial Markets

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Not too keen to pay for use?

Trigger for violence?

Serve IT hot and fast

Debt spells no dent

Pay through the mobile phone

Quiz

Good technology is almost half of health

Cartoon