The Hindu Business Line : Allsec Technologies: Avoid

INVESTORS may refrain from bidding in the book-built initial public offering (IPO) of Allsec Technologies. This is the first pure-play investment exposure in the customer care and support (call centre) business. Allsec, which has a reasonable track record in running its existing 700-seat centre at Chennai, is in the process of expanding it to 1,700 seats using funds raised through this IPO.

However, the risks and challenges associated with this business — internal and external — are high. A multitude of factors ranging from high client concentration risk, intense competition, challenges in scaling up and pricing pressures at the lower end of this business arising from consolidation within the industry are likely to impact Allsec's growth and performance.

The ongoing consolidation in the IT-enabled services industry is likely to gather momentum over the next year or two leading to a substantial change in the industry dynamics.

The growing scale and size of operations of merged entities and a switch in focus from voice-based services may contribute to greater pricing pressures and stiff competition for new business.

The price band for this offer has been fixed at Rs. 135-162; the price earnings multiple is 11.5-13.5 times its annualised per share earnings for 2004-05. Given the risks associated with this offering, the pricing appears to be fairly stiff.

If the institutional subscription for the offer turns out to be encouraging, there is a possibility of gains linked to the listing of the stock. But we have not factored gains on flipping this stock on listing into our recommendation.

We believe that as the expansion in seats in the customer care business is likely to take place in phases over the next year, there may be opportunities for entry into the stock at a later date.

Tracking the client execution record, new client acquisition in relatively high margin areas such as human resources-related processing and quality assurance solutions may also enable informed investment decision.

Encouraging signs: A few of the promising elements in this offer are:

Allsec has recently entered into a revised Master Services Agreement with CompuCredit Corporation, US, and its single largest client. For the nine months ended December 31, 2004, this client accounted for 52 per cent of Allsec's revenues.

Through a series of acquisitions, CompuCredit has managed to grow and diversify its services into a broad financial services platform. Its range of services includes credit card, micro lending, prepaid debit cards, debt collection services and auto finance.

The credit card business is the largest segment in terms of quantum of loans and profitability. This diversified portfolio will present opportunities for growth.

At present, Allsec has 10 clients predominantly focused on voice services for different verticals. Of this, financial services segment accounts for over 65 per cent of revenues.

The company is offering HR processing, quality assurance, technical support and data analytics to some of its clients. Its ability to provide value-added services and expand its client base in these areas using the existing references will help offer stability in the medium term. As already has established processes in place, it will also be in a position to mine its existing clients for growth.

Risks and challenges: Some of the challenges — internal and external — that the company will be exposed to are:

High client concentration: As three clients account for 73 per cent of the total revenues of Allsec for the nine months ended December 31, 2004, it remains exposed to high client concentration risk. Of this, the largest client accounts for 52 per cent. If additional business comes from the existing clients for the expanded 1700 seat facility, this risk may get enhanced.

Fluctuating earnings: For the 15 months ended March 31, 2004, Allsec ended with a net loss of Rs 16.9 crore on revenues of Rs 25 crore as business growth slowed. On account of high connectivity and employee costs, any downturn in business may lead to a substantial loss.

The company has, however, bounced back in the first nine months of this year, with a 65 per cent growth in revenues to Rs 41.7 crore and post-tax earnings at Rs 7.8 crore. The growth momentum has to be sustained at current operating margins of over 25 per cent on the expanded operations to derive substantial economies of scale.

Scale-up and attrition: Managing execution in a smooth fashion as Allsec expands its facility to 1700 seats is a big scale-up challenge. In an industry, where salary costs are placing pressure on operational costs, employee quality and attrition remains a cause for concern.

Sooner or later, the selling and marketing expenses may have to be stepped up to expand the client base, which may keep a tight leash on margins.

Stiff competition and pricing: The competition for companies in the IT-enabled services industry is coming from three fronts. The multinationals such as Accenture, IBM or ACS are attempting to scale-up their operations in India, using the offshoring cost-advantage.

The domestic software service companies such as Wipro, HCL Technologies, NIIT, iGate Global and Mphasis BFL, among others, are slowly progressing towards a integrated IT Services-cum-BPO model which is likely to change the pricing model in the industry.

The companies in the lower end of the IT-enabled services chain may feel the heat as these companies entrench themselves. Finally, pure- BPO companies such as WNS Global, EXL Services, ICICI OneSource and 24X7 Customer with established operations will also offer competition to the company.

The ongoing consolidation in the IT-enabled industry and to some extent, a shift in the core strategy from voice-based to transaction-based processes can also exert a significant influence on the pricing front.

External risks: Increasingly, clients will focus on the business continuity plans of its third-party service providers. Large BPO vendors with operations at several locations across India and abroad such as the Philippines, Mexico or China will derive advantages compared to Allsec's presence at Chennai. Similarly, third-party providers always face the risk on the geopolitical front and fears of backlash from the developed countries.

Background: Allsec is offering 31.4 lakh shares through the book-building route for expansion to 1700 seats and repayment of loans taken for the purpose. The price band is Rs 135-162. The offer is opening on April 13 and closes on April 20. The book-running lead manager is IL&FS Investsmart.