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BPO sector saw quite some activity on the investment front, with not less than eight deals involving some of the biggest in the game (ICICI Onesource, Hinduja TMT, 24/7 Customer, Talisma) and even some of the most high-profile ones (Nipuna, iGATE, Perot Systems). The small had their share as well, with start-up Indecomm receiving its first round of funding. The aggregate value of deals can well be over $60 million.Â
Not surprisingly, analysts and observers started predicting the heralding of a new phase of consolidation, accompanied, of course, by active discussions on the new trends in the
investment scenario–what kind of companies would buy whatÂ
kind of companies with what kind of valuations. Some of the most prophetic headlines in the media (do not blame it on us; we have to report,
you know) may still be fresh in your memory.Â
As a specialized publication in this area, when we did investigate the activities and spoke to a cross section of CEOs, CFOs, and a few VCs, what we found was not really exciting enough, for us, that is. One, we could not spot the Big Trend, which would have made our headline a real eye catcher in place of this seemingly open-ended (vague, if you like) one that we have used.Â
Two, we found that while the mergers and acquisitions are here to stay–and may even get accelerated–a shakeout, if at all, is a little far away. And what
is more, there is no clear trend in valuation.
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Led by Funding, Followed by Acquisitions
If the Indian offshore opportunity was the vision of a few zealous global corporations having strong faith in the capability of India’s workforce, the Indian outsourcing industry was the result of efforts of a bunch of venture capitalists having similar faith in Indian entrepreneurship. In fact, much before IT companies and other old-economy companies became sensitive of this opportunity, a few VC-backed companies had already started to do offshore process outsourcing business in India.
Spectramind,
Daksh, EXL, Vcustomer most of the big and successful pioneers in Indian BPO–were VC-backed. In fact, so much so that many point out the fact that before the IT companies entered the arena, the VC-funded companies set up by professionals were the only ones that were successful. And this was one big difference between how Indian IT services companies started and how the BPO companies did. This difference would be critical in determining the direction that the industry in general and the investment activities in particular would take in future.Â
And that trend has continued since then. July 2003 might be a particularly news making month, but is definitely not unique. In 2002, as much as $127 million in private equity had been invested in Indian BPO companies in 12 deals, according to the private equity tracker Asia Private Equity Review. The journal also estimates that this was as much as 25 percent of the total value and 40 percent of the total number of private equity investment, across all sectors in India. With the exception of a handful of acquisitions/strategic investments–like in Spectramind and iBackoffice–all of these have been venture investments.Â
| TOP NON-LISTED COMPANIES | |
| COMPANY | 2002-03 REVENUE (US $mn) |
| WNS Global Service | 33.5 |
| Daksh eServices | 29 |
| EXL Services | 28 |
| ICICI Onesource* | 17.4 |
| Vcustomer* | 17 |
| Sutherland Technologies | 16.5 |
| Epicenter* | 16 |
| Zenta* | 15.4 |
| 24/7 Customer* | 15 |
| Datamatics* | 14 |
| Tracmail* | 10.5 |
| Infowavz* | 6.1 |
| * Estimated by bpOrbit | |
Of course, as mentioned earlier, 2002 was not the first year and the whole BPO wave has been kickstarted by VCs. Apart from Indian funds (ICICI, IL&FS, etc) and India-specific funds (ChrysCapital, WestBridge), many major global investors have invested in Indian BPO companies, quite early in the industry evolution cycle. Prominent among them are the biggest of them all, Citicorp, the most influential name in VC circles; The Carlyle Group; and a host of other big private equity players like General Atlantic Partners, Sequoia Capital, Warburg Pincus, CDC Capital Partners, and JP Morgan Partners. Together, these companies have put close to $400 million, not taking into account the companies that they
exited from.Â
The story of acquisition is far shorter but equally interesting. So far, the lead has been taken by the IT services companies.
While the acquisition of Spectramind by Wipro has been the biggest and most noticeable, this has been supplemented since by deals closed by a few others like Polaris, iGATE, Perot, and even the biggest software outfit in India, TCS. Cognizant, which has been eyeing an acquisition, has not been able to close a deal, though it has been rumored to be talking to different companies from time to time, the latest being Bangalore-based BPO firm iSeva, specializing in tech support and financial services verticals. The company, however, has a stake in healthcare BPO firm Ajuba International. Zensar has also bought a 50 percent stake in Suntech Data Systems, a firm targeting the financial services domain.Â
It’s Sizzling, but…
The magnitude of investment-related activities in the sector prompts many to believe that the industry is fast heading towards a major consolidation.Â
The basis for such thinking is the fact that all privately held BPO companies in India that are growing fast are VC-funded and with business coming at such a fast pace, ramping up has
become the biggest challenge and even a critical success factor for these companies. To a great extent, that is
dependent on smooth access to capital, which many VC-funded companies do not have today. They need fresh flow of funds to be able to scale up and survive.
In fact, most of the investment deals today are driven by this single factor–access to capital. While this essentially means is that the investment activity will continue and speed up, it also means that the actual ‘consolidation’ may not happen. A consolidation happens when some companies have created some value in terms of services, people or technology but are not financially sound and hence sell off; or when a few companies have niche strengths and decide to merge after reaching a certain scale. Both these are not the cases in India.Â
Here, we have a few companies that have failed completely. They have not created any value whatsoever, apart from hiring real estate and building a LAN. They have been and would remain marginalized in the M&A activity. Similarly, there are not many specialized BPOs of a certain minimum scale who would take the strategic decision to merge with each other.Â
In effect, what it means is that all investment–whether venture funding or strategic equity stake or a complete buy out–would be done with just one objective–raising money for scaling up. For that, the first option that the companies would like to explore is a few more rounds of venture funding.Â
There are not more than 20-odd BPO companies that are VC-funded and are above a certain size, say $5 million. These are the attractive acquisition targets. Except for three to four like WNS, Daksh, and EXL, the rest are in the sub-$20 million range. Assuming a 1:1.5 times valuation (more about that latter), they could sell for anything between $5 million to $30 million, which makes the base of potential acquirers quite large.Â
Simply speaking, getting investment for a good company may not be that tough in BPO. With most of the deep-pocket VCs becoming active in India, many CFOs and VCs believe that there will be a further round of large-scale VC funding, and a few strategic investments of 20—30 percent. There could be few acquisitions.Â
Many also believe that a few of the smaller captive BPOs in the non-BFSI segment could also get sold to either strategic acquirers (like AFS to TCS) or to independent investors (like WNS to Warburg Pincus). However, that number is not large.Â
The biggest positive change in outlook, however, has been regarding seed/first round funding. In 2002, the general perception was that there would be no further investment in small companies. However, suddenly the proposition seems to have changed.
Focused start-ups have once again started attracting investments. In the last few months, the industry has seen a few such investments. The most prominent examples include Worldzen, focused on healthcare and receivables management, which attracted none other than Carlyle Group, which probably made the first major first-round investment in any technology-related company; and more recently Indecomm, a company focused on healthcare, that attracted investment from
Westbridge.Â
Yes, always expect a few odd acquisitions. But few are likely this year. Daksh, which has been talking of an IPO, may ultimately go for one but it is less likely that it will do that this year.
Valuation
How are the BPO companies valued?Â
The answer to that depends on whom you are asking. With early rounds of VC-funding not being a real indicator, and with few third round fundings, let us try to judge it by the companies that have already been acquired. Spectramind was acquired by Wipro at a valuation of almost three times (2.5 times when the decision was taken, as the company revised the revenue downwards afterwards and achieved $35 million against the projected $40—42 million). The same VC has since exited from Transworks
selling to Indian Rayon at a valuation of one-time forward sales less than a year later. IGATE’s acquisition of Quintant is an altogether different story and cannot be measured by the same parameters.Â
There is a widespread perception that the Indian market has been adjusting to global norms and the valuations are dropping to more realistic levels of one to 1.5 times the forward sales. It may be noted here that most of the big and successful teleservices and BPO companies in the US like Convergys, West, APAC, Exult, and even EDS trade at one to 1.5 times the revenue and sometimes go below one. Clearly measuring in those terms, the Indian valuation seems to be much higher.Â
| MOST PROLIFIC VCS | |
| INVESTOR | NO OF INVESTMENTS |
| ChrysCapital* | 5 |
| Citicorp | 2 |
| Warburg Pincus | 2 |
| WestBridge | 2 |
| Carlyle Group | 2 |
| * It has exited from two | |
However, there are a significant number of people who feel that India is a growing market and the higher valuation is justified.
They feel, the companies here are not really looking at ‘creating’ volume which can only happen at a so much rate, but are replacing the existing business in the US and so can grow at a much faster rate
than their US counterparts. In fact, a few feel even Spectramind was undervalued.Â
However, what most do agree upon is that there cannot be one single yardstick for all companies. Companies that are large and have reached a certain threshold would command a higher price. However, that argument does not justify the valuation of a company like Vision Healthsource, which was valued far higher. This was because it was a leader in its own area and was clearly India’s No 1 healthcare BPO company. Perot, which has a good IT practice in healthcare, needed BPO capability in this area and paid a slightly higher price.Â
That brings us to the age-old debate of the science and art of valuation. Though they are largely similar for any B2B service industry, it is probably apt to discuss that in brief in the context of BPO industry as it stands in 2003. Some of the parameters could be exactly the same as those in IT services. Here are some broad indicators on what determines the value of a BPO company today.Â
Size: First and foremost, this game is all about scale. The revenue/number of people is the first and most important parameter for an acquirer, not just in valuing a target but in deciding whether it is the right company to acquire. While in broad-based BPO companies, the revenue and number of people are directly proportional, for a fast growing company, the number of people actually productive as a percentage of total employees could be less.Â
Profitability: Business is done for that. While for growing companies, profitability may not be as important as scale, it is probably the next most important parameter.Â
Positioning: Again, the value is largely dependent on whether a company is broad-based (in that case, scale is very important) or specialized. Also, what processes are handled by the company and what vertical is served by the industry. Outlook of those sectors and outsourcing outlook of those processes determine the future of the company. For example, a telemarketing company has suddenly become less attractive with ‘Do Not Call’.Â
Growth Rate/Order Book: BPO being a business of long term contracts, the company’s order book often denotes how much growth the company can expect. However, order book may not be the only indicator of growth.Â
Client Concentration: How much revenues do top clients contribute? While like IT services, too much dependence on a few clients or too wide a portfolio may not be the best things to have, in BPO, the risk in case of dependence on only a few big clients is not so high, compared to IT services. The reason is simple. In IT services, the contracts are for projects, whereas in BPO, the contacts are for processes and are usually long-term. In many processes, the cost of switching the BPO vendor for the client is also far higher than switching his IT services vendor. That gives this business a far higher stability. However, the ideal concentration is when top 20 percent clients contribute anywhere between 50—70 percent.Â
Client Relationships: The quality of clients and the depth of relationship also determines the value of a company.Â
Management Team: For smaller companies and start-ups (like Quintant), the quality of management team and their track record is the only parameter to go by.Â
The strategic need of the acquirer: All other things being equal (and largely dependent on the target company), the strategic need of the acquirer often determines how a deal is valued. While acquirer ‘A’ may be willing to pay only X amount, another may pay much more if its strategic needs are fulfilled, as seen in the acquisition of Vision Healthsource by Perot Systems.Â
While the first seven parameters are typical valuation parameters, the last adds an interesting dimension. Examining it in the current context shows that so far the only companies that have done serious acquisitions are IT companies or VCs (buybacks as in WNS, EXL, and even ICICI). While VCs would typically look at it purely in terms of valuation parameters, with no strategic interest, it is the IT companies that have a strategic need.
| ACQUISITIONS | ||||
| ACQUIRER | ACQUIRED | COMPLETED IN | VALUATION | EXITS |
| ICICI Onesource | CustomerAsset | Apr-00 | 19.3 | eVentures India (A Softbank, PK Mittal, Newscorp venture) |
| Polaris | iBackOffice | 02-Dec | Undisclosed | Global Technology Venture |
| Wipro | Spectramind | 03-Jan | 102 | ChrysCapital |
| Accenture | ADSI | 03-Mar | Undisclosed | American Annuity Group |
| Mascot | IT&T | 03-Apr | 4.5 | NA |
| TCS | AFS | 03-May | 5.8 | Swissair |
| Aditya Birla Group | Transworks | 03-Jun | 13 | ChrysCapital |
| ICICI Onesource | FirstRing | 03-Jul | Undisclosed | Hero Group, Ravi Sethi |
| iGATE | Quintant | 03-Jul | 18.8 | GMR Group |
| Perot Systems | Vision Healthsource | 03-Jul | 10 | NA |
| NA: Not Applicable/Available | ||||
This strategic need, of course, would be different for different companies. However, there is some commonality. Most Indian IT services companies have done/will do acquisitions to close the time gap. They would be looking primarily at scale, specialization, and synergy with their strengths in IT business.Â
However, with other companies getting active in the space, other parameters could be equally important. A few overseas SIs like EDS and Accenture could look at the facilities, the synergies with their plans, and management talent. They could be active players in the M&A game in the near future. ACS, which has a strong acquisition track record, is the company that many are keeping an eye over.
Also, do not rule out the likes of Indian Rayon. They would be looking at keeping a foot on the space and would look at pure value for money.Â
While there is no agreement on what the trend would be, there is one broad perception–that the investment space will see a lot of action. With Gartner predicting that India’s TINA factor is going to be sustained, a lot of VC money would surely flow.
Watch this space.
VENTURE CAPITAL INVESTMENTS
CAPITAL INVESTMENTS
(Completed round)
RAISED
($million)
Venture Partners,Sequoia Capital
International
Ventures, Cognizant Technology Solutions, Ralph Wilson Equity Fund
Technologies
Mahindra Venture Capital Fund,Eurindia
Atlantic Partners
Partners
eServices
Capital Partners, Citicorp,Donald Peck, Asheesh Gupta, General Atlantic
Partners
Ventures
Technologies
Capital, Infinity Ventures
Services
Hill Capital Partners, Financial
Ventures
Ventedge
OSI
Capital, Acer Technology Ventures
Life Hewitt*
View Group, Hewitt Associates
ICICI Ventures
First
Desai of Desai Capital Management Inc., Chatterjee Group,Anthileon
Capital/Artiman Ventures,Fenwick & West Partners and Founders
Capital
Group
Outsourcing
Venture, SIDBI Venture
Data
Investment Partners, Madrona Venture Group, SeaPoint Ventures,Cedar Grove
Investments,The Carlyle Group
Group, eTech Ventures
Pincus, Oki Developments,WestRiver, Ajay Shah
Pincus
Group
Capita l Partners
information about companies marked with an (*) have been taken from
secondary sources. Information about all other companies have been either
shared with VOICE&DATA bpOrbit or have been taken from official
communications of the companies.