Private Equity: Redefining Outsourcing

We identify seven ways how private equity firms are adding value
to outsourcing and thereby redefining the rules of the outsourcing business.

Far From the Madding Street

Taking public companies private for re-structuring. When India-based
offshore services firms such as TCS, Infosys, Wipro and Cognizant began to take
on the established service providers in North America, they were not taken
seriously by the leaders. But, soon enough, not only were they winning bigger
deals, the customers were also rethinking the way they had done outsourcing
contracts. Many of them, listed in American stock markets, also got a thumbs up
from analysts. Today, both Infosys and Wipro are valued at more than $20 bn by
the market. With multiple times revenue, companies like CSC, ACS and EDS are
languishing at much lower valuations. IBM and Accenture, thanks to their
consulting capabilities, are still holding on.

In terms of depth of execution, CSC and ACS are great firms. In
terms of handling large projects, they are far mature than the Indians. But they
are not being seen as creating much value by the market. They do not match up to
the Indians either in growth or in margins. Part of it is because they do not
match the smaller companies in terms of agility; and part of it is because they
still rely a lot upon government contracts.

Enter the private-equity firms. In October 2005, a group of
private-equity firms comprising The Blackstone Group, Texas Pacific Group and
Warburg Pincus started talking to CSC for a possible buyout. They had reportedly
roped in Lockheed Martin, which was looking at the government business of CSC.
The talks, however, failed, only to resurface in January this year, when The
Wall Street Journal reported that a different combination, HP and The Blackstone
Group, are talking of a possible buyout of CSC. This time too, talks fizzled
out.

So far, these talks have not materialized, but shows that the
ambition of private-equity firms is not restricted to doing deals of a few
hundred million. Had they materialized, both these deals would have been
multibillion dollar ones. In fact, what gave them courage was a successful
earlier buyout, in March 2005, of SunGard Data Systems, a NYSE-listed firm, in a
$11 bn deal. The firms involved were the who's who of private equity: Silver
Lake Partners, Bain Capital, The Blackstone Group, Goldman Sachs Capital
Partners, KKR, Providence Equity Partners and Texas Pacific Group.

"We can look at any investment that makes sense. Size is no
longer a barrier," says Bill McGlashan, MD, TexasPacific that was part of
the consortium in all these deals.

Showing the Way from Captivity

Leveraged buyouts of captives. There was a time, not long back, when
outsourcing was a major risk; offshoring was a bigger one. Few companies dared
to do both together. But when the cost savings were too much to ignore, many
started with caution, starting with what is today popular as captive centers.

Soon, when the delivery capability matured, a few decided to get
out of the operations of these subsidiaries. Most notable was British Airways, a
pioneer that started out its offshore delivery way back in 1996, was the first
to decide to get out. But instead of selling to a strategic buyer, it sold the
controlling stake to Warburg Pincus in May 2002. The private-equity firm brought
in entrepreneur-in-residence Neeraj Bhargava to run the company under an
independent identity, WNS Global Services, and quickly started to transform the
company for an IPO. In about four years, WNS became a publicly listed company,
when it listed on NYSE in July 2006.

GE-where CEO Jack Welch pushed India offshoring as a strategic
goal within the organization is now legendary-decided to follow the same path,
when new CEO Jeff Immelt took over.

"In all captives, the growth slows at some point of time.
That is something that you have to deal with. We wanted to deal with it before
it became a problem," says Pramod Bhasin, CEO, Genpact, the independent
company, that GE's offshore subsidiary is today known as.

In 2004, GE sold 60% of the stake in the subsidiary to two
private-equity firms-Oak Hill Capital Partners and General Atlantic Partners-in
a leveraged buyout.

"I think we could have got more (money) from strategic
investors. There was a lot of interest from strategic investors. But this is the
best ownership structure that we could think up that met all the three
objectives that were key imperatives," says Bhasin.

Today, Genpact is getting ready for an IPO. EXLService, another
offshore BPO firm, has followed the same path. The firm was bought from American
Insurer Conseco by private-equity firms, Oak Hill Capital Partners and Financial
Technologies Ventures, in a leveraged buyout in November 2002. The firm recently
listed on NASDAQ.

The latest to join the leveraged buyout party is Vertex, the BPO
subsidiary of United Utilities of UK Already a significant third-party player,
it has been acquired by a private-equity consortium led by Oak Hill Capital
Partners.

More than 100 such captive operations are still operating at
least in India. Many of them are potential sell-off possibilities. While the
smaller ones would have to go to strategic investors, the larger ones that have
created delivery excellence are ideal candidates for leveraged buyouts involving
private-equity firms. American Express is one such example.

Unity After Diversity

Merger among portfolio companies. Another proactive role that private-equity
firms are playing in outsourcing is bringing their specialized portfolio
companies together to create combined entities that offer a value that is more
than the sum of the parts.

Many firms start up with one/few domain focus, services focus,
or location focus. In the early days of development, it helps them manage their
business efficiently, thus guaranteeing faster growth. But as they become
larger, to sustain growth and to meet customer demand for uninterrupted service
delivery across a complete service chain, they have to diversify. Many a times,
private-equity firms have helped their portfolio companies to merge with each
other, creating larger capability.

Take the case of Ness. Originally started as an IT-services firm
with Israel market focus, it was looking forward to tap the offshore
opportunity. Similarly, Apar Infotech, a Bangalore-based managed services
player, was looking for rapid growth. Their common investor, Warrburg Pincus,
brought them together to create Ness Technologies of today, a much larger firm,
and a leader in offshore product development and managed services.

"By 2001, it was clear that the substantially growing IT
services offering for the coming years would be offshore, coming out of
India," says Raviv Zoller, CEO and president, Ness Technologies. "We
met the founders of Apar at an annual Warburg-Pincus portfolio company event,
and eventually consummated the merger in the beginning of 2003," he add.

"Being global is essential to build a world-class company
able to compete in its target markets. Initially, Apar was regional and so was
Ness," adds Henry Kressel, MD, Information and Communications Technology,
Warburg Pincus.

While strategic acquisition of a smaller firm by a larger firm
is common, coming together of small and mid-sized companies to form a larger
company is not so. It is because of the lack of maturity to handle mergers and
acquisitions as well as agreeing to a common goal are often problem areas.

Practice What You Preach

Urging/ helping portfolio companies to outsource. Outsourcing-especially
of the offshoring variety-is today almost entirely a game for the large
corporations, and smaller players in specific verticals, such as technology and
health care. Most of the small and medium companies are still new to outsourcing
as a practice.

Service providers often blame it on the mindset of such
companies. That may be far from the truth. "It is certainly not a mindset
problem," counters Akshaya Bhargava, head, BPO Investments, 3i, a UK-based
private-equity firm that invests in medium-sized companies. "They certainly
want to do it," he adds.

When Bhargava joined 3i, after quitting as CEO of Progeon,
Infosys' BPO subsidiary, it was a no-brainer that the UK firm was looking to
invest in Indian BPO.

Today he spends most of his time finding out where and how he
can help 3i's 1,200-odd portfolio companies add value by outsourcing and/or
offshoring. "Many of them would tremendously benefit from BPO, but there is
no supplier to serve them," he says.

Small companies, he says, have no management bandwidth and
know-how to manage that. In addition to helping them build that capability, he
is actively working on a "plan to effectively connect these companies to
the right BPO partners."

One Step Ahead

Picking companies with scope to add value through outsourcing. Vashistha
contends that many forward-thinking private-equity firms today realize that
outsourcing provides tremendous opportunities to add value quickly and if they
can identify at pre-investment due diligence, where they can add maximum value,
they can make a killing.

Increasingly, private-equity firms are identifying companies
where the scope to add value through outsourcing is large. Today, apart from the
traditional sourcing advisory, Tholons is into this area as well. The scope of
working together with private-equity firms is so high that the firm has formed
partnerships with two private-equity firms-RW Baird and FlatWorld Capital-for
helping them in deal-sourcing. Vashistha describes Tholons as "the
operational partners of the private-equity firms."

This is still a fairly new trend, and the jury is still out on
whether this experimentation will succeed.

Creating Born-global Companies

Making companies globalize from day one. In certain segments, most notably
high technology products space, it is fairly common today to see private-equity
firms-in their role as venture-capital investors-push companies to globalize
from day one. In startup ISVs space, for example, today most venture capitalists
make it clear that the companies do their development in India or Eastern Europe
to save cost.

While for venture capitalists, it means they can fund three to
four companies with the amount with which earlier they would have funded just
one, thus spreading risk, that means additional cost saving for the product
companies; faster time to market, because most of them choose suppliers rather
than doing it all by themselves. That also gives them access to world-class
development practice, because these firms work for Fortune 500 software
companies as well. This practice has become fairly established in the ISVs
space, and is now spreading to other knowledge-based industries.

An External Helping Hand

Providing outsourcing firms with management discipline. This is still an
isolated example. Of late, a few large outsourcing companies are roping in
private-equity firms to partner with when they create/acquire a new business
unit. HP's partnering with Blackstone Group is a case in point.

Even Infosys roped in Citicorp as a partner when it started
Progeon. Says Akshaya Bhargava, former CEO, Progeon "It was to provide
management discipline."

An informed, external investor provides a much-needed thrust to
a small business that may not receive management attention, when it requires
that most.

Just Flavor of the Season

Is the interest level in outsourcing by private-equity firms just because of
the hype around outsourcing? Far from it. One sure-shot way of measuring the
commitment is how many high-profile outsourcing industry professionals these
firms have been able to rope in.

Vivek Paul, former vice chairman, Wipro has been appointed by
the Texas Pacific Group. Michael Marks, the former CEO, Flextronics, is with KKR.
And to top it all, the biggest private-equity firm, Carlyle, which counts among
its partners and advisors one former president and one former prime minister, is
headed by Lou Gerstner, the former CEO of IBM, better remembered as the man who
turned the Big Blue from a pusher of big boxes to a new generation, nimble
services firm.

Can Gerstener do that with many of his firm's portfolio
companies? Can Paul acquire some hot targets and grow them the way he did with
Wipro?

We don't have the answers yet. But if they do it, they would
have "transformed" the outsourcing industry with that. No turnaround
and no rapid growth is possible without disruptive transformation. The
private-equity firms are in the best position to do that. They better not lose
this opportunity.

Shyamanuja Das

vadmail@cybermedia.co.in

Republished with permission from Global Services

(www.globalservicesmedia.com)