Corporate Valuation in Indian BPO Sector

In the arena of Mergers & Acquisitions there are two major considerations from the acquiring company’s viewpoint – fundamentals of the company being acquired and price of acquisition – where price is just an externality. The acquisition of overvalued companies is justifiable by reasons which are more strategic than financial in nature.

The good times for ITES valuation may be coming to an end. During the period 2000-01 the ITES sector has been enjoying high post-investment valuations. The post-investment valuation of some ITES companies like Spectramind, Daksh eServices and CustomerAsset have been to the tune of over two times the revenues.

Wipro had invested $10 million for a 24 percent stake in Spectramind while its revenue was around $20 million. Similarly ICICI bought over CustomerAsset for $19.5 million, twice the revenues of CustomerAsset. But, with increasing competition in this sector valuations would dip as compared to the initial stages. Amul Gogna, former Executive Director (ICRA) had said in a press release way back in 2002 that the up-trend of high levels of post-investment valuations in the ITES sector would last for another six to nine months. In line with ICRA, VCs like Infinity Ventures and Baring Private Equity Partners (I) Limited also believed that the high post money valuations of the ITES companies would not last long. A similar trend was observed in the software industry as well which peaked off with passing time.

Following Wipro’s acquisition of Spectramind at over 2.5 times forward revenue, deals were hinged around 1-1.5 times forward revenue, the only exception being IBM-Daksh deal which commanded a higher premium. Analysts and industry experts were not ready to accept this deal as a benchmark for future valuations in Indian BPO sector. Though the IBM deal further endorsed India as an offshore destination for outsourcing, it did not imply that valuations of BPO companies will move up. Susir Kumar, CEO (Intelenet) feels Indian companies will command a premium only if they have either reached scalability or have a niche expertise. According to him, "Strategic buyers like IBM will pay a premium but it can't be used as a benchmark for valuation of deals from a private equity investment point of view".

In 2007-08 there were further adjustments in valuations made by the private equity investors owing to the strengthening rupee against US$; on top of that there was a continuing concern for attrition in the BPO sector. Though there was feeling among the PE investors that the interest in the BPO sector still existed, the rising rupee had impacted their profitability. But, the valuations have changed. "The rising rupee and the sub-prime crisis will affect the mood of investors in a big way," said Raju Venkatraman, Joint MD and COO, Firstsource.

Valuations, at any given time, reflect the company's profitability and growth. Since there are not too many large players left and the predominant objective of PE investors had been higher scales, therefore there are not many choices left. According to industry estimates (2007) at least 10 of the top 15 third party BPO companies have received PE backing in one form or the other.

Around 65% of the Indian BPO companies are captive units whereas 35% are third-party. The industry outlook says that there would be more Management Buyouts (MBO) in the captive BPO segment as many large companies are exiting from their non-core businesses. The acquisition of Citi’s Indian BPO arm by TCS is an example of it. PE players also expect the tick size of MBOs to increase progressively.

(Contributed by: Financionomics, Guest columnist: Mr. Anirban Dutta)

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