An analysis of December 2008 quarter results of selected BPOs

The impact of the financial crisis spread across other business verticals as several economies went into recession with declining growth. In addition, the holiday season in the month of December, with fewer working days, affected the top line of the BPO companies. Some companies reported a qoq decline in revenues in constant currency terms. A 5% qoq rupee depreciation visà- vis the US dollar minimized the impact as companies earned more in rupee terms. Companies continued to focus on improving operational efficiencies, with most of them successfully reducing daily sales outstanding (DSO) through increased focus on accelerating collections.

Source: Yahoo Finance

Players underperform the broad index

Share prices of the companies continued their downward trend except for EXL and Genpact, which performed better than the index. The impact of the financial crisis spread to other sectors which are considered to be relatively defensive (for example healthcare). The companies continued to witness a slowdown in new business as financial companies looked for government support and clients deferred closure of new contracts. Some revival was seen in the last month as a few major banks in the US announced that their operations were profitable for the first time since the crisis began unfolding. Further, BPO companies are finding new ways of bringing in business by aligning their operations with customers to help them achieve cost benefits. However, given the current economic downturn we expect growth in top line to remain sluggish.

                                                                 Source: Company filings, ValueNotes Research

Firstsource (NSe: FSL)

• Revenues in constant currency terms declined marginally by 1.9% but increased by 4.5% in rupee terms as compared to the previous quarter. The rupee revenue increase was primarily on account of a favorable currency movement.
• FSL increased its headcount by ~3,000 (net additions) and commissioned four new facilities due to ramp ups by two customers. Increase in headcount caused employee cost to increase ~10% qoq. However, revenues from these capacity additions are expected to kick-in only in subsequent quarters. As a result, operating margins for FSL declined 617 basis points to 3.6% as compared to the previous quarter.
• The company maintains its revenue guidance of a 32% yoy growth. Based on this, revenue growth in the next quarter is expected to remain flat. FSL witnessed degrowth in the current quarter and given the global recession, we expect the growth to remain sluggish in the next two quarters.

WNS (NASDAQ: WNS)

• After a strong qoq top line growth of 21.8% during the September 2008 quarter (primarily due to the Aviva acquisition), revenues declined by 10.5% qoq in the December 2008 quarter. Volumes from the travel business as well as research and analytics reduced. WNS anticipates further volume decline in the subsequent quarter.
• Better operational efficiencies, savings in SG&A expenses and integration synergies on account of the Aviva acquisition, improved current quarter EBIT margins to 5.0% compared to 3.5% in the previous quarter. Better working capital management brought down DSO by 10 days to 42. Decline in the rupee against the dollar (over 70% of costs incurred in rupees) helped offset hedging losses. WNS expects margins to increase in the subsequent quarters as it continues to focus on improving operational efficiencies.
• The company added (net) 362 employees to end the quarter with a headcount of 21,328. Attrition reduced to 29% from 37% in the previous quarter. WNS claims that this is a result of the continued effort of providing longterm career opportunities and a learning work environment. The current job scenario has also contributed to the reduction in attrition. The company aims to achieve an attrition rate in the low to mid 20% range in subsequent quarters.
• WNS derives more than 70% of its revenues in British pounds (GBP). A sharp decline in GBP against the dollar caused the company to reduce its revenue guidance during the previous earnings call. Revenue guidance for FY2008-09 was reduced to $385m-$400m (based on a conversion rate of GBP1 = $1.45 to $1.60). However, the pound has depreciated further against the dollar to 1.36-1.45. At these levels, the company expects to achieve the lower end of its revenue guidance.

  EXL Service (NASDAQ: eXLS)

• Though revenues for the quarter declined 6.2% sequentially, they were better than the guidance of $41m (resulting in a decline of almost 12%). The decline was primarily on account of a UK-based telecom client who terminated their contract with effect from October 2008.
• The EBIT margins in the quarter improved to 4.5% as compared to negative margins of 2.9% in the previous quarter, primarily on account of lower foreign exchange losses. EXL incurred significant foreign exchange losses of $6.6m (of which $4.8m was one time in nature) in the previous quarter as compared to current quarter losses of only $3.4m. The company initiated a hedging strategy in the previous quarter, which helped it reduce its foreign exchange losses in the current quarter.
• If foreign exchange losses were excluded, current quarter margins of EXL, at 12.4%, improved by almost 100 basis points over the previous quarter. Better utilization of facilities and expansion in the Philippines (375 employees in the first full year of operations) helped EXL improve operational efficiencies, and in turn its margins.
• An uncertain economic environment and muted growth potential in its transformation business (contributes 24% to total revenues) caused EXL to reduce its revenue guidance for FY2009 to $170m-$175m, which indicates a 3% - 6% decline as compared to FY2008. The company expects to earn operating margins within the range of 10% to 12% in FY2009.

Genpact (NYSe: G)

• Revenue for the quarter increased 4% qoq. Revenue from Global Clients increased 5%, while those from GE increased 2%. On a yoy basis, revenue increased 26.4% to INR 1,040.8m. BPO’s share of total revenue increased to 80% from 76% a year ago. This was due to the non-discretionary nature of spending in BPO and continued tightening of IT spending which is discretionary in nature. The full year guidance for FY 2008 was in the range of $1035m-$1055m. The company achieved its guidance with $1041m in revenues during the year.
• Savings in SG&A expenses helped improve EBIT margins on a qoq basis by 364 basis points to 16.9%. SG&A as a percentage of total revenue declined by 688 basis points compared to the previous quarter. The company achieved this on account of reduced hiring and training costs due to low attrition rates, and increased productivity through streamlining systems and effective cost management.
• The revenue guidance for FY 2009 is a growth of 10- 15%, while operating income margins is estimated at 16%-17%. The growth in revenue will be primarily from BPO, while IT is expected to see maximum pressure with some project drop-offs. While most of the growth will come from non-GE customers, growth from GE will remain healthy at low to mid single digit. The growth rate in the first quarter is expected to be slower given the low visibility due to current environment and delayed sales cycle.

HoV Services (NSe: HoVS)

• Revenue growth in rupee terms was 3.9% qoq while revenue declined 8.1% in dollar terms. The increase in rupee terms is due to the depreciation of the rupee ($1 = INR 48.6 in the current quarter as compared to $1 = 44.0 in the previous quarter). Revenue decline in dollar terms was across all segments except telecom. BFSI witnessed the largest decline of 17%, while telecom increased 31.9%. This resulted in the share of revenue from telecom and healthcare to increase to 7.9% and 40.4% respectively, while the share of BFSI declined to 23.6%.
• Employee costs as a percentage to revenues was 49% during the quarter as compared to 47% in the previous quarter. As a result, operating margins contracted marginally by 47 basis points to 11.2%.
• The company plans to buy-back shares of INR50m at a price not exceeding INR50 per share through open market operations.
• As mentioned in the previous quarter report, the company’s full year revenue guidance is INR10,000m - INR10,500m. To reach even the lower end of its guidance, HOV will need to achieve a qoq revenue growth of ~38% during the March 2009 quarter. Given the sluggish qoq growth and uncertain market conditions, we are skeptical of the company achieving its guidance.

Valuations look attractive

The market capitalizations of BPO companies have eroded significantly over the past one year. At current prices, some stocks appear attractive. Valuations are expected to remain at current levels until the economies of sourcing nations begin to recover.

HOV is currently trading the cheapest of the lot, but skeptical growth amidst market uncertainties justifies the discounted valuation.

Although all the bad news has been factored in, given the uncertain environment, a further drop cannot be ruled out. We feel current price levels offer good buying opportunities for a long term investor.
Genpact has shown a consistent growth in its top line over the past quarters. Its margins are consistent and are also the highest amongst the companies. At current price levels, we believe that Genpact is the best stock pick amongst these companies.